Front Page Titles (by Subject) VII. The Technique of Credit Control - Studies in the Theory of International Trade
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VII. The Technique of Credit Control - Jacob Viner, Studies in the Theory of International Trade 
Studies in the Theory of International Trade (New York: Harper and Brothers, 1965).
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VII. The Technique of Credit Control
The Record of the Bank of England.—In appraising the record of the Bank of England during this period, allowance must be made for the lack of an adequate statistical account of the operations of the Bank and also for the absence of any serious attempt on the part of the Bank publicly to defend its record. It nevertheless appears to me that the evidence available warrants the verdict that during the period from about 1800 to about 1860 the Bank of England almost continuously displayed an inexcusable degree of incompetence or unwillingness to fulfill the requirements which could reasonably be demanded of a central bank. During the restriction of cash payments, it not only permitted the paper pound to depreciate, prices to rise, and the exchanges to fluctuate, but it repeatedly denied that there was any relationship between these phenomena and its own activities. William Ward relates that when he became a director of the Bank in 1817, he “could trace nothing directly that could fairly be said to constitute a plan or system” of credit management. It was not until 1827 that the Bank, upon Ward's motion, rescinded a resolution which it had solemnly adopted in 1819, which appeared to deny any connection between the volume of its note issues and the level of the foreign exchanges.1 The Bank even after 1827 apparently continued to be without any reasoned policy as to its discount rate, for Ward, in 1840, could still write:
I have often pressed on the Court the necessity of regarding the market rate of interest, but I generally found it an unwelcome subject. Low interest was said to encourage speculation; and on my enquiring the principle by which the rate should be governed, I was told in answer, to look to the practice of our forefathers.2
The growing authority of Horsley Palmer and G. W. Norman in the counsels of the Bank in the 1830's brought more enlightened pronouncements to the public, but does not appear to have improved the practice of the Bank. The adoption of the Palmer rule was a flagrant error, and the rule was repeatedly violated in such manner as to make things worse instead of better. The passage of the Act of 1844 by huge majorities was evidence of a general lack of confidence in the ability of the Bank properly to carry out its responsibilities to the public. When the Act of 1844 came into effect, the Bank at once proceeded to act as if the freedom from external control which the act left to the banking department had also rendered unnecessary any internal control. During this entire period, the management of the Bank showed an almost incomplete inability to profit not only from its own recent experience, and from the advice so freely offered to it by outsiders, much of it excellent, but even from “the practice of their forefathers” in the eighteenth century.3 The Bank then knew that there was a connection between their discount policy and their note issue, on the one hand, and the level of the foreign exchanges, on the other, and that a contraction of their discounts would operate to improve the exchanges and to check an external drain of gold. It recognized the difference between an internal drain due to impairment of confidence and an external drain due to a relative excess of note issue, and it was aware that different remedies were appropriate for the two cases: courageous extension of credit in the former and contraction of credit in the latter. Until the Bank was exempted in 1833 from some of the provisions of the Usury Acts, variations in the discount rate above 5 per cent were not available to it as an instrument of credit control, but it made use of informal rationing,4 of systematic borrowing from the market, and probably also of open-market operations, during the eighteenth century.
Variations in Discount Rate vs. Rationing.—From the beginning of the nineteenth century, writers had expressed regret that the Usury Laws prevented the Bank from substituting variations in the discount rate for rationing as an instrument of credit control.5 When in 1833 the Bank was exempted from the Usury Laws, in so far as its loans of three months' maturity or under were concerned, it was done with the approval of the Bank6 but apparently not at its request, and the Bank did not make systematic use of this new instrument until after 1844, and even then with a view too much to its own profit and not enough to its responsibilities as a central bank.7 The discovery by the Bank that the discount rate was an effective instrument of control seems to have surprised it,8 although dozens of writers had been scolding it for years for its failure to use it more extensively.
The arguments then used for the substitution of variations in the discount rate for rationing were that rationing was arbitrary and capricious in its mode of behavior, and that the fear to which it gave rise, that credit facilities in sufficient quantities would be unavailable on any terms in case of credit stringency, tended to promote panic. Formal rationing seems to have been practiced only at times of unusual credit strain. But even after the Bank had adopted variations in the discount rate as its chief instrument of control, it still upon occasion made use of rationing, in the form of shortening of the maturities of the paper which it would accept for discount, as a supplementary instrument of control.9
Open-Market Operations.—The present-day literature on banking commonly treats open-market operations, or the purchase and sale of securities by the Bank on its own initiative as a means of currency and credit control, as a recent development whether as idea or as practice.10 Given its legally and traditionally fixed rate of discount, there was for the Bank of England even during the eighteenth century no alternative to rationing of discounts except open-market selling operations and borrowing from the market when it wished for any reason to increase its bullion reserves. Since rationing meant refusal to its regular commercial customers of discount of what had hitherto been fully acceptable commercial paper, it was a drastic step which it could never readily have taken in the absence of emergency conditions. We know that during the Restriction period the Bank bought exchequer bills in the open market whenever it thought the circulation inadequate for the needs of the country but found no demand for additional discounts at the traditional rate.11 Ricardo regarded the volume of commercial discount business of the Bank as too small to serve as an adequate regulator of the volume of the currency, and he held that the conservative discount policy of the Bank made it necessary that it be in a position to use other means than increase in its commercial discounts to increase the amount of the currency, if this was to be maintained under a metallic standard at a sufficiently high level.12 He took it for granted that under a metallic standard open-market operations would be relied upon by the central bank whenever it desired to reinforce or to offset the effects of automatic gold movements.13 After the resumption of cash payments, open-market operations were without question the main instrument of credit control used by the Bank.14 It was reluctant to resort to the drastic step of formal rationing of discounts when it wished to contract its credit operations, and it had no means other that open-market operations of increasing the volume of outstanding bank credit when the demand for discounts at the traditional and legally the maximum permissible 5 per cent rate was insufficient either for credit control objectives or for its own income objectives. Under the Palmer rule, which called for the maintenance of the securities held by the Bank at a constant amount once the desired balance had been attained, the only scope for open-market operations would be to offset variations in the amount of commercial paper held by the Bank by counter-variations in the holdings of governments. The critics of the Palmer rule, when they insisted that “forcible operations upon the securities” would sometimes be necessary to check a drain of gold, or to make the note circulation expand to the same amount as did the gold reserves in case of an influx of gold, meant by such operations sales and purchases of government securities in the open market as well as contraction or expansion of commercial discounts. Norman, in fact testified in 1832 that, given the restrictions of the Usury Laws, open-market operations were the only practicable means of regulating the note issue,15 and Palmer, before the same committee, stated that if contraction was necessary the Bank would sell exchequer bills first, and would contract its discounts only as a last resort and only if the market rate of discount exceeded the legal maximum.16 It was common knowledge at the time that open-market operations were the main reliance of the Bank when it wished to act on the volume of its credits outstanding.17 Probably more important was the fact that prior to the passage of the Act of 1844 the Bank of England never lowered its commercial discount rate below 4 per cent, and after resumption of cash payments the market rate, except at crisis periods, was as a rule substantially lower than the Bank rate.18 The Bank, in consequence, lost most of its commercial discount business, and except at times of financial pressure what remained consisted largely of special accounts paying less than the nominal rate.19
There was little discussion, however, of the technique of open-market operations. One writer claimed that when the Bank wished to contract its note issue, the order of its operations was, first, to raise the discount rate, second, to sell government securities, and finally, if these did not suffice, resort to “putting on the screw” or rationing.20 It was pointed out that from the point of view of the Bank open-market operations suffered from the disadvantage that ordinarily it would be when securities were low in price that sales would be in order and when they were high that purchases would be made.21 During the crisis of 1847, the Bank, to escape the capital loss which would be involved in selling government stock, and to avoid arousing as much attention in the money market as would be involved in openly borrowing from the market, sold government securities for cash and at the same time bought an equal amount forward, thus in effect borrowing from the market.22 In 1875, and later, it appears to have resorted to analogous practices.
Internal and External Gold Drains.—The banking school regarded it as one of the defects of the Bank Act of 1844 that it failed to provide different treatment for an internal and an external drain on the Bank's gold, but in both cases aimed at forcing a corresponding contraction in the note circulation. They maintained that an internal drain due to mistrust called for an expansion instead of a contraction of credit.23 Palmer, in 1840, made a further distinction between external drains due to temporary causes which could be allowed to correct themselves and external drains due to a fundamental disequilibrium of price levels which could be corrected only by forcing down prices through contraction of credit:
I think the Bank are always called upon to look for the cause of the drain as far as they can form an opinion upon it when it commences, and to act upon the best opinion they can form of the occurrences then passing. There are two causes that will act upon the bullion of the country; one I take to be the deranged state of prices between this and other countries; the other, distinct payments which are to be made to foreign countries without any derangement of the general prices; if of the latter character, ... that payment being made, and the commerce of the country not being deranged, I believe the bullion and currency would gradually resume their former state. If, as in the year 1825, a great derangement of prices existed, then it would only be by an adjustment of those prices, with reference to foreign countries, that the drain of bullion would be stopped.24
J. S. Mill drew similar distinctions between internal drains, external drains which were self-corrective in character, and external drains which could be checked only by a change in relative price levels, and criticized the Act of 1844 on the ground that it forced the Bank to apply identical treatment to all three types of drains.25 He claimed that a mechanical rule for the regulation of note issue was objectionable because it would prevent different treatment of the different types of drains,26 and he held that there would ordinarily be no difficulty for the Bank in determining the character of a drain, as the cause of a drain was generally notorious.27
The distinction between external drains according to their causes is valid and important, but Mill exaggerated the ease with which they could be so distinguished in practice, especially in a period of scanty statistical data.28 A drain, moreover, which is distinctly of one type in its origin, may imperceptibly become a drain of another type, or may, by causing alarm, give rise to another type of drain as well.29
Mill was in error also when, following Tooke, he held that while prior to 1844, and also under a purely metallic currency, a drain would generally be met from the “hoards” of bankers and merchants, under the Act of 1844 it must necessarily come out of the circulation.30 A contemporary writer pointed out the ambiguous way in which Mill here used the term “circulation.” Mill's account of the manner in which the Act of 1844 must operate was correct only if by “circulation” he meant the “gross circulation” outside the issue department. But this gross circulation included the notes and bullion held by the banking department as well as whatever reserves of notes or bullion were held outside the Bank of England. These reserves outside the issue department, however, constituted “the identical hoards from which, as he so truly argues, when speaking of a [purely] metallic currency, nearly all drains must be taken.” Mill's criticism of the Act of 1844 would be valid therefore only if under it drains must come from the “active” or net circulation, which was not the case.31 The Bank, in other words, was still able, under the Act of 1844, to discriminate in its treatment between different kinds of drains, and to meet drains out of its reserves without contracting its “active” circulation when it thought it desirable, if it kept adequate reserves in its banking department. Mill, however, later admitted in effect that at least as far as external drains was concerned the Bank of England could still deal with them as it had had the power to do before 1844, if it retained in its banking department as large reserves as before 1844 had sufficed for the Bank as a whole.32
Adequate Reserves.—Gold reserves yield no income, and banks operating for profit tend to reduce them to the lowest level that seems consistent with safety. In countries with central banks, all other banks tend to rely upon the central bank to provide the bulk of the gold reserves for the system as a whole. The Bank of England was never legally charged with this responsibility, and its obligations to its shareholders, who during this period still held its stock primarily because they wanted dividends and not as a social duty or because prestige attached to being a “Bank proprietor,” necessarily loomed large in the minds of its directors. The other banks, on the other hand, behaved as if the Bank of England were a true central bank, with full responsibilities for looking after the gold reserves of the nation. When the Bank's charter was renewed in 1833, the government made a stiff financial bargain with the Bank, which reduced its earning power and made still more onerous for it the maintenance of any surplus reserves. The rapid growth of joint-stock banks in London further deprived the Bank of England of a large part of its commercial discount business, which had hitherto been the most remunerative form of employment of its funds. As a result of these circumstances, the English credit structure was marked, during the nineteenth century, by an extraordinarily low ratio of gold reserves to aggregate gross demand liabilities of the banking system. English banking statistics for this period are too meager to make possible an accurate determination of this ratio, but it seems that, disregarding the probably negligible amounts of coin and bullion held as reserves by the joint-stock and private banks, it fell at times to as low as 2 per cent and never between 1850 and 1890 exceeded 4 per cent.
From the late 1820's33 on to the end of the century a continuous succession of writers called attention to the inadequacy of the gold reserves, but without any visible results. One writer pointed out that the interest of the public in an adequate gold reserve was so great as to render the cost of its maintenance a matter of very minor importance from the national point of view. He took it for granted that the terms of the 1833 Bank Charter made the maintenance of an adequate reserve a greater burden for the Bank than it could bear. He therefore recommended that the Bank should be required to establish, at the expense of the government, an additional reserve, not to be encroached upon without a warrant from the Treasury.34 Richard Page saw that the ambiguous status of the Bank was a source of danger: “The double interests and duties of the Bank—as the proper institution for regulating the currency, and conducting a profitable banking business—are incompatible. The two things may often consist, but times will occur when they cannot be preserved together.” 35 He warned that the economy of the use of the precious metals had already been pushed too far, and that means should be found to restore the reserves to a satisfactory level:
A banker is now encouraged to keep but a small amount of specie by him; all his transactions resolve themselves into and are based upon ready money, and yet he is relieved of all labor and anxiety in procuring specie. The charge and responsibility of that obligation are taken from his shoulders, and put upon the Bank of England. The customers for gold in the market are therefore reduced to a single body; who, if the gold comes, take it in, but confess that they do not conceive it a part of their duty to go out of their way to obtain it. This is an evil. If every banker was obliged to market for himself, we should soon find our condition amended.36
Every recent improvement in banking has gone upon the principle that we should retain gold as a standard, but bring it forward as seldom as possible, and scarcely ever touch it. The perfection of the theory would be a refinement of the thing into nothing, a spiritualizing away of the reality, until gold and no gold became one and the same. Such improvers would make it “small by degrees, and beautifully less,” until it had vanished altogether, and ceased to exist otherwise than argumentatively.37
The Bank Act of 1844 made the gold in the issue department of the Bank unavailable for external payments, except as the banking department had a disposable reserve of notes which it could exchange for issue department gold.38 The crises of 1847 and 1857, and the necessity of suspending the act in these years, could in large part be attributed to the inadequate reserves against emergencies held by the Bank. There was no lack of advice to the Bank that its reserves needed strengthening, but such advice was frequently accompanied by the recommendation that the additional expense should be borne by the government, or by the large joint-stock banks.39 One especially forceful statement was as follows:
... we say with all the emphasis we can command, that the entire question of administering the monetary system of this country resolves itself into the magnitude of the bullion reserve of the Bank of England. The present system works badly, painfully, and dangerously, because it has at the bottom of it nothing more substantial than the five, six, or seven millions of reserve in the banking department. But let the reserve be raised to such a point that on the average of the year, or some more convenient period, it shall not be less than say fourteen millions, and the whole complexion of the case would be changed. A transmission of three or four millions of bullion goes a long way in these rapid days in adjusting even a large foreign balance; and even four millions taken out of fourteen is a very different measure, and leaves behind it a very different residue compared with four millions taken out of eight or nine. Moreover, it might be a by-law of the Bank Court that for any fall of half a million in the treasure below say twelve millions, the official rate should be raised a half per cent, or in some other proportion to be determined after due inquiry. It is pitiful and mean that a country like this, containing millions of people dependent on trade, cannot afford or manage to keep a bullion reserve so reasonably sufficient for the amount and uncertainties of the business carried on, that the arrival or departure of a few parcels of gold or silver produces commercial sunshine or storm.40
It has been said that Peel was aware that the metallic base of the currency was extraordinarily narrow, but did not think that either the Bank or the people would willingly bear the expense of broadening it.41 The contemporary literature throws little light on what the attitude of the Bank was toward this vital question. Testifying before the Parliamentary Committee of 1840, Palmer had in effect admitted that the Bank had not found the Rule of 1832 practicable. Asked to suggest a better procedure for the Bank, he replied: “I know of no other course which could be taken beyond holding a larger amount of bullion, but which I am not prepared to say the Bank could do, without means being devised to remunerate that establishment for the expenses and charges that would attend such a measure.” 42 G. W. Norman, on the other hand, denied that surplus gold reserves were desirable. If the Bank had surplus gold reserves, it would not need to contract its issues at the commencement of a drain. But “a foreign drain, however arising, would always diminish, pro tanto, a [purely] metallic currency,” and should therefore be made to operate likewise on a mixed currency. The lost gold could be recovered only by a proportional contraction of the issues, and this contraction would be less injurious if it came promptly than if it was delayed. Surplus reserves would make the regulation of the currency depend (in its timing?) “on the fancy or caprice of those who have to administer the currency; while I think that the contraction should be connected with a self-acting machinery, that it should be regulated simply by the state of the English currency, compared with that of the currencies of other countries as tested by the exchanges; in other words, that it should exactly conform to what would occur had we only metallic money.” 43
During this period discussion of the proper criterion of the adequacy of bullion reserves was generally in terms of the minimum absolute amounts of bullion which, in the light of past experience of external and internal drains, would afford full safety to the Bank. Treatment of the question in terms of the minimum safe ratio of bullion holdings to note circulation or to total demand liabilities of the Bank—or of the banking system—became common only toward the end of the century, and I have found only two contemporary discussions of the adequacy of reserves which were couched in terms of reserve ratios. One writer, while conceding that the Palmer rule did not call for maintenance of the bullion reserve ratio at one-third of the demand liabilities, claimed that the public had nevertheless so understood the rule, and insisted that it was a better rule than that of maintaining the security holdings constant.44 He proposed “that for the future the Bank of England govern her issues of notes (without reference at all to deposits) on the principle of holding one-third of gold against notes in circulation.” 45 Another writer, in the same year, recommended that instead of following the Palmer rule the Bank aim at maintaining a 50 per cent reserve against its note circulation. He apparently set the required reserve at so high a ratio because of his recognition that bullion could be drawn out of the Bank through its deposits as well as by presentation of notes and his belief that consideration should also be given to the existence of private bank note circulation dependent upon the Bank of England for its ultimate bullion reserve. He conceded that a 25 per cent reserve ratio would be adequate if the Bank followed the rule of withdrawing £4 in notes for each £1 loss in bullion. He called his proposal the “principle of proportion,” to distinguish it from “the principle hitherto assumed as the correct one, and which may be called the principle of diminution in equal amounts.” 46
The practice of extreme economy in the maintenance of bank reserves did have as an accidental by-product the beneficial effect that it guaranteed to the metallic standard world that as far as England was concerned there would be no hoarding of gold and that all gold reaching that country would quickly exercise an influence in the appropriate direction for international equilibrium on interest rates and the volume of bank credit. But it tended to intensify the growing tendency for instability of business conditions within England itself. Without willingness at times to maintain greater metallic reserves than were absolutely necessary to secure convertibility of the paper currency and without excess reserves which could be released during times of pressure as an alternative to credit contraction, there could be no “management” of a metallic standard currency in the interest of internal stabilization, and it is arguable that even the outside world had more to gain from greater internal stability in England than it would have had to lose by the occasional “sterilization” by the Bank of England of several million pounds of gold. While the English currency was undoubtedly even then a “managed” rather than a purely “automatic” one, the main objective of management appears to have been to achieve the maximum economy of reserves, i.e., the maximum banking profits, consistent with maintenance of convertibility. But the Bank of England was not set up as an eleemosynary institution, and during this period it probably could not have afforded to assume greater control responsibilities without financial guarantees from the government which could not be asked for without injury to its prestige and which would, moreover, probably not have been obtainable merely for the asking.
Foreign Securities as a Secondary Reserve.—In the hearings before the Committee of 1840, it was brought out that the Bank had given some consideration to the desirability of adopting the practice of holding foreign securities as a secondary reserve which would yield income while providing an emergency means of international payment. In reply to questions, Palmer and Norman agreed that foreign securities would serve equally with gold for this purpose, with the advantage over gold that they would earn interest while serving as a reserve. Palmer agreed also that the sale of foreign securities would be preferable to forced recourse to borrowing from foreign central banks as a means of checking an abnormal pressure on the gold reserves. Norman, however, thought that it would prove difficult in practice to find suitable foreign securities whose salability in the places with which the balances of payments were adverse could be relied upon, and Overstone was inclined to disapprove of the practice, on the ground that it would serve as an expedient to avoid resort to contraction of the note issue, which he regarded as the only sound method of dealing with an external drain of gold, and that it would tend to injure the credit of the Bank abroad.47
The discussion before the Committee of 1840 attracted some attention. James Ward claimed that the practice would prove highly profitable for the Bank of England—not only would foreign interest-bearing securities be substituted for bullion, but purchases of the securities would be made when the exchanges were favorable to England and sales when the exchanges were unfavorable, with an additional profit, therefore, on the turn of the exchanges. If the Banque de France should also adopt this practice, then “the joint operation would in fact be the same as if each country kept a banking account with the other to draw upon for the payment of any balances between them without the necessity of actually sending gold backwards and forwards for the purpose; and it must be evident that such an arrangement would very much diminish fluctuations in the rates of exchange.” 48
Robert Somers, writing in 1857, comments as follows on a suggestion made in a letter to the Times, recommending that mint certificates of deposit of bullion be used as a means of making international payments and thus of saving the cost of transport of the actual bullion:
The bullionists [i.e., the currency school] are so formal in adherence to their principle, that they would consider gold in the British mint a proper basis of money, though the right to it belonged to, and was doing service in, another country; but surely gold in another country, the right to which resides in this, must be a fully better security for British currency to rest upon. This is a distinction constantly overlooked under the Bank charter act. It is not the right of property in bullion, not the control over its movements and its possession, but the mere place where it may happen to be lodged, that forms the sole guide of the Bank in regulating the rate of discount. Though the whole stock of bullion in the Bank of England were in the power of a foreign capitalist, and could be removed any hour he chose, the Act would recognize it as a valid basis of paper money; but if British capitalists sent their gold temporarily to France or America, and held securities equivalent to such gold, these securities would pass for nothing.49
It is true that under the Act of 1844 the Bank could not have counted gold carmarked to its account abroad, or holdings by itself of foreign securities, to say nothing of private holdings of foreign securities, as part of its bullion reserve in the issue department. But there was nothing in the Act of 1844 to prevent the Bank from treating gold earmarked abroad or holdings by itself of foreign securities as part of its banking department reserves, or, in appraising its reserve position, from taking into account holdings by the British public of foreign securities and holdings by foreigners of British securities.
Silver as a Reserve Metal.—The Bank of England before 1844 bought and sold silver and always included its silver holdings at the market value in its returns of bullion held. In 1819 the Bank had opposed Baring's recommendation of a bimetallic standard on the ground that “silver bullion answered equally their purpose of checking an adverse state of exchange and a demand of their gold from abroad, as if it were converted into a current coin.” 50 The Bank in 1844 asked that it continue to be permitted to issue notes against silver and that it be permitted to count its silver holdings as part of its bullion reserves in the issue department. It claimed that foreign remittances could often be made more cheaply in silver than in gold, but that the variations in the market price of silver were too slight to compensate private concerns for holding it in stock, and were too slight also to compensate the Bank for holding it unless it could count it as part of its issue department reserve. The Act of 1844 gave the Bank the right to issue notes against silver not to exceed one-fourth of the gold held in the issue department, although the Bank had asked that this limit be set at not lower than one-third, and the Bank continued for a while to complain that the limit set by the act was too low.51
There is some evidence, however, that the attempt to operate a two-metal reserve under a monometallic standard had not been very successful. During the crisis of 1825, it apparently required the cooperation of the Banque de France to enable the Bank of England to exchange silver for gold.52 According to Baring, during the crisis of 1847 the Bank at one time had upward of £1,500,000 in silver, for which it was unable to get gold in exchange.53 In any case the Bank in 1850 ceased to issue against silver, except for a minor resumption of the practice in 1860–61, when, to help the Banque de France, it exchanged £2,000,000 of gold for silver on the basis of a repurchase agreement.54
Cooperation between Central Banks.—The Bank of England found itself forced, no doubt very reluctantly, to appeal to the aid of foreign money markets on a number of occasions. In 1836 the Bank of England, by arrangement with the Banque de France, drew bills of credit on Paris for over £400,000. This transaction was not publicly acknowledged until 1840. In 1838, while the Bank of England was under pressure, it arranged with the Governor of the Banque de France, who was in London at the time, for credit in Paris to be drawn upon if needed. In 1839, as the gold reserves of the Bank of England were approaching exhaustion, the Bank of England took advantage of this arrangement. As the Bank of England was not accustomed to draw on foreign countries, and the Banque de France made loans only on bills of exchange bearing French names or on French public securities, the transaction was carried out with the aid of intermediaries. Baring Brothers, on behalf of the Bank of England, drew bills on twelve Paris bankers to the extent of £2,000,000, which the Banque de France, in accordance with the arrangement, discounted for these bankers. At the same time similar credits established in Hamburg brought the Bank £900,000 additional gold.55 The necessity of resort to Paris for assistance, at a time, moreover, when relations with France were not too friendly, was regarded in England as rather humiliating, especially as it was reported that the followers of M. Thiers were boasting of the generosity of Frenchmen in coming to the assistance of the Bank of England when in difficulty while recommending that under no circumstances should such liberality be repeated in future.56
In 1847 the financial crisis and the shortage of gold were common to both London and Paris. By arrangement with the Banque de France, the Emperor of Russia and the Imperial Russian Bank bought from the Banque de France and other sources, with gold taken from the Russian reserves, Russian and foreign securities to the amount of £6,600,000, thus relieving the strain in the Paris and London money markets.57 It does not appear, however, that the Bank of England was a direct party to this transaction, and it, in fact, indirectly gave assistance to the Banque de France in that year. The Banque de France, after giving consideration to proposals that it should engage in openmarket sales of rentes in order to check the drain of gold which it was undergoing, decided not to, on the ground that such operations would reduce the circulation, but would not increase the metallic reserve. Instead, it raised its discount rate and engaged a banker to borrow 25,000,000 francs in London, on rente collateral, and used the proceeds to withdraw gold from the Bank of England.58
Cooperation between central banks in the management of metallic currencies was during this period exceptional rather than an established policy. On the contrary, it appears that ordinarily the central banks either paid little attention during this period to what was going on in other money markets, or else engaged in competitive increases of their discount rates and in raids on each other's reserves at a time of actual or anticipated credit stringency.59
There were only scattered references in the literature of this period to the need for international cooperation in credit management. Poulett Scrope, in 1830, found fault with the suppression of small notes by the Act of 1826, on the ground that it operated to cause a rise in the value of gold throughout the world and produced distress in the other great commercial nations as well as in England. He remarked that this international aspect had apparently failed to attract any attention, although “There have been times when a far less injury would have been resented by a declaration of war. But this fact is one only of many, showing how, in the close relations by which commerce knits nations together, each is interested in the welfare and good government of the other, almost, if not quite as much, as in her own.” 60 Several writers pointed out that the growth of commerce and the increasing international mobility of capital was bringing about a greater interdependence of the world's money markets, with the result that single-handed regulation of its metallic currency by any country was becoming increasingly difficult. Because of this trend William Blacker predicted that “monetary panics will year after year become more frequent and more severe as long as a metallic basis is preserved, which, with the aid of steam, conveys the monetary convulsion from country to country with a rapidity which, for all practical effect, may be compared to a metallic wire passing through the lands of all nations conveying the electric shock almost simultaneously to the most remote quarters of the globe.” 61 Another writer stressed the importance of the comparative rate of expansion of credit in different countries as affecting the severity and the area of monetary pressure which would follow. If the expansion was widespread, there would be a general scramble for gold when the pressure came.62
Cf. William Ward, On monetary derangements, 1840, pp. II ff., and his evidence in Report ... on the Bank of England charter, 1832, p. 143.
On monetary derangements, p. 13.
Two doctrines expounded in 1867 by Thomson Hankey, a former governor of the Bank of England, are of interest as revealing what views could still be held in Bank circles at that late date. First, he denied that the Bank of England had any responsibility to come to the assistance of the market in times of monetary pressure: “The more the conduct of the affairs of the Bank is made to assimilate to the conduct of every other well-managed bank in the United Kingdom, the better for the Bank and the better for the community at large.” (The principles of banking, 1867, pp. 18 ff.) This was, in effect, a denial that the Bank of England was a “central bank.” Second, he held “that the amount of ready money, or even to use the larger expression, of floating capital, in the country at any one moment is a fixed quantity; whatever part is taken or appropriated to the use of any one class, is so much abstracted from all others, or at least from some one of the others....” (Ibid., p.30.) This was in effect a denial of the power of the banking system to create or destroy means of payment. Not much could rightly be expected in the way of effective credit control from a central bank in which such views prevailed.
In at least one instance of credit pressure, it resorted to formal and systematic rationing. Cf. the Resolution of the Court of Directors, Dec. 31, 1795: “That in future, whenever the bills sent in for discount, shall on any day amount to a larger sum than it shall be resolved to discount on that day, a pro rata proportion of such bills in each parcel as are not otherwise objectionable, will be returned to the person sending in the same, without regard to the respectability of the party sending in the bills, or the solidity of the bills themselves. The same regulation will be observed as to [promissory?] notes.” Cited from The life of Abraham Newland, Esq., 1808, p. 39.
Cf. Henry Thornton, Paper credit, 1802, p. 287: Francis Horner, review of Thornton, Edinburgh review, I (1802), 195.)
Cf. Report from the Committee of Secrecy on the Bank of England charter, 1832, evidence of Mr. Palmer, pp. 16 ff.; Mr. Norman, p. 170.
Cf. the criticism of the Bank in this respect by the Lords Committee on commercial distress, 1848, Report, pp. xxxv-xxxviii.
Cf. the evidence of G. W. Norman, Report from the Select Committee on Bank acts, 1857, part I, p. 319: “We have found, contrary to what would have been anticipated, that the power we possess, and which we exercise, of raising the rate of discount leeps the demand upon us within manageable dimensions. There are other restrictions which are less important. The rate we charge for our discounts, we find, in general, is a sufficient check.”
Cf. the letter of T. M. Weguelin, Governor of the Bank of England, in Report from the Select Committee on Bank acts, 1857, part II, p.3
Cf. e.g., J.M. Keynes, A Treatise on Money, 1930, II, 170: “Those days [i.e., 1893–94] when ‘open-market’ policy had not been heard of.”
Cf. the testimony of Samuel Thornton, Report from the Secret [Commons] Committee on the expediency of the Bank resuming cash payments, 1819, p. 152.
Hansard, Parliamentary debates, Ist series, XL (May 24, 1819), 744.
“If the funds of the Commissioners become so ample as to leave them a surplus which might be advantageously disposed of, let them go into the market and purchase publicly Government securities with it. If, on the contrary, it should become necessary for them to contract their issues, without diminishing their stock of gold, let them sell their securities, in the same way, in the open market.” (Plan for the establishment of a national bank , Works, p. 507.) “If the circulation of London should be redundant, ... the remedy is also the same as that now in operation, viz. a reduction of circulation, which is brought about by a reduction of the paper circulation. That reduction may take place two ways; either by the sale of exchequer bills in the market, and the cancelling of the paper money which is obtained for them,—or by giving gold in exchange for the paper, cancelling the paper as before, and exporting the gold. The exporting of the gold will not be done by the Commissioners; that will be effected by the commercial operation of the merchants, who never fail to find gold the most profitable remittance when the paper money is redundant and excessive. If, on the contrary, the circulation of London were too low, there would be two ways of increasing it,—by the purchase of government securities in the market, and the creation of new paper money for the purpose; or by the importation and purchase, by the Commissioners, of gold bullion, for the purchase of which new paper money would be created. The importation would take place through commercial operations, as gold never fails to be a profitable article of import when the amount of currency is deficient.” (Ibid., p. 512. Italics not in original.)
The banking school tended to deny that purchase or sale of securities would have any effect on the volume of note circulation, on the ground that it would affect solely or mainly the volume of deposits. Cf. Fullarton, On the regulation of currencies, 2d ed., 1845; pp.96 ff.; James Ward, The true action of a purely metallic currency, 1848, p. 43.
“I certainly think that if the issues were to be regulated in one way or the other, I should much prefer exchequer bills. Under present circumstances, I consider it quite impossible, without at times doing immense mercantile mischief, to attempt to regulate them by discounts. The usury laws alone are quite decisive upon that point.” (Report ... on the Bank of England charter, 1832, p. 170)
Cf. the evidence of Overstone, ibid., p. 249; Richard Page, Banks and bankers, 1842, p. 231. Cf. also E. S. Cayley, Agricultural distress—silver standard, 1835, p. 42 (a reprint of a speech in the House of Commons): “Whenever the Bank (it is well known) wishes to enlarge its circulation, it buys up exchequer bills, sending out its notes in their place. On the other hand, when it wishes suddenly to diminish its circulation, it sells exchequer bills.” Cf. however, Henry Parnell, A plain statement of the power of the Bank of England, 2d ed., 1833, pp. 57–58: “When circumstances arise to make it necessary to lessen the amount of paper in circulation, the process by which it must be effected, is by issuing a less amount in accommodating trade; for when the price of the funds is greatly depressed, as is always the case when a large contraction of paper is indispensable, the Directors cannot sell exchequer bills, or other securities, without incurring an increase of loss ...”
Cf. A.H. Gibson, Bank rate; the banker's vade mecum, 1910, pp. 56–57. Palmer, however, had testified in 1832 that the Bank charged only 3 per cent to country banks for the discount of their bills (Report ... on the Bank of England charter, 1832, p. 33.), and it seems clear that a substantial fraction of the Bank's discounting was done at less than the regular rate whenever this exceeded the market rate. The Bank, on the other hand, had a number of ways of evading the legal maximum of 5 per cent. (Cf. The evidence, given by Lord Overstone before the ... committee ... of 1857, on Bank acts, 1858, pp. 104–05.)
Testifying in 1848, Governor James Morris of the Bank of England gave the following explanation of the reasons for the more extensive resort by the Bank after 1844 to variations in the discount rate: Previous to September, 1844, the minimum rate of discount charged by the Bank of England was for a long period not less than 4 per cent; the consequence was, that when money was abundant, and the current rate of interest below 4 per cent, the only means the Bank had of getting out its notes was by the purchase of securities; when the current rate of interest was high, a demand naturally arose for discount at the Bank, and the Bank was then obliged to resort to the sale of securities for the purpose of obtaining notes from the public to meet the demand. This practice of buying securities when money was abundant and the price high, and of selling securities when money was scarce and the price low, caused a loss to the Bank and incon[venience] in the money-market which it was desirable to avoid; it was also considered advantageous that a portion of the Bank's deposits should be constantly employed in the discount of bills, and constantly, therefore, under control. (Report from the [Commons] Secret Committee on commercial distress, 1848, Minutes of evidence, pp. 199–200.)
R. Cockburn, Remarks on prevailing errors respecting currency and banking, 1842, p. 16.
James Ward, The true action of a purely metallic currency, 1848, p. 39. David Salomons thought that the Bank made a mistake in ordinarily using exchequer bills instead of government stock in its open-market operations, as the latter would depreciate less under forced sale. He suggested, therefore, that the Bank arrange to borrow stock from the Savings Bank Commissioners when needed for open-market sales. (A defence of the joint-stock banks, 2d ed., 1837, pp. 34–35.) He fails to make clear why he thought that short-term securities would depreciate more during a crisis than long-term bonds, but apparently he believed that exchequer bills had a thinner market and that short-term rates rose more during a crisis than did long-term rates.
See R. G. Hawtrey, The art of central banking, 1932, p. 151, and the testimony of James Morris, Governor of the Bank, in Report from the Secret Committee [of the House of Commons] on the commercial distress, 1848, pp. 199–200.
In 1857, the Governor of the Bank, Weguelin, criticized the Act of 1844 on the same grounds. See his letter in Report from the Select Committee on bank acts, 1857, part II, pp. 1, 2.
Report from Select Committee on banks of issue, 1840, p. 138.
Principles of political economy , Ashley ed., p. 665; ibid., in Report from the Select Committee on bank acts, part I, 1857, p. 182. James Ward (The Bank of England justified in their present course, 1847, pp. 24 ff.) also claimed that the rule of contracting the circulation when a drain of gold occurred was properly applicable only when the drain was external and was due to international price disequilibrium. Fullarton in an elaborate discussion of drains containing much which is valuable argued that all drains were ultimately self-correcting, and that in the main the Bank of England had power to check a drain only after most of the damage had been done and the drain would in. any case soon have ceased. (On the regulation of currencies, 2d ed., 1845, pp. 136–73.)
Cf. also Lord Ashburton (Alexander Baring), The financial and commercial crisis considered, 4th ed., 1847, p. 15: External drains arise from different causes and therefore call for different treatment; “nothing can be more absurdly presumptuous than to substitute machinery in such a case for human intelligence.” Also John G. Hubbard (Baron Addington), The currency and the country, 1843, p. 19.
Report from the Select Committee on bank acts, part I, 1857, p. 189. Cf. Mill's memorandum to the French Enquéte, 1867, V, 591: Une banque dirigé par des hommes capables, dès que sa réserve commence à s'en aller, trouvera dans sa connaissance des antécédents commerciaux le moyen de reconnaitre les causes particuliers qui ont produit l'écoulement;elle saura si le numéraire tend à sortir en quantité indéfinie ou seulement en quantité définie.
Cf. William Fowler, The crisis of 1866: A financial essay, 1867, p. 44: The directors of the Bank, and other men of practical experience, do not agree with Mr. Mill as to the facility of distinguishing the causes of a drain of bullion.
Cf. I. C. Wright, Thoughts on the currency, 1841, p.11: “under our present system, a foreign drain is always likely to produce a domestic one.” Cf. Overstone, Letters of Mercator on the Bank charter act, 1855–57, pp. 54–55: “A drain of bullion may arise from the joint operation of several causes; indeed it is seldom otherwise. Who is to say how much of the drain arises from one cause, and how much from another cause? Such a distinction is utterly impracticable....A drain of bullion, whatever the cause of it, would produce a contraction of metallic money; it ought, therefore, to be met by a corresponding contraction of the paper money” [apparently because such was the purpose of the Act of 1844].
Principles, Ashley ed., p. 665.
William Hooley, “On the bullion reserve of the Bank of England,” Transactions Manchester Statistical Society, 1859–60, p. 85.
Principles, Ashley ed., p. 674. The relevant passage was not in the first edition, and Ashley omits to indicate the date of its first appearance.
Cf. Burgess, A letter to ... George Canning, 1826, pp. 110, 123; Tooke, History of prices, II (1838), 330–31, and his evidence in Report from Select Committee on banks of issue, 1840, pp. 355 ff.
R. Cockburn, Remarks on prevailing errors respecting currency and banking, 1842, pp. 57 ff.
Banks and bankers, 1842, p. 221.
Ibid., p. 308.
Ibid., p 400. Cf. also, Lord Ashburton (Alexander Baring), The financial and commercial crisis considered, 4th ed., 1847, p. 39, for a warning to the supporters of the gold standard to “consider whether the desire to refine too much on the absolute perfection of the standard may not endanger their having no standard at all, and leave them to lapse into the Birmingham mire of inconvertible rags.”
Cf. Richard Webster, Principles of monetary legislation, 1874, p. 123: An ample reserve of bullion is as necessary to the nation as is an ample storage of water to a city, but both should be provided, not simply to be looked at, but for use whenever the necessity arises....The very essence of the utility of a reserve lies in its being available; to lock it up is to completely ignore the very reason for its maintenance. Vary the conditions on which it may be used by putting up the rate of interest, if necessary, but do not practically prohibit its use, or you at once attack the confidence which it alone can preserve.
Cf. “Tristram Trye,” The incubus on commerce, 1847, pp. 8–9 (if necessary, the country should bear a portion of the cost of procuring and maintaining the needed increase in the stock of bullion); Adam Hodgson, Letter ... on the currency, 1848, pp. 14 ff. (there should be an extra reserve for emergencies, maintained at the public expense, to render unnecessary violent credit contractions); J. E. Cairnes, An examination into the principles of currency, 1854, pp. 73 ff.; J. S. Mill, in Report from the Committee on bank acts, 1857, part I, p. 178.
N. W., “The recent financial panic,” reprint from British quarterly review, July, 1866, pp. 15–16. For earlier suggestions that the discount rate should be made to vary with the amount of bullion reserves in accordance with a more-or-less definite plan, see Suggestions for the regulation of discount by the Bank of England, 1847, and Tooke's proposals of 1848, summarized in T. E. Gregory, An introduction to Tooke and Newmarch's A history of prices, 1928, pp. 102–03.
Adam Hodgson, Letter ... on the currency, 1848, p. 13.
Report from Select Committee on banks of issue, 1840, p. 136.
Letter to Charles Wood, Esq., M. P. on money, 1841, pp. 92 ff. Norman later stated that during the 1850's the excess of bankers' balances with the Bank of England above what they thought necessary plus the excess above these bankers' balances of the bullion reserves of the Bank of England over what it thought necessary together rarely exceeded £4,000,000, so that a comparatively small external drain of gold was sufficient to force a rise in the interest rate. (Papers on various subjects, 1869, pp. 105–07.) He now welcomed, however, the suggestion that the joint-stock banks should share with the Bank of England the burden of maintaining adequate gold reserves. (Ibid., p. 138.)
“A Merchant,” Observations on the crisis, 1836–37, 1837, pp. 5 ff.
Ibid., p. 13.
John Hall, A letter ... containing a new principle of currency, 1837, pp. 10 ff. I am indebted to Mrs. Marion J. Wadleigh for this reference.
Report from Select Committee on banks of issue, 1840, pp. 136, 159, 241.
James Ward, The true action of a purely metallic currency, 1848, p. 74. note. Cf. also J. W. Gilbart, “The Currency: Banking,” Westminster review, XXXV (1841), 126.
The errors of the banking acts of 1844–5, 1857, pp. 18–19.
Lord Ashburton (Alexander Baring), The financial and commercial crisis considered, 1847, p. 38.
Cf. Report from the [Lords] committee [on] the causes of the distress ... among the commercial classes, 1848, pp. xli ff.
See J. H. Clapham, An economic history of modern Britain, 1926, I, 282, and the sources there cited.
The financial and commercial crisis considered, p. 38.
Cf. The bullion business of the Bank of England, 1869, p. 20; Sir Felix Schuster, The Bank of England and the State (a lecture delivered in 1905), 1923, p. 34; Economist, XVIII (1860), 1301, 1357.
For these transactions see: A. Andréadès, History of the Bank of England, 2d ed., 1924, p. 268; Report from ... Committee on banks of issue, 1840, testimony of Mr. Horsley Palmer, pp. 130, 138; David Buchanan, Inquiry into the taxation and commercial policy of Great Britain, 1844, p. 295. During October, 1839, after £2,900,000 had thus been acquired abroad, the bullion holdings of the Bank amounted at one time to only £2,525,000.
The banker's circular for Nov. 19, 1841, as cited by William Leatham, Letters ... on the currency, 2d series, 1841, p. 12.
See The currency question, 2d ed., 1847(?), pp. 35–38, where the Russian decrees are reprinted in translation.
Cf. Horace Say, “La crise financière et la Banque de France,” Journal des économistes, XVI (1847), 200. It would be interesting to know whether the Banque de France consulted the Bank of England before engaging in this transaction, as it came at a most embarrassing time for the latter.
Cf. R. H. Patterson, “On the rate of interest ... during commercial and monetary crises,” Journal of the Royal Statistical Society, XXXIV (1871), 343. Cf. also Robert Somers, The errors of the banking acts of 1844–5, 1857, p. 95: “The manner in which the various commercial nations deal with the great mediums of exchange seems dictated by caprice rather than by any intelligent principle, and so far from adopting some general system in the interests of all, their monetary policy is conceived in hostility one to another.” Somers, however, had in mind the monetary standards, rather than the day-to-day monetary practices, of the different countries. Cf. also the later comment of Luzzati: “Aujourd'hui, ... les banque d'émission restent presque inaccessibles dans leur majesté solitaire, et ne communiquent qu'exceptionellement entre elles.” “Une conférence internationale pour la paix monétaire,” (Séances et traveaux de l'académic des sciences morales et politiques, new series LXIX (1908), 363–64.)
The currency question, 1830, pp. 32–33.
The evils inseparable from a mixed currency [Ist ed., 1839], 3d ed., 1847, pp. 128–29.
T. H. Williams, “Observations on money, credit, and panics,” Transactions of the Manchester Statistical Society, 1857–58, pp. 58–59.