XVIII

THE REGULATION OF THE CURRENCY

_February_, 1919

Macaulay on Depreciated Currency--Its Evils To-day--The Plight of the
Rentier--Mr Goodenough's Suggestion--Sir Edward Holden's Criticisms of
the Currency Committee--His Scheme of Reform--Two Departments or One
in the Bank of England?--Not a Vital Question--The Ratio of Notes
to Gold--Objections to a Hard-and-fast Ratio--The Limit on Note
Issues--The Federal Reserve Act and American Optimism--Currency and
Commercial Paper--A Central Gold Reserve with Central Control.


Everyone has read, and most of us have forgotten, the great passage in
Macaulay's history which describes the evils of a disordered currency.
"It may well be doubted," he says, "whether all the misery which had
been inflicted on the English nation in a quarter of a century by bad
Kings, bad Ministers, bad Parliaments and bad judges was equal to the
misery caused in a single year by bad crowns and bad shillings....
While the honour and independence of the State were sold to a foreign
Power, while chartered rights were invaded, while fundamental laws
were violated, hundreds of thousands of quiet, honest and industrious
families laboured and traded, ate their meals and lay down to rest in
comfort and security. Whether Whigs or Tories, Protestants or Jesuits
were uppermost, the grazier drove his beasts to market, the grocer
weighed out his currants, the draper measured out his broadcloth,
the hum of buyers and sellers was as loud as ever in the towns, the
harvest-time was celebrated as joyously as ever in the hamlets, the
cream overflowed the pails of Cheshire, the apple juice foamed in the
presses of Herefordshire, the piles of crockery glowed in the furnaces
of the Trent, and the barrows of coal rolled fast along the timber
railways of the Tyne. But when the great instrument of exchange became
thoroughly deranged, all trade, all industry, were smitten as with a
palsy.... Nothing could be purchased without a dispute. Over every
counter there was wrangling from morning to night. The workman and his
employer had a quarrel as regularly as the Saturday came round. On a
fair-day or a market-day the clamours, the reproaches, the taunts, the
curses, were incessant; and it was well if no booth was overturned,
and no head broken.... The price of the necessaries of life, of shoes,
of ale, of oatmeal, rose fast. The labourer found that the bit of
metal which, when he received it was called a shilling, would hardly,
when he wanted to purchase a pot of beer or a loaf of rye bread, go as
far as sixpence."

From some of the evils thus dazzlingly described we are happily free
in these times. We are not cursed with a currency composed of coins
which are good, bad and indifferent, with the result that the public
gets the bad and indifferent while the nimble bullion dealers absorb
and export the good. There is nothing to choose between one piece of
paper and another, and all that is wrong with them is that there are
too many of them. But the general result as it affects the labourer
who wants to purchase a pot of beer or anyone else who wants to buy
anything is very much the same. A bit of metal that is called a
shilling has about the value of a pre-war sixpence and a bit of paper
that is called a Bradbury fetches half as much as the pound of five
years ago. Compared with what other peoples are suffering from the
same disease arising from the same surfeit of money in one form or
another, this nuisance that we are enduring is not too terribly
severe. It has entailed great hardship on a class that is small
in number, namely, those who have to live on fixed incomes. The
salary-earner and the rentier have borne the brunt, while the
wage-earner and the profit-maker have been able to expand their
earnings, in paper, at least to a point at which the depreciation of
currency have left them no worse off. Seeing that the wage-earners
are those who do the dreariest and dirtiest jobs, and that the
profit-makers are those who take the risks of industry and the
enormous responsibility of organising enterprise, they are the classes
whom it is clearly most desirable to encourage. The rentier in these
days gets less than no sympathy, but we make a great mistake if we
think that we can with impunity crush him between the upper and nether
millstone of fixed income and rising prices. With his help we have
equipped industry at home and abroad. We can, if we choose, by
depreciating the currency still further, lessen still more the reward
that we pay him for that benefit. He may kick, but he cannot abolish
the equipment with which he has already provided industry. But if
we make his life too hard he can strike like the rest of us, and by
refusing to provide for any further expansion in industrial equipment,
he can hold up production until we have devised some new method of
laying up capital. Currency depreciation is good for the debtor and
bad for the creditor; if it goes too far it kills the creditor and
reduces business to chaos.

We are a very long way from the chaos to which many of our Continental
neighbours have already reduced their monetary systems; but there
is fortunately a very general feeling that we are a country with a
reputation and a prestige on this point; and the business world is
growing restive concerning the delay on the part of those responsible
in putting an end to a state of things which may have been justified
by the war's exigencies (though there is much to be said for the view
that in fact it only added to the war's difficulties) but is
now clearly as out of date as the censorship, which, like it,
nevertheless, continues to flourish. This state of things arises from
the arrangement tinder which an unlimited supply of legal tender
currency can be manufactured by the Government, which encouraged to
continue the system by the fact that each note issued is in effect a
loan to itself without interest. At the meeting of Barclays Bank on
January 27th, Mr. Goodenough demanded that the issue of currency notes
by the Government should be stopped forthwith, and that if it were
necessary to provide more currency it would be better for the banks
to be allowed to issue notes themselves. This suggestion involves, of
course, a complete reversal of the principles on which our monetary
system has grown up, since it has long been based on a note-issuing
monopoly in the hands of the Bank of England. But these are
topsy-turvy days, in which greyheaded precedent is very justly at a
heavy discount; and Mr Goodenough's suggestion very practically gets
over a big difficulty that stands in the way of stopping the stream
of Bradburys. This difficulty lies in the fact that if the banks were
pulled at by their customers for currency and could not supply them
with Bradbury notes, they would be forced to take notes from the Bank
of England, with a bad effect on the appearance of its reserve. If
the business of issuing notes were put into the hands of the clearing
banks, their power to do so would be limited by the extent of their
assets, or of such of their assets as were thought fit to rank as
backing for their notes. In other words, the note-issuing business
would once more have to be regulated on banking principles and
controlled by the price asked, for advances, instead of expressing
the helplessness and improvidence of an impecunious and invertebrate
Government. In this manner the new departure might be a convenient
halfway-house on the way from chaos back to sanity. But probably it is
too revolutionary and goes too straight in the teeth of the Bank of
England's privilege to receive much practical consideration; and there
is the question whether the public would take the new paper readily
and whether it could be made legal tender.

Sir Edward Holden, in one of those masterly surveys of world finance
with which he now instructs the shareholders of the London Joint City
and Midland Bank, assembled at their annual meeting, gave much of his
attention to an attack on the report of Lord Cunliffe's Committee on
Currency. This was only to be expected, since the Committee had made
recommendations on lines which were largely conservative and did
not embody any of the reforms or changes which had been previously
advocated by Sir Edward. Being on this occasion chiefly critical, he
did not make very clear in his latest speech the precise proposals
that he favours. For them we have to go back to his speech of a year
ago, as reported in the _Economist_ of February 2, 1918, p. 171, where
he stated that "if the Bank (of England) had been working on the same
principles as other national banks of issue, there would have been
little ground for anxiety," and that these principles are:--

1. One bank of issue and not divided into departments.

2. Notes are created and issued on the security of bills of exchange
and on the cash balance, so that a relation is established between the
notes issued and the discounts.

3. The notes issued are controlled by a fixed ratio of gold to notes
or of the cash balance to notes.

4. This fixed ratio may be lowered by the payment of a tax.

5. The notes should not exceed three times the gold or the cash
balance.

As will be remembered, the Cunliffe Committee recommended that the
division of the Bank of England into an Issue Department and a Banking
Department, should be retained; that the old principle by which above
a certain fixed limit all notes should be backed by gold, should also
be retained, but that if at any time a breach of this rule should
be found necessary it should be possible, with the consent of the
Treasury, and that Bank rate "should be raised to a rate sufficiently
high to secure the earliest possible retirement of the excess issue."
Since it was formerly only possible to exceed the limit on the
fiduciary issue by a breach of the law, under the Chancellor of the
Exchequer's promise to get an indemnity for it from Parliament, and
since Treasury tradition insisted on a 10 per cent. Bank rate whenever
such a breach was permitted or contemplated, it will be seen that the
Cunliffe Committee proposed some considerable modifications in our
system and hardly justified Sir Edward's assertion that it "proposed
that the Bank should continue to work under the Act of 1844 as
heretofore."

At first sight there seems to be a good deal of difference between Sir
Edward's ideal and Lord Cunliffe's, but is not the difference to
a great extent superficial? Whether the Bank be divided into two
departments, each presenting a separate account, or its whole business
be regarded as one and stated in one account, seems to be rather a
trifling question. And the arguments put forward for their several
views by the two champions are not strikingly convincing. Sir Edward
wants only one account, because he thinks the consequence would be a
stronger reserve and fewer changes in bank rate. But a mere change of
bookkeeping such as the amalgamation of the two accounts would not
make a half-pennyworth of difference to the extent of the Bank's
responsibilities and its ability to meet them, and it is on variations
in these factors that movements in bank rate are in most cases
decided. On the other hand, Lord Cunliffe and his colleagues argue
that the main effect of putting the two departments into one would be
to place deposits with the Bank of England in the same position as
regards convertibility into gold as is now held by the note. On this
point Sir Edward's answer is telling: "In reply to this statement, I
say that the depositors at the present time can always get gold by
drawing out notes from the reserve and taking gold from the Issue
Department. There seems to be little difference between the depositors
attacking gold direct and attacking the gold through the notes in the
reserve. If the Bank cannot pay the notes when demanded the whole
machinery stops." Quite so. The notion that the holder of a Bank of
England note has now a stronger hold over the Bank's gold than the
depositor seems to be baseless. He can exercise his hold more quickly
perhaps, though even this is doubtful. Since banknotes are not
legal tender at the Bank of England, it is not quite clear that the
depositor would even have to take the trouble to go first to the
Banking Department for notes and then to the Issue Department for
gold. He might be able to insist on gold in immediate payment of his
deposit. Still less convincing is the Committee's argument that "the
amalgamation of the two departments would inevitably lead in the end
to State control of the creation of banking credit generally." Their
report might have explained why this should be so, for to the ordinary
mind the chain of consequence is not apparent. On the whole it is hard
to see much good or harm to be achieved by changing the form of the
Bank return. It might make the Bank's position look stronger, but it
could not make it really stronger. Nor would it really impair the
strength of the note-holder's position as against the depositor,
because even now there is no essential difference. It would substitute
a more businesslike and simple statement for a form of accounts which
is cumbrous and stupid and Early Victorian--a relic of an age which
produced the crinoline, the Crystal Palace and the Albert Memorial. On
the other hand, to alter a statistical record merely for the sake of
simplicity and symmetry is questionable. Unless we are getting more
and truer information, it is a pity to make comparisons between one
year and another difficult by changing the form in which figures are
given.

A more essential difference between the two policies lies in Sir
Edward's advocacy of a ratio--three to one--between notes and gold,
and the Committee's support of the old fixed line system. By the
latter, if gold comes in, notes to the same extent can be created,
and if gold goes out notes to the amount of the export have to be
cancelled. Under Sir Edward's policy the influx and efflux of gold
would have an effect on the note issue which would be three times the
amount of the gold that came in or went out. This at least is the
logical effect of his statement that "the notes should not exceed
three times the gold or the cash balance." This law does not seem to
be quite consistent with his view that the fixed ratio of gold to
notes may be lowered by the payment of a tax; but presumably the tax
would come into operation before the three to one part was reached,
and at three to one there would be a firm line drawn. On this
assumption the Committee's argument is a very strong one. "If,"
says its report (Cd. 9182, p. 8), "the actual note issue is really
controlled by the proportion, the arrangement is liable to bring about
very violent disturbances. Suppose, for example, that the proportion
of gold to notes is actually fixed at one-third and is operative.
Then, if the withdrawal of gold for export reduces the proportion
below the prescribed limit, it is necessary to withdraw notes in the
ratio of three to one. Any approach to the conditions under which the
restriction would become actually operative would then be likely to
cause even greater apprehension than the limitation of the Act of
1844." Certainly if, during a foreign drain, for every million of gold
that went out, another two millions of credit, over and above, had
to be cancelled, it is easy to imagine a very jumpy state of mind in
Lombard Street and on the Stock Exchange. Sir Edward and the Committee
seem to be agreed as to a limit on the note issue, but of the two
limiting systems the old one advocated by the Committee, though
apparently more severe, would seem to have much less alarming
possibilities behind it.

A point on which the commercial world does not seem to have made up
its mind, however, is whether there should be a limit at all. Under
the old Act there was a limit which could only be passed by a breach
of the law. Under the Cunliffe proposal the limit could be passed
with the consent of the Treasury. Sir Edward has not told us of what
machinery he proposes for the passing of the limit which he lays down;
but in view of the great apprehension that an approach to the limit
point would, as shown by the Committee, produce, it is clear that
there would have to be a way round. In Germany there is no limit; you
pay a tax on the excess issue and go on merrily. In America it would
seem that the German system has been taken for a model. In his speech
on January 29th Sir Edward quoted Senator Robert Owen, who was the
principal pioneer of the Federal Reserve Bill through the Senate, as
follows:--"The central idea of the system is elastic currency issued
against commercial paper and gold, expanding and contracting according
to the needs of commerce.... It is of great importance that the volume
of these notes should contract when the commerce of the country does
not require the notes to be circulation, and the reserve board can
require them to be returned by imposing a tax upon the issue.... Under
the reserve system a financial panic is impossible. People will
not hoard currency nor hoard gold when they know that they can get
currency or get gold when required.... America no longer believes
a financial panic possible, and therefore the business men, being
perfectly assured as to the stability of credits, do not hesitate to
enter manufacturing and commercial enterprises from which they would
be deterred under old conditions of unstable credit." Well, let us
hope the Senator is right and that America is right in believing that
a financial panic is no longer possible there. But one cannot help
feeling that such a belief may be rather dangerous in the minds of
people so ready to take rose-coloured views as our American cousins.
The Federal Reserve system has worked beautifully in a period in
which American finance has had nothing to do but rake in the enormous
profits of American production at the expense of warring Europe and
lend part of them, to be spent in America, to the Allied belligerents.
It may work equally well if and when the problem to be faced is
different, but it will be interesting to see--for those of us who live
to see--what sort of a tax will be needed to "require" America, in one
of its holiday moods, to return currency that it thinks it needs and
the Federal Reserve Board regards as redundant.

Another point on which Sir Edward lays great stress, in his attack
on the Bank Act of 1844 and the Committee which supports its main
principles, is the beauty of the bill of exchange as backing for a
note issue, as opposed to Government securities. "There is," he says,
"no automatic system for the redemption of currency notes as would be
the case if they were issued against bills of exchange, which in due
course would have to be paid off." Again, "it seems to me that notes
should not be issued against Government securities which may or may
not be paid off, but against bills of exchange which must be met at
due date." This advantage about a bill of exchange is a very real
one to the individual holder who can always put himself in funds by
letting the contents of his portfolio "run off"; but is there much
in it as a safeguard against excessive issue of currency in times of
exuberance? In such times bills that fall due are pretty sure to
be replaced by new ones drawn against fresh production--since
over-production is a common symptom of commercial exuberance--or
against a resale of the goods on which the original bills were based.
As long as anyone who can show produce can be certain to get credit
and currency, the notion that the maturing of bills of exchange can be
relied to restrict currency expansion within safe limits is surely a
dangerous assumption. The principle of a fixed limit, to be broken in
case of real need, but only after some ceremony has been gone through
giving notice of the fact that a crisis has been reached, seems rather
to be required by the psychology of speculative mankind. But even if
Sir Edward's preference for bills of exchange as backing for notes has
all the merits that he claims that is no reason for urging the repeal
of the Bank Act to secure their use. Because the Bank Act does not
forbid it: it merely says, "there shall be transferred, appropriated
and set apart by the said governor and company to the Issue Department
of the Bank of England securities to the value of," etc. It is the
practice of the Bank to put Government securities into the Issue
Department, but the terms of the Act do not compel them to do so, and
if an excess issue were needed they would seem to be empowered to put
any bills that they discounted into the assets held against the note
issue. On the whole the terms of the Act leaving them freedom in the
matter, except with regard to the "Government debt" of L11 millions,
which is specially mentioned as to be transferred to the Issue
Department, seem to be preferable to a special stipulation in favour
of bills of exchange.

But the most important difference between Sir Edward Holden and the
Cunliffe Committee seems to be in their attitude towards the gold
reserve and the relation between the Bank of England and the rest of
the items that compose the London money market. The Committee, working
to restore the conditions which made our market the centre of the
world's finance, endeavoured to give back the control of the central
gold reserve to the Bank of England by suggesting, among other things,
that the other banks should hand over their gold to it. They omitted
to discuss the serious question of the greater difficulty that the
Bank is likely to find in future in controlling the price of money in
the market, owing to the huge size that the chief clearing banks have
now reached. But a central gold reserve under central control was
evidently the object at which they aimed. Sir Edward will have none of
this. He says that if this were done the position of the Joint Stock
banks would be weakened, though he does not explain why, since they
would obviously hold notes in place of their gold and so would be able
to meet their customers' demands, now that the latter are accustomed
to the use of notes for pocket money. He points out that "the gold
which was held by the Joint Stock banks before the war proved most
useful.... At the beginning of the war the banks paid out gold,
satisfied the demands of their customers for small currency, and thus
eased the situation until currency notes became available." He seems
to have forgotten that the banks, or most of them, refused to part
with their gold, paid their customers in Bank of England notes which,
being for L5 at the smallest, were of little use for pocket money, and
so drove them to the Bank to get gold; and we had to have a prolonged
bank holiday and a moratorium. Sir Edward is in favour of three gold
reserves, one to be held by the Government, one by the clearing banks,
and one by the Bank of England. If there were differences between the
three controllers of the reserve at a time of crisis the consequence
might be disastrous.

In view of the admiration expressed by Sir Edward for the new American
system which is so clearly based on central control it is rather
illogical that he should be so strongly in favour of independence on
this side of the water. His opinion is that "the policy of the Joint
Stock banks ought to be to make themselves independent of the Bank of
England by maintaining large reserves in their vaults." Independence
and individualism are a great source of strength in most fields of
financial activity, but in view of the great problems that our money
market has to face there seems to be much to be said for co-operation
and central control, at least until we have got back to a normal state
of affairs with regard to the foreign exchanges.