THE REGULATION OF THE CURRENCY

February, 1919

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

Everyone has read, and most of us have forgotten, the great passage inMacaulay's history which describes the evils of a disordered currency."It may well be doubted," he says, "whether all the misery which hadbeen inflicted on the English nation in a quarter of a century by badKings, bad Ministers, bad Parliaments and bad judges was equal to themisery caused in a single year by bad crowns and bad shillings....While the honour and independence of the State were sold to a foreignPower, while chartered rights were invaded, while fundamental lawswere violated, hundreds of thousands of quiet, honest and industriousfamilies laboured and traded, ate their meals and lay down to rest incomfort and security. Whether Whigs or Tories, Protestants or Jesuitswere uppermost, the grazier drove his beasts to market, the grocerweighed out his currants, the draper measured out his broadcloth,the hum of buyers and sellers was as loud as ever in the towns, theharvest-time was celebrated as joyously as ever in the hamlets, thecream overflowed the pails of Cheshire, the apple juice foamed in thepresses of Herefordshire, the piles of crockery glowed in the furnacesof the Trent, and the barrows of coal rolled fast along the timberrailways of the Tyne. But when the great instrument of exchange becamethoroughly deranged, all trade, all industry, were smitten as with apalsy.... Nothing could be purchased without a dispute. Over everycounter there was wrangling from morning to night. The workman and hisemployer had a quarrel as regularly as the Saturday came round. On afair-day or a market-day the clamours, the reproaches, the taunts, thecurses, 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 ofmetal 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 asfar as sixpence."

From some of the evils thus dazzlingly described we are happily freein these times. We are not cursed with a currency composed of coinswhich are good, bad and indifferent, with the result that the publicgets the bad and indifferent while the nimble bullion dealers absorband export the good. There is nothing to choose between one piece ofpaper and another, and all that is wrong with them is that there aretoo many of them. But the general result as it affects the labourerwho wants to purchase a pot of beer or anyone else who wants to buyanything is very much the same. A bit of metal that is called ashilling has about the value of a pre-war sixpence and a bit of paperthat is called a Bradbury fetches half as much as the pound of fiveyears ago. Compared with what other peoples are suffering from thesame disease arising from the same surfeit of money in one form oranother, this nuisance that we are enduring is not too terriblysevere. It has entailed great hardship on a class that is smallin number, namely, those who have to live on fixed incomes. Thesalary-earner and the rentier have borne the brunt, while thewage-earner and the profit-maker have been able to expand theirearnings, in paper, at least to a point at which the depreciation ofcurrency have left them no worse off. Seeing that the wage-earnersare those who do the dreariest and dirtiest jobs, and that theprofit-makers are those who take the risks of industry and theenormous responsibility of organising enterprise, they are the classeswhom it is clearly most desirable to encourage. The rentier in thesedays gets less than no sympathy, but we make a great mistake if wethink that we can with impunity crush him between the upper and nethermillstone of fixed income and rising prices. With his help we haveequipped industry at home and abroad. We can, if we choose, bydepreciating the currency still further, lessen still more the rewardthat we pay him for that benefit. He may kick, but he cannot abolishthe equipment with which he has already provided industry. But ifwe make his life too hard he can strike like the rest of us, and byrefusing to provide for any further expansion in industrial equipment,he can hold up production until we have devised some new method oflaying up capital. Currency depreciation is good for the debtor andbad for the creditor; if it goes too far it kills the creditor andreduces business to chaos.

We are a very long way from the chaos to which many of our Continentalneighbours have already reduced their monetary systems; but thereis fortunately a very general feeling that we are a country with areputation and a prestige on this point; and the business world isgrowing restive concerning the delay on the part of those responsiblein putting an end to a state of things which may have been justifiedby the war's exigencies (though there is much to be said for the viewthat in fact it only added to the war's difficulties) but isnow clearly as out of date as the censorship, which, like it,nevertheless, continues to flourish. This state of things arises fromthe arrangement tinder which an unlimited supply of legal tendercurrency can be manufactured by the Government, which encouraged tocontinue the system by the fact that each note issued is in effect aloan to itself without interest. At the meeting of Barclays Bank onJanuary 27th, Mr. Goodenough demanded that the issue of currency notesby the Government should be stopped forthwith, and that if it werenecessary to provide more currency it would be better for the banksto be allowed to issue notes themselves. This suggestion involves, ofcourse, a complete reversal of the principles on which our monetarysystem has grown up, since it has long been based on a note-issuingmonopoly in the hands of the Bank of England. But these aretopsy-turvy days, in which greyheaded precedent is very justly at aheavy discount; and Mr Goodenough's suggestion very practically getsover a big difficulty that stands in the way of stopping the streamof Bradburys. This difficulty lies in the fact that if the banks werepulled at by their customers for currency and could not supply themwith Bradbury notes, they would be forced to take notes from the Bankof England, with a bad effect on the appearance of its reserve. Ifthe business of issuing notes were put into the hands of the clearingbanks, their power to do so would be limited by the extent of theirassets, or of such of their assets as were thought fit to rank asbacking for their notes. In other words, the note-issuing businesswould once more have to be regulated on banking principles andcontrolled by the price asked, for advances, instead of expressingthe helplessness and improvidence of an impecunious and invertebrateGovernment. In this manner the new departure might be a convenienthalfway-house on the way from chaos back to sanity. But probably it istoo revolutionary and goes too straight in the teeth of the Bank ofEngland's privilege to receive much practical consideration; and thereis the question whether the public would take the new paper readilyand whether it could be made legal tender.

Sir Edward Holden, in one of those masterly surveys of world financewith which he now instructs the shareholders of the London Joint Cityand Midland Bank, assembled at their annual meeting, gave much of hisattention to an attack on the report of Lord Cunliffe's Committee onCurrency. This was only to be expected, since the Committee had maderecommendations on lines which were largely conservative and didnot embody any of the reforms or changes which had been previouslyadvocated by Sir Edward. Being on this occasion chiefly critical, hedid not make very clear in his latest speech the precise proposalsthat he favours. For them we have to go back to his speech of a yearago, as reported in the _Economist_ of February 2, 1918, p. 171, wherehe stated that "if the Bank (of England) had been working on the sameprinciples as other national banks of issue, there would have beenlittle 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 exchangeand on the cash balance, so that a relation is established between thenotes issued and the discounts.

3. The notes issued are controlled by a fixed ratio of gold to notesor 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 cashbalance.

As will be remembered, the Cunliffe Committee recommended that thedivision of the Bank of England into an Issue Department and a BankingDepartment, should be retained; that the old principle by which abovea certain fixed limit all notes should be backed by gold, should alsobe retained, but that if at any time a breach of this rule shouldbe found necessary it should be possible, with the consent of theTreasury, and that Bank rate "should be raised to a rate sufficientlyhigh to secure the earliest possible retirement of the excess issue."Since it was formerly only possible to exceed the limit on thefiduciary issue by a breach of the law, under the Chancellor of theExchequer's promise to get an indemnity for it from Parliament, andsince Treasury tradition insisted on a 10 per cent. Bank rate wheneversuch a breach was permitted or contemplated, it will be seen that theCunliffe Committee proposed some considerable modifications in oursystem and hardly justified Sir Edward's assertion that it "proposedthat the Bank should continue to work under the Act of 1844 asheretofore."

At first sight there seems to be a good deal of difference between SirEdward's ideal and Lord Cunliffe's, but is not the difference toa great extent superficial? Whether the Bank be divided into twodepartments, each presenting a separate account, or its whole businessbe regarded as one and stated in one account, seems to be rather atrifling question. And the arguments put forward for their severalviews by the two champions are not strikingly convincing. Sir Edwardwants only one account, because he thinks the consequence would be astronger reserve and fewer changes in bank rate. But a mere change ofbookkeeping such as the amalgamation of the two accounts would notmake a half-pennyworth of difference to the extent of the Bank'sresponsibilities and its ability to meet them, and it is on variationsin these factors that movements in bank rate are in most casesdecided. On the other hand, Lord Cunliffe and his colleagues arguethat the main effect of putting the two departments into one would beto place deposits with the Bank of England in the same position asregards convertibility into gold as is now held by the note. On thispoint Sir Edward's answer is telling: "In reply to this statement, Isay that the depositors at the present time can always get gold bydrawing out notes from the reserve and taking gold from the IssueDepartment. There seems to be little difference between the depositorsattacking gold direct and attacking the gold through the notes in thereserve. If the Bank cannot pay the notes when demanded the wholemachinery stops." Quite so. The notion that the holder of a Bank ofEngland note has now a stronger hold over the Bank's gold than thedepositor seems to be baseless. He can exercise his hold more quicklyperhaps, though even this is doubtful. Since banknotes are notlegal tender at the Bank of England, it is not quite clear that thedepositor would even have to take the trouble to go first to theBanking Department for notes and then to the Issue Department forgold. He might be able to insist on gold in immediate payment of hisdeposit. Still less convincing is the Committee's argument that "theamalgamation of the two departments would inevitably lead in the endto State control of the creation of banking credit generally." Theirreport might have explained why this should be so, for to the ordinarymind the chain of consequence is not apparent. On the whole it is hardto see much good or harm to be achieved by changing the form of theBank return. It might make the Bank's position look stronger, but itcould not make it really stronger. Nor would it really impair thestrength of the note-holder's position as against the depositor,because even now there is no essential difference. It would substitutea more businesslike and simple statement for a form of accounts whichis cumbrous and stupid and Early Victorian--a relic of an age whichproduced the crinoline, the Crystal Palace and the Albert Memorial. Onthe other hand, to alter a statistical record merely for the sake ofsimplicity and symmetry is questionable. Unless we are getting moreand truer information, it is a pity to make comparisons between oneyear and another difficult by changing the form in which figures are given.

A more essential difference between the two policies lies in SirEdward's advocacy of a ratio--three to one--between notes and gold,and the Committee's support of the old fixed line system. By thelatter, 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 becancelled. Under Sir Edward's policy the influx and efflux of goldwould have an effect on the note issue which would be three times theamount of the gold that came in or went out. This at least is thelogical effect of his statement that "the notes should not exceedthree times the gold or the cash balance." This law does not seem tobe quite consistent with his view that the fixed ratio of gold tonotes may be lowered by the payment of a tax; but presumably the taxwould come into operation before the three to one part was reached,and at three to one there would be a firm line drawn. On thisassumption the Committee's argument is a very strong one. "If,"says its report (Cd. 9182, p. 8), "the actual note issue is reallycontrolled by the proportion, the arrangement is liable to bring aboutvery violent disturbances. Suppose, for example, that the proportionof gold to notes is actually fixed at one-third and is operative.Then, if the withdrawal of gold for export reduces the proportionbelow the prescribed limit, it is necessary to withdraw notes in theratio of three to one. Any approach to the conditions under which therestriction would become actually operative would then be likely tocause even greater apprehension than the limitation of the Act of1844." Certainly if, during a foreign drain, for every million of goldthat went out, another two millions of credit, over and above, hadto be cancelled, it is easy to imagine a very jumpy state of mind inLombard Street and on the Stock Exchange. Sir Edward and the Committeeseem to be agreed as to a limit on the note issue, but of the twolimiting systems the old one advocated by the Committee, thoughapparently more severe, would seem to have much less alarmingpossibilities behind it.
A point on which the commercial world does not seem to have made upits mind, however, is whether there should be a limit at all. Underthe old Act there was a limit which could only be passed by a breachof the law. Under the Cunliffe proposal the limit could be passedwith the consent of the Treasury. Sir Edward has not told us of whatmachinery he proposes for the passing of the limit which he lays down;but in view of the great apprehension that an approach to the limitpoint would, as shown by the Committee, produce, it is clear thatthere would have to be a way round. In Germany there is no limit; youpay a tax on the excess issue and go on merrily. In America it wouldseem that the German system has been taken for a model. In his speechon January 29th Sir Edward quoted Senator Robert Owen, who was theprincipal pioneer of the Federal Reserve Bill through the Senate, asfollows:--"The central idea of the system is elastic currency issuedagainst commercial paper and gold, expanding and contracting accordingto the needs of commerce.... It is of great importance that the volumeof these notes should contract when the commerce of the country doesnot require the notes to be circulation, and the reserve board canrequire them to be returned by imposing a tax upon the issue....

Under the reserve system a financial panic is impossible. People willnot hoard currency nor hoard gold when they know that they can getcurrency or get gold when required.... America no longer believesa financial panic possible, and therefore the business men, beingperfectly assured as to the stability of credits, do not hesitate toenter manufacturing and commercial enterprises from which they wouldbe deterred under old conditions of unstable credit." Well, let ushope the Senator is right and that America is right in believing thata financial panic is no longer possible there. But one cannot helpfeeling that such a belief may be rather dangerous in the minds ofpeople so ready to take rose-coloured views as our American cousins.The Federal Reserve system has worked beautifully in a period inwhich American finance has had nothing to do but rake in the enormousprofits of American production at the expense of warring Europe andlend 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 isdifferent, but it will be interesting to see--for those of us who liveto see--what sort of a tax will be needed to "require" America, in oneof its holiday moods, to return currency that it thinks it needs andthe Federal Reserve Board regards as redundant.
Another point on which Sir Edward lays great stress, in his attackon the Bank Act of 1844 and the Committee which supports its mainprinciples, is the beauty of the bill of exchange as backing for anote issue, as opposed to Government securities. "There is," he says,"no automatic system for the redemption of currency notes as would bethe case if they were issued against bills of exchange, which in duecourse would have to be paid off." Again, "it seems to me that notesshould not be issued against Government securities which may or maynot be paid off, but against bills of exchange which must be met atdue date." This advantage about a bill of exchange is a very realone to the individual holder who can always put himself in funds byletting the contents of his portfolio "run off"; but is there muchin it as a safeguard against excessive issue of currency in times ofexuberance? In such times bills that fall due are pretty sure tobe replaced by new ones drawn against fresh production--sinceover-production is a common symptom of commercial exuberance--oragainst 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 creditand currency, the notion that the maturing of bills of exchange can berelied to restrict currency expansion within safe limits is surely adangerous assumption. The principle of a fixed limit, to be broken incase of real need, but only after some ceremony has been gone throughgiving notice of the fact that a crisis has been reached, seems ratherto be required by the psychology of speculative mankind. But even ifSir Edward's preference for bills of exchange as backing for notes hasall the merits that he claims that is no reason for urging the repealof the Bank Act to secure their use. Because the Bank Act does notforbid it: it merely says, "there shall be transferred, appropriatedand set apart by the said governor and company to the Issue Departmentof the Bank of England securities to the value of," etc. It is thepractice of the Bank to put Government securities into the IssueDepartment, but the terms of the Act do not compel them to do so, andif an excess issue were needed they would seem to be empowered to putany bills that they discounted into the assets held against the noteissue. On the whole the terms of the Act leaving them freedom in thematter, except with regard to the "Government debt" of L11 millions,which is specially mentioned as to be transferred to the IssueDepartment, seem to be preferable to a special stipulation in favourof bills of exchange.

But the most important difference between Sir Edward Holden and theCunliffe Committee seems to be in their attitude towards the goldreserve and the relation between the Bank of England and the rest ofthe items that compose the London money market. The Committee, workingto restore the conditions which made our market the centre of theworld's finance, endeavoured to give back the control of the centralgold reserve to the Bank of England by suggesting, among other things,that the other banks should hand over their gold to it. They omittedto discuss the serious question of the greater difficulty that theBank is likely to find in future in controlling the price of money inthe market, owing to the huge size that the chief clearing banks havenow reached. But a central gold reserve under central control wasevidently the object at which they aimed. Sir Edward will have none ofthis. He says that if this were done the position of the Joint Stockbanks would be weakened, though he does not explain why, since theywould obviously hold notes in place of their gold and so would be ableto meet their customers' demands, now that the latter are accustomedto the use of notes for pocket money. He points out that "the goldwhich was held by the Joint Stock banks before the war proved mostuseful.... At the beginning of the war the banks paid out gold,satisfied the demands of their customers for small currency, and thuseased the situation until currency notes became available." He seemsto have forgotten that the banks, or most of them, refused to partwith their gold, paid their customers in Bank of England notes which,being for L5 at the smallest, were of little use for pocket money, andso drove them to the Bank to get gold; and we had to have a prolongedbank holiday and a moratorium. Sir Edward is in favour of three goldreserves, one to be held by the Government, one by the clearing banks,and one by the Bank of England. If there were differences between thethree controllers of the reserve at a time of crisis the consequencemight be disastrous.

In view of the admiration expressed by Sir Edward for the new Americansystem which is so clearly based on central control it is ratherillogical that he should be so strongly in favour of independence onthis side of the water. His opinion is that "the policy of the JointStock banks ought to be to make themselves independent of the Bank ofEngland by maintaining large reserves in their vaults." Independenceand individualism are a great source of strength in most fields offinancial activity, but in view of the great problems that our moneymarket has to face there seems to be much to be said for co-operationand central control, at least until we have got back to a normal stateof affairs with regard to the foreign exchanges.