THE CURRENCY REPORT

December, 1918

Currency Policy during the War--Its Disastrous Mediaevalism--TheReport of the Cunliffe Committee--A Blast of Common Sense--TheCondemnation of our War Finance--Inflation and the Rise in Prices--TheFigures of the Present Position--The Break in the Old Relation betweenLegal Tender and Gold--How to restore it--Stop Borrowing and reducethe Floating Debt--Return to the Old System--The Committee's SaneConservatism--A Sound Currency vital to National Recovery.

Among the many features of the late war (how comfortable it is to talkabout the "late war"!) that seem likely to astonish the historianof the future, perhaps the thing that will surprise him most is thebehaviour of the warring Governments in currency matters. It issurely, a most extraordinary thing after all that has been thought,said and written about monetary policy since money was invented thatas soon as a great economic effort was necessary on the part of theleading civilised Powers, they should all have fallen back on the oldmediaeval dodge of depreciating the currency, varied to suit modernneeds, in order to pay part of their war bill, and should havecontinued this policy throughout the course of the war, in spite ofthe obvious results that it was producing in the shape of unrest,suspicion and bitterness on the part of the working classes, who verynaturally thought that the consequent rise in prices was due to themachinations of unscrupulous capitalists who were exploiting them. Itis even possible that the historian of a century hence may ascribe tothis cause the beginning of the end of our present economic system,based on the private ownership of capital, for it is very evident thatwe have not yet seen the end of the harvest that this bitterness anddiscontent are producing.

A less important but still very objectionable consequence of the floodof currency and credit that the Government has poured out to fill agap in its war finance is the encouragement that it has given to ahost of monetary quacks who believe that all the financial ills ofthe world can be saved if only you give it enough money to handle,oblivious of the effect on prices of mere multiplication of claims togoods without a corresponding increase in the volume of goods. Theseenthusiasts have seen that during war a Government can produce moneyas fast as it likes, and since they think that producing money makesevery one happy they propose to adopt this simple method for payingoff war debt, restarting trade and generally creating a monetarymillennium. How far their nostrums are likely to be adopted, noone can yet say, but some of the utterances of our rulers make oneshudder.

Into this atmosphere of quackery and delusion the report of theCommittee on Currency and Foreign Exchanges breathes a refreshingblast of sound common sense. Everybody ought to read it. It costs buttwopence; it is only a dozen pages long, and it is described (if youwant to order it) as Cd. 9182. In view of the many attacks that havebeen made on our banking system--especially the Bank Act of 1844--byChambers of Commerce and others before the war, it is rathersurprising that so little criticism should have been heard of thisReport, which practically advocates a return, as rapidly as possible,to the practice and principles imposed by that Act. It may be thatpeace, and all the preoccupations that have followed it, have absorbedmen's minds so entirely that questions of currency seem to be anuntimely irrelevance; or possibly the very heavy weight of theCommittee's authority may have silenced the opposition to itsrecommendations. Presided over by Lord Cunliffe, the late Governor ofthe Bank, and including Sir John Bradbury and Professor Pigou and animposing list of notable bankers, it was a body whose opinioncould only be challenged by critics gifted with the most sereneself-confidence.

One of the most interesting--especially to advocates of soundfinance--points in its Report is the implied condemnation that itpronounces on the methods by which the war has been financed by ourrulers. It points out that "the need of the Government for fundswherewith to finance the war in excess of the amounts raised bytaxation or by loans from the public has made necessary the creationof credits in their favour with the Bank of England.... The balancescreated by these operations passing by means of payments tocontractors and others to the Joint Stock banks have formed thefoundation of a great growth in their deposits, which have alsobeen swelled by the creation of credits in connection with thesubscriptions to the various War Loans.... The greatly increased volume of bank deposits, representing a corresponding increase ofpurchasing power and, therefore, tending in conjunction with othercauses to a great rise of prices, has brought about a correspondingdemand for legal tender currency which could not have been satisfiedunder the stringent provisions of the Act of 1844." Here we have thestory of bad war finance put as clearly as it can be. Because theGovernment was not able to raise all the money needed for the war onsound lines--that is, by taxation and loans to it of money saved byinvestors--it had recourse to credits raised for it by the Bank ofEngland and the other banks against Treasury Bills, Ways and MeansAdvances, War Loans, War Bonds, and loans to customers who were takingup War Loans, etc. Thereby as these credits created fresh depositsthere was a huge increase in the community's purchasing power; andsince the supply of goods to be purchased was stationary or reduced,the only result was a great increase in prices which made the war,perhaps, nearly twice as costly as it need have been and producedall the suspicion and unrest that has already been referred to.Considering that the Committee included an ex-Governor of the Bankand the Permanent Secretary to the Treasury it could hardly have beenexpected to use much plainer language concerning the failure of ourrulers to get money out of us in the right way for the war andthe vigour with which they made use of the demoralising weapon ofinflation.

It followed as a necessary consequence that the volume of legal tendercurrency had to be greatly increased. As prices rose wages rosewith them, and so much more "cash" was needed in order to pay for aturnover of goods which, fairly constant in volume, demanded morecurrency because of their inflated prices. As the Committee says inits Report (page 5): "Given the necessity for the creation of bankcredits in favour of the Government for the purpose of financing warexpenditure, these issues could not be avoided. If they had not beenmade, the banks would have been unable to obtain legal tender withwhich to meet cheques drawn for cash on their customers' accounts. Theunlimited issue of currency notes in exchange for credits at the Bankof England is at once a consequence and an essential condition of themethods which the Government have found necessary to adopt in order tomeet their war expenditure."
The effect of these causes upon the amount of legal tender currency(other than subsidiary coin) in the banks and in circulation issummarised by the Committee in the following table:--

"The amounts on June 30, 1914, may be estimated as follows:--

"Fiduciary Issue of the Bank of England L18,450,000
"Bank of England Notes issued against
gold coin or bullion 38,476,000
"Estimated amount of gold coin held
by Banks (excluding gold coin held
in the Issue Department of the
Bank of England) and in public
circulation 123,000,000
___________
"Grand total L179,926,000
___________

"The corresponding figures on July 10, 1918, as nearly as they can beestimated, were:--

"Fiduciary Issue of the Bank of England 18,450,000
Currency Notes not covered by gold 230,412,000
___________
"Total Fiduciary Issues [1] L248,862,000
Bank of England Notes issued against
coin and bullion 65,368,000
Currency Notes covered by gold 28,500,000
Estimated amount of gold coin held
by Banks (excluding gold coin held
by Issue Department of Bank of
England), say 40,000,000
___________
"Grand total L382,730,000

"[Footnote 1: The notes issued by Scottish and Irish banks which havebeen made legal tender during the war have not been included in theforegoing figures. Strictly the amount (about L5,000,000) by whichthese issues exceed the amount of gold and currency notes held bythose banks should be added to the figures of the present fiduciaryissues given above.]

"There is also a certain amount of gold coin still in the hands of thepublic which ought to be added to the last-mentioned figure, but theamount is unknown."

It will be noted that the gold held by the banks (other than the Bankof England) and by the public has declined from L123 to L40 millions,according to the Committee's estimate, while, on the other hand, thecirculation of bank notes has risen by L27 millions and the issue ofcurrency notes has taken place to the tune of L259 millions (at thedate of the Report; it is now nearly L300 millions), making a netaddition to legal tender currency of over L200 millions. When wealso remember that there has been a very heavy coinage of silver andcopper, that the Bank of England's deposits have risen by over L100millions and the deposits of the other banks by nearly L700 millions,and all this at a time when most of the industrial activity of thecountry was going into the production of destructive weapons and thesupport of those who were using them, the behaviour of commodities ofordinary use in rising by nearly 100 per cent. seems to be an exampleof remarkable moderation. With all this new buying power in the handsof the community there is little wonder that some people shouldthink that we have enormously increased our wealth during this mostdestructive and costly war, and should then feel hurt and disappointedwhen they find that this new buying power is robbed of all itsbeauty by the fact that its efficiency as buying power is seriouslydiminished by its mere quantity.

Such being the state of affairs--a great mass of new credit andcurrency based on securities--it is clear that our currency has beendeprived for the time being of that direct relation with its goldbasis that used in former time to regulate its volume according toworld prices and our international trade position. As the Committeesays, "It is not possible to judge to what extent legal tendercurrency may in fact be depreciated in terms of bullion. But it ispractically certain that there has been some depreciation, and to thisextent therefore the gold standard has ceased to be effective." Verywell, then, what has to be done to get back to the old state of thingsunder which there was a more or less automatic check on the creationof credit and the issue of currency? This check worked by a systemwhich was elastic and simple. It was not entirely automatic, becauseits working had to be controlled by the Bank of England, which, by theaction of its discount rate, could, more or less, quicken or check theworking of the machine. Legal tender currency could only be increasedby imports of gold; and exports of gold reduced the available amountof legal tender currency; and since a stock of legal tender currencywas essential to meet the demands upon them that bankers madepossible by creating credits, there was thus an Indirect and variableconnection between the country's gold stock and the extent to whichbankers would think it prudent to multiply credits. If credits weremultiplied too fast, our currency was depreciated in value as comparedwith those of other countries and the exchanges went against us andgold either was exported or began to look as if it might be exported.If it was exported the legal tender basis of credit was reduced andthe creation of credit was checked. If the Directors of the Bank ofEngland thought it inadvisable that gold should be exported theycould, by raising the rate of discount and taking artificial measuresto control the supply of credit, produce, without the actual loss ofgold, the effects which that loss would have brought about.

The keystone of the system was the rigid link between legal tendercurrency and gold. This was secured by the provisions of the Bank Actof 1844, which laid down that above a certain line--which was beforethe war roughly L18-1/2 millions--every Bank of England note issuedshould have gold behind it, pound for pound. In other words, the Bankof England note was, for practical purposes, a bullion certificate.The legal limit on the fiduciary issue (that is, the issue of L18-1/2millions against securities, not gold) could only be exceeded by abreach of the law. The many critics of our banking system seized onthis hard-and-fast restriction and accused it of making our systeminelastic as compared with the German arrangement, under which thelegal limit could at any time be exceeded on payment of a tax or fineon any excess perpetrated. These critics might have been right iflegal tender currency had been the only, or even the predominant,means of payment in England. But, as every office boy knows, it wasnot. Legal tender--gold and Bank of England notes--was hardly everseen in commercial and financial transactions on a serious scale. Wepaid, sometimes, our retail purchases of goods and services in gold;and Bank notes were a popular mode of payment on racecourses and inother places where transactions took place between people who were notvery certain of one another's standing or good faith. But the greatbulk of payments was made in the cheque currency which our bankers haddeveloped outside of the law and could create as fast as prudence--andan eye to the supply of legal tender which every holder of a chequehad a right to demand--allowed them to do so. While cheques providedthe currency of commerce, another form of "money" was produced, againwithout any restriction by the Act, by the pleasant convention whichcaused a credit in the Bank of England's books to be regarded as"cash" for balance-sheet purposes by the banks. These advantagesgave the English system a freedom and elasticity, in spite of thestrictness of the law that regulated the issue of paper currency, thatenabled it to work in a manner that, judged by the test of practicalresults, had one great advantage over that of any of the rivalcentres. It alone in days before the war fulfilled the functions of aninternational banker by being ready at all times and without questionto pay out the gold that was, in the last resort, the final means ofsettling international balances.

It is the object of Lord Cunliffe's Committee to restore as quicklyas possible the system which, has thus been tried by the test ofexperience, "After the war," they say in their Report, "our goldholdings will no longer be protected by the submarine danger, and itwill not be possible indefinitely to continue to support the exchangeswith foreign countries by borrowing abroad. Unless the machinery whichlong experience has shown to be the only effective remedy for anadverse balance of trade and an undue growth of credit is oncemore brought into play there will be very grave danger of a creditexpansion in this country and a foreign drain of gold which mightjeopardise the convertibility of our note issues and the internationaltrade position of the country.... We are glad to find that there wasno difference of opinion among the witnesses who appeared before us asto the vital importance of these matters." The first measure that theyput forward as essential to this end is the cessation at the earliestpossible moment of Government borrowings. "A large part of the creditexpansion arises, as we have shown, from the fact that the expenditureof the Government during the war has exceeded the amounts which theyhave been able to raise by taxation or by loans from the actualsavings of the people. They have been obliged therefore to obtainmoney through the creation of credits by the Bank of England and theJoint Stock banks, with the result that the growth of purchasing powerhas exceeded that of purchasable goods and services." It is thereforeessential that as soon as possible the State should not only livewithin its income but should begin to reduce indebtedness, especiallythe floating debt, which, being largely held by the banks, has beena cause of credit creation on a great scale. "The shortage of realcapital must be made good by genuine savings. It cannot be met by thecreation of fresh purchasing power in the form of bank advances tothe Government or to manufacturers under Government guarantee orotherwise, and any resort to such expedients can only aggravate theevil and retard, possibly for generations, the recovery of the countryfrom the losses sustained during the war." With these weighty wordsthe Committee brushes aside a host of schemes that have been urged forputting everything right by devising new machinery for the manufactureof new credit. That new credits will be needed for industry after waris obvious, but what else are our banks for, if not to provide it?They can only be set free to provide it on the scale required if, bythe necessary reduction of the floating debt, they are relieved of thelocking up of their funds in Government securities, which has been oneof the bad results of our bad war finance.

It goes without saying that the Committee does not recommend thecontinuance in peace of the differential rates for home and foreignmoney that were introduced as a war measure with a view to loweringa rate at which the Government borrowed at home for war purposes. Itwould evidently be too severe a strain on human nature to attempt towork such a system, except in war-time, when the artificial conditionsby which the market was surrounded made it both feasible and desirableto do so. With regard to the note issue, the Committee proposes areturn to the old system and a strictly drawn line for the amount ofthe fiduciary note issue, the whole note issue (with the exception ofthe few surviving private note issues) being put into the hands of theBank of England, all notes being payable in gold in London onlyand being made legal tender throughout the United Kingdom. Thesesuggestions are subject to any special arrangements that may be madewith regard to Scotland and Ireland. An early resumption of thecirculation of gold for internal purposes is not contemplated. Thepublic has become used to paper money, which is in some ways moreconvenient and cheaper; and the luxury of a gold circulation is onethat we can hardly afford at present. Gold will be kept by the Bank ofEngland in a central reserve, and all the other banks should, it issuggested, transfer to it the whole of their present holdings of themetal. In order to give the Bank of England a closer control of thebullion market the Committee thinks it desirable that the export ofgold coin or bullion should, in future, be subject to the conditionthat such coin or bullion had been obtained from the Bank for thepurpose. This measure would give the Bank of England a very closecontrol of the bullion market, so close that there is a danger thatif this control were too rigorously exercised, gold that now comes tothis country might be diverted, with a view to more advantageous sale,to other centres. The amount of the fiduciary issue is a matterthat the Committee leaves open to be determined after experience ofpost-war conditions. They "think that the stringent principles ofthe Act (of 1844) have often had the effect of preventing dangerousdevelopments, and the fact that they have had to be temporarilysuspended on certain rare and exceptional occasions (and those limitedto the earlier years of the Act's operation, when experience ofworking the system was still immature) does not," in their opinion,invalidate this conclusion. So they propose that the separation of theIssue or Banking Departments should be maintained, but that in futureif an emergency arose requiring an increase in the amount of fiduciarycurrency, this should not involve a breach of the law, but should bemade legal (as it is now under the Currency and Bank Notes Act of1914), subject to the consent of the Treasury.

It is not proposed at present to secure the circulation of paperinstead of gold by legislation. The Committee considers that "informalaction on the part of the banks may be expected to accomplish allthat is required." If necessary, however, it points out thatthe circulation of gold could be prevented by making the notesconvertible, at the discretion of the Bank of England, into coin orbar gold. The amount which, in the opinion of the Committee, should beaimed at for the central gold reserve is L150 millions (a sum which isalready almost in sight on its figures quoted above); and "untilthis amount has been reached and maintained concurrently with asatisfactory foreign exchange position for a period of at least ayear," it thinks that the policy of reducing the uncovered note issue"as and when opportunity offers" should be consistently followed. Howthis opportunity is going to "offer" is not made clear; but presumablya reflow of notes from circulation can only happen through a fall inprices or a reduction in bank deposits by the liquidation of advancesmade to the Government, directly or indirectly, by the banks.
Concerning the difficult problem of replacing the Bradbury notes byBank of England notes of L1 and 10s., an ingenious suggestion is madeby the Committee. It observes that there would be some awkwardnessin transferring the issue to the Bank of England before the futuredimensions of the fiduciary issue have been arrived at; and itsuggests that during the transitional period any expansion in Treasurynotes that may take place should be covered, not as now, by Governmentsecurities, but by Bank of England notes taken from the Bank. By thismeans any demands for new currency would operate in the normal way toreduce the reserve of the Banking Department, "which would have to berestored by raising money rates and encouraging gold imports," and soa step would have been taken to getting back to a business basis inthe currency system and away from the profligate printing-press policyof the war period.
Such are the suggestions made by this distinguished body for therestoration of our currency. Little has been said against them in theway of serious criticism, but their conservative tendency and thefact that they practically recommend a return to the _status quo_ hascaused some impatience among the financial Hotspurs who proposed tobegin to build a new world by turning everything upside down. Inmatters of finance this process is questionable, interesting as theresult would undoubtedly be. To get to work on tried lines and then,when once industry and finance have recovered their old activity, toamend the machine whenever it is creaking seems to be a more sensibleplan than to delay our start until we have fashioned a new heavenand earth, and then very probably find that they do not work. If themachine is to be set moving, it can only be done by close co-operationbetween the Bank of England and the other banks which have grown byamalgamation into institutions the size of which seem likely tomake the task of central control more difficult than ever. On thisimportant point the Committee is curiously silent. But it recommendsthe adoption of a suggestion made by a Committee of Bankers, whoproposed that banks should in future be required "to publish a monthlystatement showing the average of their weekly balance-sheets duringthe month." (Will this requisition apply to the Bank of England?) Thisis a welcome suggestion as far as it goes, but unless something isdone by co-operative action to make the Bank rate more automatic inits influence on the actions of the other banks, the difficulty ofmaking it effective seems likely to be considerable.

Getting the currency right is a most important matter for the futureof our financial position. Another is the question of our debt toforeigners. Most of this debt we owe to America, and we only owe itbecause we had to finance our Allies. We surely ought to be able toarrange with America that anything that we have to do in giving ourAllies time before asking for repayment they also should do forus--within limits, say, up to thirty years. In view of all that theyhave made and we have lost by this war waged for the cause of allmankind, this would seem to be reasonable concession on America'spart.