Now we come to the creation of credit by the Bank of England in its own books. Were the Bank to suddenly lend £3,000,000, the "Other Deposits" would be up to that extent, and "Other Securities" would also be up to a like amount, because the Bank would credit its customers and debit the loans. Both sides of its return are increased, but, so far, credit has not been created by these mere book entries, though the way for its creation has been prepared. The customers or persons to whom the advances have been made begin to draw upon their accounts by cheques, and as these cheques are returned by the other bankers to the credit of their accounts (bankers' balances) it follows that "Other Deposits" are not reduced at the Bank. The Bank, then, has created £3,000,000 of credit in its books, and though it can no longer make sudden loans by a huge issue of notes as was possible prior to 1844, yet, because it holds the bankers' balances, we can see that it is able to produce precisely the same effect by means of another instrument.
If the Bank lends £3,000,000 to the Government, "Public Deposits" and "Government Securities" advance proportionately. When the Government begins to pay out, then a large part of this sum returns to "Bankers' Balances," and credit is created at the Bank of England to the extent of the sum so returned. But the banks (Lombard Street) have more to lend; therefore money is made artificially cheap.
On the other hand, the Government sometimes borrows in the open market on Treasury bills. Credit is then transferred at the Bank through the medium of the Clearing House from "Bankers' Balances" to "Public Deposits." The resources of Lombard Street are reduced, and until Government disbursements are made, and credit thereby transferred to Lombard Street, money becomes tight, and borrowers are often driven to the Bank.
We have seen that in the end an over-issue of notes is certain to reduce the Bank's reserve to a dangerously low level, and that, therefore, directors who know their business would hesitate to make so risky an experiment. The same argument is equally applicable to the creation of credit by sudden large loans on the part of the Bank in its own books. Such loans, we have seen, increase both sides of the return; but the Bank's reserve of notes and coin in the Banking Department remains at the same figures, consequently, its ratio per cent. to liabilities shows an ominous decline, which is, of itself, a warning that something is wrong.
Let us assume that the Bank suddenly lends £5,000,000. Money is thereby made artificially cheap, and the market rate for bills must fall in consequence. But the bankers' balances have been increased in the books of the Bank of England, and Lombard Street is not going to quietly look on while Threadneedle Street does all the business. Consequently, the bankers lend a portion of their balances at lower rates still, in order to attract business to themselves, and the market rate falls again. Here we have a situation analogous to that described in the earlier part of this chapter.
Now suppose this movement took place in October, and that a drain of gold occurred outwards. The Bank, in order to arrest the said drain, would have to raise its rate, and to bring the market rate in touch with its own it would be compelled to sell Consols, thereby reducing the bankers' balances in its books, and, of course, lessening the power of the banks to lend. But such a process is an expensive one, for the Bank is in reality borrowing back at panic prices the capital it created during a time of temporary ease.
Although the Bank undoubtedly possesses this power, the directors are not likely to abuse it, because the risk incurred is out of all proportion to the possible gain if the deal is carried through successfully; so we may say that their power to create credit in their books is limited or regulated by the ratio per cent. of the Bank's reserve to its liabilities.
Of course, it may be asked: Is it safe to entrust such power to a board of directors who have to earn dividends for a body of stockholders?
That is a difficult question to answer, and one, moreover, to which there is no occasion to reply in this work. It may safely be said that no director who understands his business would take the risk upon any consideration; but there is the remote chance that an incompetent Governor might be placed at the helm, and in that event, however improbable, should he lose sight of everything but the dividends, he might create a terrible panic throughout the land. On the other hand, all who see the Bank return from week to week may read the signs, and should the ratio fall abnormally low the critics would flagellate the Governor unmercifully, and the business man, who is unaccustomed to the pleasantries of criticism, unless he be a most hardened member of his species, squirms under such a lash, fearful that his friends may read just what the Press thinks of him; so he takes heed.