CHAPTER IX.
Banks and the Creation of Credit.
We have seen how the Bank of England came to occupy so commanding a position in the money market, and we now have to consider why its rate of discount is still a fairly reliable index to the value of loanable capital. Its advent was extremely distasteful to the private bankers, who then reigned supreme in London, and who were not slow to recognise in the new corporation a formidable competitor, for a company which financed the Government was obviously to be feared. Before 1826 the Bank of England was the only joint stock bank in the country. Its notes gradually drove those of the London bankers out of circulation, and until its joint stock rivals firmly established themselves in the Metropolis, the Bank was in every sense the most powerful institution of its kind in the land.
Being by far the largest lender of capital in the country, it was only natural that its rate should accurately interpret those forces which make loanable capital dear or cheap, as the case may be. But the Bank could not arbitrarily fix the value of money for a very considerable period, even when it was able to issue notes without let or hindrance, any more than it can now. Supply and demand must settle that ultimately; and whenever the Bank inflated prices by the over-issue of paper, we have seen that the reaction produced thereby invariably threatened its existence. This is easily explained.
Persons borrow money in order that they may trade with it; and sudden loans of large amounts of capital in the shape of notes immediately stimulate the markets, and the increased demand engendered thereby causes the prices of commodities to rise. Rising prices, whether of securities or goods, give a marked impetus to speculation—so hopeful are traders directly markets begin to improve; and increased speculation causes further rises in the prices of both commodities and loanable capital. Everybody wants to borrow, and to share, in the coming period of great prosperity.
With prices rising here, imports naturally increase, as foreigners are anxious to sell their goods in the best market. On the other hand, the English markets have become less profitable to buyers, and, consequently, exports fall off, the result being that the balance of our indebtedness to other nations is largely increased. The foreign exchanges soon begin to move against England, and the Bank of England (we will assume) which had created the speculation by large issues of notes, suddenly finds that it is threatened with a foreign drain of gold, and is compelled to raise its rate in order to protect its reserve.