Part 5

Now in this most important particular the superiority of our proposed measures over the present system must be at once apparent. It is unquestionable that the Bank of England could never have been induced to force its notes upon the money market, at so low a rate of interest as 1¾ and 2 per cent. if it had not been allowed the privilege of issuing, for the purpose of loans, at no expense to itself. If a certain rate of interest had been charged upon the issue of all its unrepresented notes, that rate would have sufficed to prevent its loaning or discounting on such terms. And, supposing 1¾ per cent. to be the lowest rate at which the Directors might consider it profitable to advance money to the public, when the notes were perfectly free of charge, it is only a legitimate conclusion, that if a certain rate should be imposed on the issue of the notes, they would then be restrained from making advances on lower terms than the sum of that rate, added to the 1¾ per cent. supposed to be the present minimum. Now, the rate we have proposed to be levied on the first £11,000,000 of the unrepresented issues, being 1 per cent., there is no probability, according to this principle, that they would ever make loans on securities at a lower rate than 2¾, or discount lower than 3 per cent. In practise, indeed, it is not likely that they would ever descend so low as this, as it is highly improbable that the unrepresented issues would not at all times exceed £11,000,000, and, in that case, the imposition of the 2 per cent. upon the notes in excess of the first £11,000,000, would inevitably keep the rates of interest and discount about 1 per cent. higher than if the issues were ever to consist entirely of notes that would be subject to no higher charge than 1 per cent. On our plan, therefore, there appears no probability that the Bank rate of discount would ever fall, for any considerable period, below 3½ to 4 per cent. And, if this be correct, then whatever evils are admitted to arise from the encouragement of undue speculation, and the ultimate aggravation of a drain of the precious metals, through the low rate of discount at times adopted by the Bank of England, it must be conceded that our scheme of currency possesses this one advantage in addition to those already described, that it would, in very great measure, provide an adequate safeguard against such aggravation.

So far with respect to the operation of the present system in augmenting the evils arising out of an excess of circulating medium, together with our provision for preventing that augmentation. We have still to justify our assertion that the present system also aggravates the evils arising out of a deficiency of circulating medium, and that our proposed system provides a remedy for this as well as the former evil. And here the subject will demand a greater degree of amplification. For a deficiency of circulating medium may arise out of several different causes, each of which will require a special consideration. To treat of them generally, in the first place, they may be disposed of under two cases, the one proceeding from an actual drain of the precious metals, the other arising out of the hoarding of currency by merchants and bankers, through the dread of monetary pressure. In point of fact, these two cases are not always kept distinct; indeed the former is not unfrequently accompanied by the latter. But it will be more convenient to treat of them separately, and to dispose of the latter before proceeding with the former.

The principal instance of a domestic drain, that is of a scarcity of money produced by domestic hoarding, which has occurred in recent years, was that which took place in October, 1847. In this case, as is well known, there was no actual deficiency of currency in the country at the moment of pressure. There was no unfavourable exchange; on the contrary, gold was steadily returning after the drain of the previous twelve months. The apparent deficiency, therefore, as compared with the pressure of the preceding April, originated solely in the accumulation of currency by the merchants and bankers. And this accumulation is admitted to have been caused exclusively by the knowledge that the Bank of England was rapidly drawing towards the end of its resources, under the law that limits the unrepresented issues to £14,000,000; and the truth of this is clearly demonstrated by the fact, that the temporary suspension of the Act of 1844, at once removed the panic without requiring the issue of a single note beyond the statutable limitation. Now, we contend that our provision for allowing the Bank of England to issue unrepresented notes, beyond the £22,000,000 at present allowed to be issued by the whole united banks of England and Wales, subject to the charge of 4 per cent., would entirely preclude the possible recurrence of any similar panic. For it was not the rate of interest at which the Bank had been discounting in the previous months that produced the alarm, but solely the knowledge that the reserve of unrepresented notes was nearly exhausted, and that the provisions of the Act prohibited the extension of that reserve, no matter what rate of interest might be offered by the public for increased accommodation. The certainty, therefore, that whenever the rate of interest should materially exceed 4 per cent., the Bank would be placed in a position to afford any further accommodation that might be required by the public, would effectually prevent the recurrence of any apprehension as to the possible exhaustion of the Bank’s available resources.

We will now proceed to the case in which the deficiency of currency is produced by an actual drain of the precious metals. Such a drain may obviously arise from a variety of causes too numerous to specify. But there are three cases which are not only in themselves the most important, but which also serve as fair representatives of the remainder. These three are, first, a drain arising out of general high prices at home, originally produced by an excess of currency and great overtrading; secondly, the exportation of gold to pay for some staple article of food or manufacture, caused by the deficient supply of such article at home; and thirdly, the maintenance of a large military expenditure abroad during time of war. The first of these was the main cause of the crisis of 1825; the second was the chief, but not the exclusive, agent in producing the pressure of April, 1847; the third is now in operation, and should the war prove of long continuance, may possibly subject the present system to as severe a test as that of October, 1847, provided the Act should not in the mean time undergo amendment.

To take the case of a drain produced by over speculation first. We have already seen that one operation of the present currency system is, either directly to produce a drain whenever money is redundant, or else materially to aggravate it if produced by other agencies. We have now to consider the effect of another part of the same system, which comes into operation when the drain has taken place, and money is deficient. It is a generally admitted principle, that in such a case as this, in which the drain has been occasioned by a low rate of interest and high prices, there is nothing but a rise in the rate of interest, and a fall in prices, that can remedy the evil and recover the exported treasure. But it by no means follows that prices must necessarily fall as much below, as they had previously risen above their average, or that the rate of interest must rise as much above, as it had previously fallen below its average; as, in this case, the evil produced would be fully equal to that which it was designed to cure. For it must be remembered that the exported treasure will, in its turn, produce an excess of currency in the countries which receive it; and that that excess will necessarily lead to a rise in prices and a fall in the rate of interest, precisely commensurate with the amount received. It will not be necessary, therefore, that prices should fall much below the average at home, in order to stimulate an increased export of commodities to those countries in which prices have risen; nor that the rate of interest should much exceed the average, in order to encourage the purchase of our securities on account of the same countries; both of which operations will have the effect of recovering the treasure. But secondly, there is no necessity for our regaining the gold as rapidly as we have previously parted with it; as the less violent is the reaction, the less severe are the concomitant evils. And thirdly, if indeed it should not have taken the first place, it has been repeatedly proved to demonstration, that a rapid fall in prices, instead of stimulating exportation, has the inevitable effect of paralyzing industry, and thereby retarding the production of those very commodities of which a more than ordinary quantity is required. Now, in each of these respects, the effect of the present system is to aggravate the severity of the reaction in every case in which the reserve of unrepresented notes in the Bank of England, is not at the very highest point when the drain begins to operate. For, supposing the gold exported considerably to exceed the amount of this reserve, which is invariably the case in every extensive drain which commences while the reserve is either at or below its ordinary average, the amount of circulating medium in the hands of the public must contract, at least by the difference between the amount of the available reserve and that of the exported treasure. Now this contraction in itself would alone suffice to cause a serious fall in general prices, and could hardly fail to put a sensible check upon the operations of productive industry. But long before the contraction would have reached its climax, and indeed before the available reserve of the Bank would have been exhausted, the Bank would be compelled, in self defence, to raise the rate of discount so high as completely to arrest the demand for increased accommodation consequent on the drain. In addition, therefore, to the contraction in the amount of circulating medium operating directly upon prices, we have a rapid and excessive rise in the rate of interest, proceeding step by step with that contraction, till, ultimately, as the Bank reserve approaches to the verge of exhaustion, a state of general discredit arises; the hoarding of currency at once ensues, a still more ruinous decline in prices is the consequence, and nothing but the suspension of the Act can avert the spread of universal panic.

But, secondly, a drain may be produced by the failure of some staple article of food or manufacture, and the consequent importation of an adequate substitute. The most calamitous case of this kind which has occurred in recent times, was the general failure of the potato crop in 1846, which necessitated the transmission of more than £8,000,000 of treasure in payment for bread-stuffs, chiefly to America. In this and similar cases the efflux of gold is not produced by any excess of circulating medium, with its attendant rise in prices and fall in the rate of interest; the recovery of the gold, therefore, should be effected with the smallest possible diminution of currency, reduction of prices, or enhancement of the rate of interest, and any unnecessary aggravation of either of these is a perfectly gratuitous evil. Yet here, as in the previous case, the provisions of the Act of 1844 require that the circulating medium should contract, at least by the difference between the amount of the available reserve and that of the exported gold. For example, should the drain commence when the available reserve should amount to only £4,000,000, which is about the average, and should it extend to six, eight, or even ten millions, the amount of the circulating medium must inevitably contract, at the very least by two, four, or six millions. And yet, there can be little doubt that in such a case as this, a contraction of one or two millions would be amply sufficient for the recovery of the treasure.

But the remaining case is still more glaring in its character. For, should the war be protracted for several years in succession, it will necessitate, not merely a single drain of gold to the extent of some £8,000,000 or £10,000,000, but a continued series of annual drains, every one of which may extend to that amount. In this case, therefore, under the Act of 1844, the currency will be subjected either to one continuous strain throughout the whole duration of the war, or else to a succession of violent oscillations from deficiency to excess, and from excess to deficiency, according as the bullion imported exceeds that exported, as would probably be the case during the winter months; and as the bullion exported may exceed that imported, as would probably be the case during the summer months. Should the amount of bullion received during the winter be equal to the amount exported during the previous summer, we should then have an excess of currency with high prices, and a low rate of interest in every spring, followed by a deficiency of currency with low prices, and excessively high interest in every autumn, except so far as this rule might be interfered with in the case of those commodities, the supply of which would be diminished through the rupture of our commercial relations with the hostile country. But should the influx of gold during the winter, fall short of the previous efflux, the effect would be, that the currency would be subjected to a permanent deficiency; and we should only have to look forward to low prices and enormous interest throughout the whole continuance of the war, with the not improbable contingency of the spread of general panic at every period of unusual pressure. And to this it must be added, that should any serious deficiency in some staple article of domestic consumption occur in the meantime, requiring the importation of an adequate substitute from abroad, the additional efflux of treasure which this would necessitate, might not only lead to a suspension of cash payments by the Bank of England, but be the means of throwing the whole commercial affairs of the nation into extreme, if not irreparable, disorder.

It is now admitted by the best authorities, both practical and theoretical, that what is really wanted in such cases as those just described, is the adoption of some system that would recover the exported treasure, with the smallest possible interference with the amount of circulating medium, and the general prices of commodities. It is likewise admitted that a rise in the rate of interest, accompanied by a very moderate contraction of the currency, would be quite sufficient to recover the exported treasure, without inflicting any serious injury on the commercial public. For example, Mr. J. S. Mill, who is perhaps the most eminent of living economists, in the chapter on the Regulation of the Currency, thus expresses himself: “In the first place, the gold might be brought back, not by a fall of prices, but by the much more rapid and convenient medium of a rise of the rate of interest, involving no fall of any prices except the prices of securities. Either English securities would be bought on account of foreigners, or foreign securities held in England, would be sent abroad for sale, both which operations took place largely during the mercantile difficulties of 1847, and not only checked the efflux of gold, but turned the tide and brought the metal back.” And in confirmation of this statement, we have the evidence of Mr. Morris, late Governor of the Bank, before the Committee of the House of Commons on Commercial Distress, to the fact, that a rise in the rate of discount to 6 per cent. sufficed to recover the gold from Russia and other continental countries--“Parties were importing gold during the time that we were discounting at 6 and 7 per cent., but latterly, when gold became scarce, they exerted themselves still more to bring it.” But the testimony of Mr. J. Horsley Palmer, who has passed the Bank Chair, is still more decisive. He was asked, “May not a favourable exchange be maintained by the rate of interest being higher in this country than on the Continent?” His answer is emphatic: “It is the only mode, in my judgment, for correcting the foreign exchanges.”

Now this is the precise mode in which our proposed system would operate in the case of every drain of bullion. The immediate effect of any drain, from whatever cause produced, would be, not a contraction of the circulating medium, but a gradual rise in the rate of interest. If the drain were not very great, this rise in the rate of interest would be sufficient to turn the exchanges in the manner described by Mr. J. S. Mill. If the drain were more severe, the rate of interest would rise still higher, till it would ultimately affect the public demand for loans and discounts, at which point it would begin to produce a very gradual contraction of the circulation. With this contraction would proceed a slight reduction in prices sufficient to stimulate an increased exportation, but not to paralyze domestic industry; and the united operation of the rise in the rate of interest and the moderate fall in prices, would recover the exported treasure, without involving any serious convulsion in the commercial system.

As this is a matter of more than ordinary importance, it will be best to enter somewhat more minutely into the mode of operation. We have already observed that the present average amount of bullion held by the Bank of England is about £14,000,000. Should the Bank, as we propose, be allowed to issue some £10,000,000 of small notes, the average amount of bullion would probably be thereby increased to about £24,000,000. We have also shown that the present average issue of unrepresented notes by the Bank is about £8,000,000, and that if it were allowed to replace the country issues, the average would probably be thereby increased to £15,000,000. We shall now suppose that a drain of bullion commences when the amount both of the bullion and the unrepresented issues is at this estimated average. In such a case the total issues of the Bank of England would be thus composed:

Issued on bullion £24,000,000 ” at 1 per cent. 11,000,000 ” at 2 per cent. 4,000,000 ----------- £39,000,000

the Bank having still a reserve of £7,000,000 of unrepresented notes, which it might issue at 2 per cent. before the issues at 4 per cent. would be called into requisition. We shall also assume that the rate of interest is at its ordinary average of about 4 per cent. In these circumstances, then, we shall suppose that a drain originates from any of the preceding causes to the extent of say £4,000,000;[D] the effect will be as follows:--According as each million of bullion is withdrawn from the Bank, for exportation, the amount of bullion notes, and therefore of circulating medium in the possession of the public, will suffer a corresponding diminution: an increased demand for banking accommodation will therefore arise; but as this can only be accorded by the Bank of England, through a further extension of the issues at 2 per cent., and as any considerable issue of such notes would require a higher rate of interest than 4 per cent. to render it adequately profitable, the effect of this increased demand for accommodation will probably be a rise in the rate of interest from 4 to 4½ or, perhaps, 5 per cent. It is possible that this rise in the rate of discount might not produce any effect upon the demand for accommodation, but the probability is, that it would have some sensible influence, though not very considerable. We shall estimate it, therefore, as likely to diminish the amount of the currency by £1,000,000 of the £4,000,000 exported. The total issues would then have undergone the following change:--

Issued on bullion £20,000,000 ” at 1 per cent. 11,000,000 ” at 2 per cent. 7,000,000 ---------- £38,000,000

[D] In order to guard against misapprehension, it may be necessary to observe, that when speaking of the amount of any drain of bullion, we invariably mean the excess of the treasure exported over that imported during the given period. For example, should the efflux amount to £6,000,000 and the influx to only £2,000,000, the effect would be the same as if there had been an efflux of £4,000,000 and no simultaneous influx: we should, therefore, assign £4,000,000 and not £6,000.000, as the actual drain in such a case.

and we should have a rise in the rate of interest to 4½ or perhaps 5 per cent., accompanied by a contraction in the total circulation to the extent of £1,000,000, as a means of correcting the exchanges, which there is little doubt it would suffice to do, if the drain were one of only slight severity.

The drain of 1847, however, was much more severe than this--and in order to show the operation in a somewhat analogous case, we shall suppose the efflux of bullion to proceed to the extent of a second £4,000,000. The effect would necessarily be very similar to that just described, except that it would be more strongly marked in its features. According as the demand for accommodation would increase, and as the Bank would approach the exhaustion of the £11,000,000 of unrepresented notes allowed to be issued at 2 per cent., it would be obliged to raise the rate of discount still higher, so that, by the time that the efflux of the second £4,000,000 would be complete, the rate of discount would probably be not less than 5½ or 6 per cent., and as this rise would undoubtedly have considerable effect in checking the increased demand for accommodation, we may confidently assume the consequent contraction of the circulation to be at least one million of the four. The total issues therefore would have assumed this position:--

Issued on bullion £16,000,000 ” at 1 per cent. 11,000,000 ” at 2 per cent. 10,000,000 ----------- £37,000,000

exhibiting a rise in the rate of discount, from 4 to 5½ or 6 per cent., and a decrease of £2,000,000 in the amount of circulating medium, as the total effect produced by a drain of £8,000,000 of bullion. And should the drain proceed no further, we have ample data both in theory and practise, for assuming that this rise in the rate of interest would draw over foreign capital in the purchase of securities--that this contraction in the currency would lower prices sufficiently to stimulate the export of commodities, without paralyzing industry--and that through the combined operation of the two agencies, the bullion would be slowly but certainly recovered, with the smallest possible detriment to commercial interests.