Front Page Titles (by Subject) CHAP. VI - An Enquiry into the Nature and Effects of the Paper Credit of Great Britain
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CHAP. VI - Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain 
An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, edited and with an Introduction by F.A. Hayek (London: George Allen and Unwin, 1939).
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This works appears online with the permission of the Estate of F.A. Hayek. A further annotated version of Hayek’s introduction appears as a chapter in volume 3 of the Collected Works of F.A. Hayek (University of Chicago Press, 1991).
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Error of imagining that Gold can be provided at the Time of actual Distress—Reasons for not admitting the Presumption that the Directors of the Bank must have been to blame for not making beforehand a more adequate Provision.
The impracticability of encreasing the fund of gold in the Bank of England, when an alarm at home has already taken place, or even during the period of a very unfavourable balance of trade, has been manifested in the preceding pages.
There is a peculiar inconsistency in the supposition that a country ought, at such a season, to take its measures for encreasing the quantity of its gold. The argument for such an attempt would run thus—“The stock of gold has been in past time too low, as appears by the experience of the present period, for it is not now sufficient to supply what is necessary for our own circulation, and to enable us also to pay our unfavourable balance. We ought, therefore, to take due care that, in time to come, there shall be a larger provision of gold in the country.” So far, undoubtedly, there may be some general justice in the reasoning. But if the further inference is added, that we must, therefore, now begin to make the provision, this is to propose to take measures to provide against a want, which is future and contingent, at a time when that very want which we would prevent is actually pressing upon us. With as fair an appearance of justice it might have been argued in respect to the stock of corn in hand in the country—“The stock of corn has been, as now appears, for some time too low; for it is, at the present season, insufficient for the due supply of the country. We ought, therefore, to take care that, in time to come, there shall be a better provision for such contingencies as the present.” So far, undoubtedly, there might be justice in the observation. But to proceed in our reasoning as to corn, in the same manner as is sometimes done in respect to guineas, would be to add—“Therefore, now, while the scarcity is pressing upon us, let us begin to make this provision; let us instantly stock our granaries with a surplus quantity of corn; let us divert the little grain which we possess from those most necessary uses to which it is now destined. Let us encrease our present difficulty, in order that the country may be put, for the future, out of the reach of the danger which it is experiencing at the present hour.” The two cases are not, indeed, precisely parallel; but there seems to be sufficient resemblance to justify the elucidation.
There is, however, another ground on which the directors of the bank may possibly be thought censurable—that of having failed to supply themselves with a sufficient quantity of gold at an antecedent period. Let us, therefore, enquire whether the public has sufficient reasons for entertaining this suspicion.
Let it be premised, that, since the directors of the Bank of England can have no particular temptation to improvidence; and since our national bank is, from its very nature, liable to that accident which has lately, for the first time, befallen it, a liability which, for obvious reasons, it may have been the custom too studiously to conceal, there is not all that previous presumption of blame which might be supposed. There can be no doubt that the credit of the Bank of England has been, at all periods, most anxiously consulted by its directors; and that present profit has uniformly been only the second consideration.
There are, however, certain limits which, even when gold is most easily purchased, the bank naturally prescribed to itself in respect to its stock of that article. The amount of the disposable effects of the bank, on the 26th of February, 1797, was stated under three heads in a former place; and it was then observed, that the only part of them which the bank itself could enlarge was the deposits lodged in return for bank notes issued. But even the bank notes cannot safely be encreased in a degree which is very considerable. Indeed, experience has proved, that there may be some sort of limit to the demand for them; for the applications for loans have often amounted, during peace, to less than the bank has been disposed to afford on the credit of good bills at the existing rate of discount.
Let us, then, proceed to illustrate our subject by supposing the disposable effects of the bank to have usually stood, for some years antecedent to the suspension of its cash payments, at the sum of about nineteen millions; that is to say, let us allow them to have been about a million and a half more than they amounted to at that period.
It must not be imagined that these nineteen millions could, at any time, be with propriety invested in gold. For the Bank of England, like every other mercantile establishment, carries on its business on such principles as will produce a profit. And the very lowest profit which can serve as a sufficient inducement to pursue the trade of banking, must be somewhat higher than the mere current interest of money. Let us reckon this necessary profit of the bank to be six per cent. The bank makes no more than three per cent. interest on the capital subscribed by its members, which is permanently lent to the government. It must, then, so manage its disposable effects as to gain an annual sum equal to an additional three per cent. upon its own capital, that is, about 350,000l. This it must do by lending out at interest a part of the nineteen millions; and it must lend out, at interest, a still farther part of it, both in order to defray the annual charges of its establishment, and in order also to furnish the means of paying those occasional sums to government which are required as the price of the renewal of its charter. It will be found, perhaps, that not less than ten or twelve of the nineteen millions must be always at interest in order to provide for these objects; and, consequently, that eight or nine millions will have formed the highest average sum which the bank can have kept in gold, consistently with the acquisition of merely the necessary profit on its capital. But neither is it fair to suppose, that these eight or nine millions ought to have been the general or average sum kept in gold. The cash of the bank fluctuates very greatly; and in order to secure the keeping of cash and bullion to the average amount of eight or nine millions, it will occasionally have been necessary to keep twelve or fourteen millions, or possibly even more. This sum would be most unreasonably large; for, during the time when twelve or fourteen millions are invested in gold, the bank, instead of gaining six per cent. on its capital, will not gain above three or four; and, moreover, it cannot exactly know how long this extraordinary quantity of gold may continue in its coffers. It certainly can never count beforehand on those great reductions of cash which may serve, by increasing the sum at interest, to compensate for what is lost by a large detention of bullion: for the reduction of cash happens not through any measures taken by the bank, but in consequence of events difficult to be foreseen, and, as has been already shewn, by no means easy to be controlled. The bank, therefore, without impeachment of the character of its directors, may be reasonably presumed to have been at least somewhat indisposed to make investments in bullion, which, while they lasted, should reduce its income very far below the necessary annual profit.
Thus the bank, in endeavouring to secure what has been termed the necessary annual profit, would naturally be led to make, on the whole, something more than that profit; and, indeed, a variety of circumstances have lately occurred which have had a tendency to encrease its gains to a degree which must have been unexpected by the bank itself. Let us, then, suppose that the profits which the bank, considering all circumstances, may fairly and properly have derived from its business for some years past, may have been not six per cent. (which was spoken of as the lowest sum necessary for carrying on the trade of banking), but seven or eight per cent. Now seven or eight per cent. or a little more, seems likely to be that profit which the bank has, in point of fact, been gaining. The dividends which it has paid to the proprietors have been, for some time, seven per cent., and it has also added 3,800,000l to its capital. This addition has been accruing, no doubt, during a long course of years. If we assume that it has accumulated at the rate of about 116,000l. per annum, the bank will have gained annually one per cent. on its capital, besides the seven per cent. which has been divided; if at 232,000l* per annum, the bank will have gained annually two per cent on its capital, besides the seven per cent. which has been divided.
The bank, then, let it be supposed, has been gaining eight or nine per cent. when seven or eight per cent. is as much as it is reasonable that it should have acquired. I have entered into this detail, which, in various parts, may be somewhat erroneous, merely for the sake of shewing that any proposed enquiry whether the quantity of gold kept by the bank may or may not have been too small, must necessarily be much narrower than many persons may imagine. According to the supposition just made, it can relate only to the propriety of a past annual gain of about one per cent. or at most of two per cent. on the bank capital. A gain of one per cent. would have been about 116,000l. per annum; and consequently the bank, by taking this gain, have, on an average, kept a stock of gold which has been smaller than it would otherwise have possessed by about 2,300,000l. Whether this sum of 2,300,000l. or whether any sum somewhat greater than this, or somewhat short of it, ought or ought not, in time past, to have been invested in gold in addition to the sum which was invested, is a point on which all that it seems safe to affirm with confidence, is, that no person unacquainted with the affairs of the bank can be capable of pronouncing any clear judgement. There must have existed many arguments, and some standing even on the ground of safety and credit, against maintaining the additional fund which has been mentioned.
If the whole profits of the bank had been lately restricted to seven per cent., they would have been limited to that sum which the bank proprietors had been for some time in the habit of receiving. They would have been confined to a sum which would not easily have admitted of accumulations. By obtaining a higher profit the directors have secured to the proprietors the continuation of the same regular dividend, and have thus prevented that uncertainty which would have encouraged gambling in bank stock. They have also made, in the course of years, an important addition to their capital; an addition which has caused it to maintain nearly an uniform proportion to the growing extent of the transactions of the bank, and to the advancing commerce of the country, an addition also, by the help of which they have lately lent to government three millions without interest, for a short term of years, as the price of the renewal of their charter. They have thus strengthened that security which the creditors of the bank possess, so far as additional capital can strengthen it; and they will be able hereafter, if it shall seem necessary, to invest in gold, in addition to what they could otherwise have invested, a much larger sum than they could with any propriety have so invested in time past.
It must farther be borne in mind, that the necessity under which the bank has been placed of providing gold which is to fill the void occasioned by the disappearing of country bank notes, has been, in part, a new necessity, country bank notes not having circulated, at remoter periods, in so great a degree as they have lately; and that the additional sum of two or even of three or four millions would have been no security against the effects of a general alarm in the country. The fluctuation in the balance of trade with foreign countries, which we experience, is also become, in consequence of the greater extent of our population and commerce, larger than heretofore. The scale of all things having encreased, the scale of this balance may have encreased also to a degree unexpected by the bank. A war, moreover, unprecedented as that in which we have lately been engaged was not to be anticipated; and the case of a succession of two bad harvests, and of an importation of corn, amounting in two years to the value of fifteen or twenty millions, is felt by all to have been an extraordinary event. We need not wonder, then, if events unforeseen by others, were not foreseen by the Bank of England; nor if for unforeseen events an adequate provision was not at hand.
On the whole, it may be suggested to those who cast blame on the bank for its improvidence in time past, that they should consider well the several points which have here been briefly pointed out; and that if, afterwards, they continue to think the bank censurable, they should ask themselves, before they become the censurers, whether they are sure that, in taking upon themselves the office they exercise that candour with which they would expect to be judged if they had been themselves, during the late difficult and trying period, directors of that institution.
It has already been observed, that, in that crisis during which the conduct of the directors has been more particularly known, they proceeded, perhaps, with too great fear and caution rather than with too little. There seems, therefore, to be a presumption, that a character, if not for caution, at least for tolerable prudence, must have generally been their due. To say the least, there appears to be no ground for charging them with having acted in antecedent times on a directly opposite principle.
[* ]This is to suppose that the savings of the bank have been between sixteen and seventeen years in accumulating, a period certainly much too short; but the accumulation must have been more rapid during the last years.