London - The World's Monetary Clearing House
( Originally Published 1909 )
So far money has been dealt with chiefly as a matter of internal experience, and from the point of view of the relations between the Englishman and his banker. In the account given of the origin and development of the bill of exchange the horizon was expanded for a time, but otherwise our attention has been concentrated on the forms of cash with which we English buy and sell commodities and services, and the process by which these forms of cash, and the right to draw and use them, are created by our bankers and their customers, through loans against goods and securities.
But the money market is a very much bigger and more interesting affair than it appears to be from this merely insular examination. It is, in fact, the most interesting of all markets, because it is world wide to a greater extent than the market in anything else, with the possible exception of wheat.
The use of money in cash transactions is obviously world-wide ; wherever men buy and sell they must use some medium of exchange which is commonly accepted in their country, even though it be only an inconvertible paper dollar printed at the caprice of a Central American Republic. But money in its wider sense, in the sense of bankers credits, is also a matter of world-wide use, or at any rate demand, and it is only in London that money of this kind is to be had freely, and in the fullest meaning of its real definition, which implies, as we have seen, the right to demand, and the certainty of receiving, payment in gold.
It is clear that in order to be of any use in international finance, money must be immediately and unquestionably convertible into gold, the only form of payment which is universally and always acceptable in economically civilized countries. And money of this kind is only to be had in London.
In a pleasant American comedy produced very many years ago, one of the characters, holding out a bundle of papers to her husband, exclaims,
What's this ? You said you'd give me some money I" " That's so," says the husband, "and so it is. Why, it's Wabash ! " Wabash was the name of a railroad stock of somewhat problematical value, and quite useless as a medium of exchange for the purposes of household shopping. And any one who has a credit in any other centre but London, is liable to find himself, when he tries to realize it and turn it into cash, met by an offer of Wabash, or something equally inconvenient for his purposes.
The French are clever and versatile financiers, and the unfailing thrift which distinguishes the inhabitants of their country gives it a great and almost unsatiable power of absorbing investments, so that Paris is a very important factor in the international loan market. But the French temperament is essentially cautious, and the Bank of France does not attempt to do the business that we regard as banking, which includes readiness to meet all demands in gold. Its notes are convertible, but convertible at its option into either gold or silver; and it frequently takes advantage of this option, when it considers it undesirable to part with its gold. So that any one who has a credit in Paris has a credit which is of no international value, except in so far as he can make use of it, by means of the machinery of exchange, to buy a credit in London, which is convertible as a matter of course.
In theory Berlin has a gold standard, and the notes of the Imperial Bank are theoretically payable on demand in gold. But Germany is young as a financial nation, and its banks have been so busily and deeply engaged in promoting the industrial activities of the country that their resources and energies have been hitherto absorbed by this task, which they have performed with great success.
Consequently they have not yet addressed themselves to this question of international banking and of being prepared to meet all demands on them in gold ; and any one who wants to draw on the Imperial Bank's store to any large extent is likely to find obstacles and difficulties in his way, and is moreover likely to be met with a most discouraging countenance when next he requires accommodation.
With the store of sagacity and scientific method that it has available, it is probable enough that Berlin may one day rise to the full responsibilities of a monetary centre, ready to face the real tasks of the international banker. At present, it is chiefly engaged with the solution of internal problems.
In New York the right to gold is less ostensible, but in ordinary circumstances more practicable. A credit in the United States carries with it the right to legal tender currency, and the general probability of securing what is called a gold certificate and turning it into the metal. But in the autumn of 1907, the whole American system broke down, and an interesting form of emergency currency, created to fill the gap caused by an outbreak of hoarding on the part of both the public and the banks, became the only available medium of exchange. It took the form of " clearing-house certificates " issued by the American banks, but whatever else they certified, it was not a certainty, or even a chance, of obtaining gold.
It is a cherished ambition among Americans to see New York some day established as the monetary centre of the universe, and with their vast natural resources and population there is no doubt that the United States can achieve any material tasks that they choose, if they can learn the necessary lessons and develop the necessary character. At present the characteristics of the typical American business man seem to fit him to do most things better than banking. His haste to grow rich, his eager enthusiasm and buoyant optimism followed by plunges into apprehension and depression, his quickness and versatility, his keen sensibilities, his craving for speculative excitement, and his genius in exaggeration all these qualities make him an excellent producer, a first-rate distributor, a miraculous advertiser, an unapproachable gambler, and a somewhat questionable banker. There are hundreds of good bankers in the United States, who take a scientific interest in the problems of their business such as is comparatively rare among their English brethren. But they are developed in spite of their environment, and of the atmosphere of eager enterprise which makes it difficult to observe the humdrum laws and limitations of banking. In 1907, the American banks were so strongly suspected by their own public of having made indiscreet use of their opportunities and capacities, that the public preferred to take care of its own money.
And American banking met the situation by refusing to meet demands on it. Banks that can be so suspected by their own public, and can meet the suspicion in such a manner, have much to do and undo before they can constitute themselves into an international banking centre. Thoughtful Americans, from whose illuminating conversation I have gleaned these explanations of the shortcomings of American banking, also point out that it has not yet distinguished between solvency after an interval, and readiness to meet demands at once and without question. It seems, they say, to think that it has done all that can be expected if it holds securities that will ultimately, if it is given time, be capable of realization ; and has not grasped the fact that no banker who takes a serious view of his banking responsibilities, could ask to be given time in meeting demands on him. The internal effects of the recent panic will doubtless soon be forgotten; but it will be long before international finance will look with much confidence on a draft on New York, which has been shown by experience to be inconvertible in times of crisis.
When it has lived down this lapse, and provided the confidence that is now lacking, and the necessary machinery of a discount and money market, American banking may set about making New York the monetary centre of the world. And an American can learn anything, if he thinks it worth while.
Some of the smaller centres meet drafts on them in gold, but their limited resources limit their powers. Practical financiers of all nationalities will admit that a draft on another centre is only valuable from the international point of view from the readiness with which it can be turned, through the machinery of exchange, into a draft on London, which is the real cash of international commerce and finance, because money in the real sense of the word, gold or its equivalent, is only to be had, always and without question, and to any amount, in London. But this is only one of several reasons which make London pre-eminent as the money factory. Its money is not only more genuine, that is, more undoubtedly convertible than that of any other centre, but is also under normal circumstances both more cheaply and easily produced to suit the convenience of the user.
In recent years London has not been able to boast that its money is cheaper than that of all other centres ; in the first place because the South African war destroyed a vast mass of English capital, and gave foreign countries, from which we bought material for it, claims on us which we have since then been painfully liquidating; and, in the second, because the great strain on the money machine caused by the extraordinary and world-wide activity of trade during the period which culminated in 1907, imposed 0n London, as the world's money factory, the necessity for guarding the basis of credit by the maintenance of high rates for money.
Perhaps it should here be explained that when a large and increasing number of people require money, or the right to draw a cheque, for trade or other purposes, they naturally have to pay more for it, that is, they have to promise more money some day for the money here and now that they borrow.
And the centre which alone is prepared to meet demands on it in gold is obliged to be especially careful to make them pay more, that is, to charge higher rates for money, so as to keep the demands on it within bounds, and also because, by charging higher rates, it attracts gold from abroad by a process which will be explained later.
But even though money was not always cheaper in London than elsewhere, it was always more easily to be had. In the case of the most obvious form of credit-raising, as for example when foreign governments are raising loans or American railroads are offering bond issues, there are times when France is a readier market for the borrower than England, owing to the greater thrift of the French people, which gives the Paris banks a bigger mass of accumulated capital to handle; but even then Paris often hands the borrower most of the money in the shape of a draft on London, and in times of uncertainty or strain London becomes the only place in which the loan-issuing machinery can work. ln the summer of 1907 Japan wanted a loan to spend on the South Manchurian railway. It was a most inopportune request, for at that time the springs of capital had dried up under the stress of intensified drafts on them, and all the foreign lenders, who had previously competed for the privilege of supplying Japan's monetary needs, were deaf to the appeal. But London, having in former years prospered by reason of Japanese loans, found the money, with a bad grace, it is true, and amid protests against borrowing at a moment so ill chosen ; but found it, at a time when in no other centre could such an operation have been contemplated.
This power is due to the unparallelled freedom and elasticity which mark the English system. It has been shown that bankers' money here merely means the right to draw a cheque, and is generally created by a banker lending it to a customer, who passes it on to a creditor, who pays it into another bank, and so one bank's loan becomes another bank's deposit. This system could be continued indefinitely if bankers were reckless, for the only checks on the multiplication of bankers' money are the supply of unpledged security, concerning the fitness of which as collateral the banker decides, and the relation that the banker thinks it right to maintain between liabilities and cash assets. And when the supply of ordinary bankers' money runs dry, borrowers have, as we shall see in a later chapter, another source to tap in the Bank of England, which again can lend as freely as it pleases, for in its case its loans probably become its own deposits, and the only restraint imposed upon it also is discretionary regard for the proportion between its cash and liabilities.
Now this elasticity is found nowhere else. In New York bankers have to keep their compulsory 25 per cent. of cash to liabilities, and the multiplication of credits, which create liabilities, is thus restricted by law. And the legal tender currency of the United States is ,peculiarly inelastic, though efforts are now being made to correct this defect.
In Paris the amount of the note circulation of the Bank of France is limited by law, and the credit facilities available are limited by French caution and fear of taking risks. In Berlin complete elasticity exists in theory, and this theoretical elasticity of the German system is sometimes held up as a model for imitation in England, by reformers who fix their attention on the regulations in the two countries relative to the issue of bank-notes. In this respect Germany can certainly claim greater freedom. In England, as we have seen, after a fixed limit has been passed, not a note can be issued ç unless backed by gold ; in Germany, also, there is a limit on the number of notes that may be issued against securities, but it may be passed at any time on payment of a tax of 5 per cent. interest on the further issue, and consequently when borrowers are prepared to pay more than 5 per cent to the Reichsbank, it can manufacture notes for them as rapidly as it considers to be prudent.
The elasticity of the German system thus only arrives when money is at a high price, and in England elasticity is constant and chronic, since the supply of currency here does not depend on the number of notes issued, but on the power of the community to draw cheques which is furnished to it by its bankers without any legal restriction, and subject only to the limits imposed by the prudence of the bankers, and the supply of unpledged security. The German system is very scientific and excellent on paper, for a banking machine which is at the note-issuing stage of development. Under it notes can always be had at a price, and the high price involved reduces their volume when they are no longer needed.
But we have seen that, at present, the preoccupation of German banking with the task of financing industrial development imposes restrictions on its other activities ; and hitherto the elasticity of its currency arrangements has been hindered, for international purposes, by the fact that the' currency created is not, in practice, to be relied on as completely and unquestionably convertible.
The success with which Germany has faced and dealt with other problems makes it highly probable that this one of international banking will be faced by it and dealt with in due course.
But at present it leaves the responsibility to London.
The frequent assertion that money and a money market in the full sense of the words are only to be found in London, is not made by way of vainglorious boasting of English supremacy in this respect rather, as will be seen later, because the very fact carries with it a danger and a responsibility that must on no account be lost sight of in any examination of London's monetary position. I am not attempting to deduce, from the unquestionable fact that London is the only monetary centre that is always ready to undertake the full responsibilities of international banking, that Englishmen are naturally abler and more trustworthy bankers and financiers than any other nation. There is much to be said for this contention, and both the virtues and defects of the English character help it to produce good bankers. But it must be admitted that English bankers have had the advantage of longer and less interrupted experience, and that exceptional circumstances have enabled them to make full and profitable use of it. At present, however, we are dealing with the facts of the present day and their consequences rather than their causes.
Quick-witted foreigners were very ready to see the advantages which London's credit system pro- vided for them. " Lo ! " they said, " here is a banker who has the courage to be prepared at all times to pay demands on him in gold, and the good luck or some other quality which enables him to do so.
Moreover, he has a delightfully simple system by which any one who borrows from him becomes his creditor. "Let us go and get a credit in London."
So they brought their securities and borrowed on them, or brought their bills and discounted them, and so raised credits here, which they were enabled to count in their balance-sheets as so much gold in hand. And all this suited London very well, because London, being a banker and not a philanthropist, always charged its foreign or any other customers rather more for the loans and discounts than it allowed them for the credits so created, and also made various commissions and profits out of the process. And the foreigners, having begun the system of depending on London as a banking reserve centre, found it convenient to continue, and many of them decided that it was not safe to keep credits here which were only produced by borrowing, and that they ought to have more real balances in London which were really their own ; and so they sent over goods or securities to be sold here, and left the money in London as a gold reserve. And this again suited London's convenience very well, for it took the goods and securities in exchange for its promise to pay, and now has the use of its customers' money to lend to other people. Which it does with easy freedom and profit to itself, and is enabled to continue to earn and expand this very comfortable income by merely being prepared to meet demands in gold, when called upon. This may seem to be rather an easy mode of earning a living, but the responsibility is, in fact, so great that no other centre tries to do business on the same lines.
But lest it should be thought that this account of the relations between London and her foreign customers is a creation of a bombastic fancy of a patriotically biassed Briton, let me quote an American opinion.
In 1901 a meeting of the American Bankers' Association was held at Milwaukee, and a paper was read by Mr. A. B. Stickney on the " Medium of Exchange and the Banking Function." In the course of this discourse he made the following remarks :--
" England has so organized her capital by means of her magnificent banking system that she is the banker of the world, and collects tribute from all the nations of the world in the form of interest, not for the use of her wealth or capital, but for the use of her credit. Paradoxical as it may sound, it is literally true that by means of her splendid banking organization England collects interest upon millions and millions of her own indebtedness to other nations. It is a very profitable business to collect interest on what one owes, and it is this which makes England the creditor nation."
The same interesting paper, which is printed together with many other thoughtful and illuminating utterances by practical American financiers, in a book called " Practical Problems in Banking and Currency," throws some light on the vexed question of the divergent interests of English trade and English finance, which make some English traders hostile to the international banking business done by their bankers. Mr. Stickney tells them that the wares of commerce follow the drafts of commerce," in other words that the unrivalled international trade done by this little island is partly due to its unrivalled banking system. " I venture to suggest," he says to his American audience, " that you may subsidize ships to sail the seas, and your armies and navies may carry the flag to all the islands of the seas, but you will never control the commerce of the world, nor the wealth of the world, nor the world itself, until you have a banking system which can manage the exchanges of the world during commercial crises, and maintain at all times a fairly uniform rate of interest."
As to the maintenance of a fairly uniform rate of interest, London cannot compete with Paris. Paris, thanks to the protection given to the Bank of France by its right to meet demands in silver if it choose to do so, maintains a level of uniformity to which English traders, harassed by the greater fluctuations of Threadneedle Street, sometimes point with envy, But it is fair to remind English manufacturers that the big profits earned by London's international banking are a strong argument in favour of its advantage to the community as a whole, and that, even from their own point of view, it may be questioned whether the serene tranquillity of rates in France would not be readily exchanged by their French brethren and competitors for the ease and elasticity of credit operations as conducted here.
The business of managing the exchanges of the world during commercial crises is obviously thrown upon London, as things are at present, by its position as the only monetary centre which is prepared to produce gold on demand. In the autumn of 1907, when sudden crisis compelled the United States to liquidate their financial position, they ceased to a great extent from buying other people's goods, and began to sell everything in the shape of securities and commodities that they could dispose of, and, being a very rich and resourceful nation, held the civilized world in fee for the time being, demanding payment in gold.
Nearly all the gold shipped to New York at that time, estimated to have amounted to some twenty-five millions sterling, came from London.
But London, or the Bank of England, which, as usual at times of crisis, took a firm hold of London's operations, decided very early in the proceedings that it was not prepared to finance America's demands out of its own bullion-vaults. And so it raised its rate for money, and thus, by setting in motion a process, the working of which will be explained in a later chapter, pulled in gold from other centres to such an extent that some four-fifths of the amount shipped to the United States were supplied by foreign contributions.
It was, to all appearance, a very remarkable demonstration of London's complete control over the world's exchanges, and an interesting feature of the operation was the fact that Paris and Berlin, though obliged from motives of self-protection to let some of their gold go to assuage the American craving for it, did not send it direct to New York, but to London. Because they knew that gold that went to London could be got back again after a reasonable interval, but the state of affairs then prevalent in America made them very uncertain concerning the time that might elapse before the monetary arrangements of the United States could return to normal conditions.
It was thus shown, by the events of this memorable crisis, that London's tremendous responsibility of providing gold when it is required anywhere by a pressing emergency, is one that can be bravely and cheerfully borne as long as England is in a position, by applying sufficient twists of the monetary screw, to force other nations to contribute their share to the common necessity. And on the face of the matter it would appear that London's power to do so was demonstrated in a very unmistakable manner. Regarded superficially, the events of 1907 seemed to show that the Bank of England's rate has only to go up to a certain point, and the Bank Court need only to show a sufficiently stiff necked determination to put it still higher if necessary, for gold to pour in from other centres.
Nevertheless, it must not be forgotten that the great producing power of the United States was a potent assistance to London in this particular case. We have seen that the Americans left off buying other people's goods and sold everything they could sell, so making the rest of the world their debtor for the time being. And it is an open question as to how much of the gold that was drawn into London, and so on to New York, came because it was owed to New York, and how much was drained out of other centres by London's masterful policy.
In most economic questions, these insoluble problems lie under the surface, and it is because it is so easy to miss them, and to ignore, or be ignorant of, their presence, that many people find it easy to be quaintly dogmatic about economic matters, which, in fact, become more and more complicated and obscure, the more thoroughly they are understood.
But whatever doubt there may be as to the causes of the ease and success with which London carried through its task of managing the world's exchanges during the latest crisis, there is no doubt whatever that the task lay upon London, owing to its position as custodian of the only gold reserve which is available at all times to all comers.
And hence emerges the consideration that English banking, which we have already seen to depend on the sense and sanity of the public at home, is also liable to pressure and disturbance if the public anywhere in the world, in any centre in which economic development has made con- siderable progress, takes it into its head to mistrust the custodians of its money.
And this consideration opens up a wide field. Sense and sanity in money matters may be expected with a fair approach to confidence in the British public, and also in the public elsewhere. But elsewhere, in countries where banking is less soundly conducted, the public may at times, without any loss of its sense or sanity, find genuine cause to mistrust its bankers. The mistrust of its bankers shown by the American public in 1907 was probably misplaced, as far as most of the banks were concerned; but it arose largely from suspicion of the trust companies, which conducted banking business on questionable lines, and were suspected not without reason. Between the well-conducted banks and the ill-conducted trust companies, the American public, recognizing no distinction, could not be expected to discriminate. The strength of a chain is that of the weakest link, and the reputation of the banks of any country in the eyes of the uninformed public is, in times of difficulty and mistrust, that of the least ably managed.
This complication, to which the leading and most prudent English bankers are very keenly alive, accounts for the energy with which they try to impress on their more backward brethren the duty of maintaining a high ideal of strength and caution.
The latter are rather apt to resent what they regard as unwarranted and officious good advice from folk who, in their view, would do better to mind their own business. But banking in all countries hangs together so closely, that the strength of the best may easily be menaced if scandal arises owing to the mistakes of the worst.
But at present we are concerned with the foreigner ; since it has been shown that banking trouble in other countries is almost bound to throw strain on London, and that in other countries banking trouble may sometimes arise from bad banking, we begin to see how many possibilities have to be guarded against by the London money market, and with how many thousand eyes and ears and with how acute telepathic perception it has to watch the signs of financial weather. We saw, in examining the relations of the banks with their home customers, that the perfection of the system and the absolute smoothness of its working, sometimes produce its one defect, in the shape of an inability on the part of some few unimaginative bankers to see reason for counsels of austere prudence. And in the relations of the English money market with its foreign customers we find the same thing. The system is so perfect and elastic and easy, and works so freely and prettily, that at times it runs the risk of working just a little too well.
When Falstaff was ordered on active service again, immediately after his Shrewsbury exploits, he complained that " it was always yet the trick of our English nation, if they have a good thing, to make it too common." Our English nation has a good thing in a credit system of marvellous elasticity. Clever foreigners appreciate the beauties of it very fully and are always ready to make eager use of it, raising credits here by means of finance paper or other devices, and sometimes it happens that we "make it too common." At the time of the latest crisis, the London market was very well prepared for possible trouble, because it had recently suffered from a fit of virtuous self-examination on the subject of the kind of paper that it was prepared to handle, and the number of finance bills current had been drastically reduced.
But this is a matter which requires constant vigilance. It is not good business for the London market to give credits, too readily and too cheaply, against securities that could not easily be realized, to customers whose demands for cash are likely to be at any moment inconvenient. The problem of gold reserves, of which we hear so much from time to time, is only one side of a very big and manysided question ; another side is the necessity for holding only the most readily realizable assets, and yet another is the need for vigilance, common sense and promptitude in the regulation of the price of bankers' money. The double responsibility that the English money market has to face, of providing credit and currency for its home customers, and of meeting drafts on London from all parts of the world, in gold on demand, makes its functions doubly interesting. And these functions will be most simply set forth by means of a description of the various members which compose its body.
The chief and most important members of the London money market are the banks, bill-brokers and discount houses, accepting houses and foreign bankers, all of which are clustered round the central figure, the Bank of England. Their mutual relations and duties, and the manner in which the Bank of England regulates the action of the rest, can only be understood when we have seen with what class of work each of them is busied.