War-Time Financial Problems

by Hartley Withers

1. One bank of issue and 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 issued are controlled by a fixed ratio of gold to notes or of the cash balance to notes.

4. This fixed ratio may be lowered by the payment of a tax.

5. The notes should not exceed three times the gold or the cash balance.

As will be remembered, the Cunliffe Committee recommended that the division of the Bank of England into an Issue Department and a Banking Department, should be retained; that the old principle by which above a certain fixed limit all notes should be backed by gold, should also be retained, but that if at any time a breach of this rule should be found necessary it should be possible, with the consent of the Treasury, and that Bank rate "should be raised to a rate sufficiently high to secure the earliest possible retirement of the excess issue." Since it was formerly only possible to exceed the limit on the fiduciary issue by a breach of the law, under the Chancellor of the Exchequer's promise to get an indemnity for it from Parliament, and since Treasury tradition insisted on a 10 per cent. Bank rate whenever such a breach was permitted or contemplated, it will be seen that the Cunliffe Committee proposed some considerable modifications in our system and hardly justified Sir Edward's assertion that it "proposed that the Bank should continue to work under the Act of 1844 as heretofore."

At first sight there seems to be a good deal of difference between Sir Edward's ideal and Lord Cunliffe's, but is not the difference to a great extent superficial? Whether the Bank be divided into two departments, each presenting a separate account, or its whole business be regarded as one and stated in one account, seems to be rather a trifling question. And the arguments put forward for their several views by the two champions are not strikingly convincing. Sir Edward wants only one account, because he thinks the consequence would be a stronger reserve and fewer changes in bank rate. But a mere change of bookkeeping such as the amalgamation of the two accounts would not make a half-pennyworth of difference to the extent of the Bank's responsibilities and its ability to meet them, and it is on variations in these factors that movements in bank rate are in most cases decided. On the other hand, Lord Cunliffe and his colleagues argue that the main effect of putting the two departments into one 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. On this point Sir Edward's answer is telling: "In reply to this statement, I say that the depositors at the present time can always get gold by drawing out notes from the reserve and taking gold from the Issue Department. There seems to be little difference between the depositors attacking gold direct and attacking the gold through the notes in the reserve. If the Bank cannot pay the notes when demanded the whole machinery stops." Quite so. The notion that the holder of a Bank of England note has now a stronger hold over the Bank's gold than the depositor seems to be baseless. He can exercise his hold more quickly perhaps, though even this is doubtful. Since banknotes are not legal tender at the Bank of England, it is not quite clear that the depositor would even have to take the trouble to go first to the Banking Department for notes and then to the Issue Department for gold. He might be able to insist on gold in immediate payment of his deposit. Still less convincing is the Committee's argument that "the amalgamation of the two departments would inevitably lead in the end to State control of the creation of banking credit generally." Their report might have explained why this should be so, for to the ordinary mind the chain of consequence is not apparent. On the whole it is hard to see much good or harm to be achieved by changing the form of the Bank return. It might make the Bank's position look stronger, but it could not make it really stronger. Nor would it really impair the strength of the note-holder's position as against the depositor, because even now there is no essential difference. It would substitute a more businesslike and simple statement for a form of accounts which is cumbrous and stupid and Early Victorian—a relic of an age which produced the crinoline, the Crystal Palace and the Albert Memorial. On the other hand, to alter a statistical record merely for the sake of simplicity and symmetry is questionable. Unless we are getting more and truer information, it is a pity to make comparisons between one year and another difficult by changing the form in which figures are given.

A more essential difference between the two policies lies in Sir Edward's advocacy of a ratio—three to one—between notes and gold, and the Committee's support of the old fixed line system. By the latter, if gold comes in, notes to the same extent can be created, and if gold goes out notes to the amount of the export have to be cancelled. Under Sir Edward's policy the influx and efflux of gold would have an effect on the note issue which would be three times the amount of the gold that came in or went out. This at least is the logical effect of his statement that "the notes should not exceed three times the gold or the cash balance." This law does not seem to be quite consistent with his view that the fixed ratio of gold to notes may be lowered by the payment of a tax; but presumably the tax would come into operation before the three to one part was reached, and at three to one there would be a firm line drawn. On this assumption the Committee's argument is a very strong one. "If," says its report (Cd. 9182, p. 8), "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 limitation of the Act of 1844." Certainly if, during a foreign drain, for every million of gold that went out, another two millions of credit, over and above, had to be cancelled, it is easy to imagine a very jumpy state of mind in Lombard Street and on the Stock Exchange. Sir Edward and the Committee seem to be agreed as to a limit on the note issue, but of the two limiting systems the old one advocated by the Committee, though apparently more severe, would seem to have much less alarming possibilities behind it.

A point on which the commercial world does not seem to have made up its mind, however, is whether there should be a limit at all. Under the old Act there was a limit which could only be passed by a breach of the law. Under the Cunliffe proposal the limit could be passed with the consent of the Treasury. Sir Edward has not told us of what machinery he proposes for the passing of the limit which he lays down; but in view of the great apprehension that an approach to the limit point would, as shown by the Committee, produce, it is clear that there would have to be a way round. In Germany there is no limit; you pay a tax on the excess issue and go on merrily. In America it would seem that the German system has been taken for a model. In his speech on January 29th Sir Edward quoted Senator Robert Owen, who was the principal pioneer of the Federal Reserve Bill through the Senate, as follows:—"The central idea of the system is elastic currency issued against commercial paper and gold, expanding and contracting according to the needs of commerce…. It is of great importance that the volume of these notes should contract when the commerce of the country does not require the notes to be circulation, and the reserve board can require them to be returned by imposing a tax upon the issue…. Under the reserve system a financial panic is impossible. People will not hoard currency nor hoard gold when they know that they can get currency or get gold when required…. America no longer believes a financial panic possible, and therefore the business men, being perfectly assured as to the stability of credits, do not hesitate to enter manufacturing and commercial enterprises from which they would be deterred under old conditions of unstable credit." Well, let us hope the Senator is right and that America is right in believing that a financial panic is no longer possible there. But one cannot help feeling that such a belief may be rather dangerous in the minds of people so ready to take rose-coloured views as our American cousins. The Federal Reserve system has worked beautifully in a period in which American finance has had nothing to do but rake in the enormous profits of American production at the expense of warring Europe and lend part of them, to be spent in America, to the Allied belligerents. It may work equally well if and when the problem to be faced is different, but it will be interesting to see—for those of us who live to see—what sort of a tax will be needed to "require" America, in one of its holiday moods, to return currency that it thinks it needs and the Federal Reserve Board regards as redundant.

Another point on which Sir Edward lays great stress, in his attack on the Bank Act of 1844 and the Committee which supports its main principles, is the beauty of the bill of exchange as backing for a note issue, as opposed to Government securities. "There is," he says, "no automatic system for the redemption of currency notes as would be the case if they were issued against bills of exchange, which in due course would have to be paid off." Again, "it seems to me that notes should not be issued against Government securities which may or may not be paid off, but against bills of exchange which must be met at due date." This advantage about a bill of exchange is a very real one to the individual holder who can always put himself in funds by letting the contents of his portfolio "run off"; but is there much in it as a safeguard against excessive issue of currency in times of exuberance? In such times bills that fall due are pretty sure to be replaced by new ones drawn against fresh production—since over-production is a common symptom of commercial exuberance—or against a resale of the goods on which the original bills were based. As long as anyone who can show produce can be certain to get credit and currency, the notion that the maturing of bills of exchange can be relied to restrict currency expansion within safe limits is surely a dangerous assumption. The principle of a fixed limit, to be broken in case of real need, but only after some ceremony has been gone through giving notice of the fact that a crisis has been reached, seems rather to be required by the psychology of speculative mankind. But even if Sir Edward's preference for bills of exchange as backing for notes has all the merits that he claims that is no reason for urging the repeal of the Bank Act to secure their use. Because the Bank Act does not forbid it: it merely says, "there shall be transferred, appropriated and set apart by the said governor and company to the Issue Department of the Bank of England securities to the value of," etc. It is the practice of the Bank to put Government securities into the Issue Department, but the terms of the Act do not compel them to do so, and if an excess issue were needed they would seem to be empowered to put any bills that they discounted into the assets held against the note issue. On the whole the terms of the Act leaving them freedom in the matter, except with regard to the "Government debt" of £11 millions, which is specially mentioned as to be transferred to the Issue Department, seem to be preferable to a special stipulation in favour of bills of exchange.