Money - Bill Brokers And Discount Houses
( Originally Published 1909 )
WE have seen that the main functions in the manufacture of credit and currency are performed by the cheque-paying banks, and we have now to examine the operations of several minor but important subsidiaries, which the specializing tendency of civilization has called into being.
The banks manufacture money by making advances, that is, giving the right to draw cheques, against all kinds of security and by buying or, according to the technical phrase, discounting bills, that is, giving the immediate right to draw a cheque or cash in return for an instrument which conveys the right to cash at a later date. The bill-brokers appear to have originally performed the function of intermediaries between the banks who were buyers of bills and the merchants who had bills to dispose of. This function they still carry on to a great extent, and, in so far as they remain bill-brokers, this is the chief part of their business. But several distinctions have arisen through the natural tendency to diversification of function, and it may now be said that there are roughly three classes of firms to be included under the titles which head this chapter.
(1) There is the bill-broker pure and simple, who devotes himself entirely to taking a parcel of bills from the merchants, accepting houses, foreign and colonial banks, and other chief agents, who receive them in batches by every mail, and selling them there and then on the best terms that he can obtain, receiving a commission for his pains, and for his knowledge of the market. This variety, which is the real survivor of the original bill-broker, is now comparatively rare. It is commonly described by the term " running broker."
(2) There is the retail dealer in bills, who is still generally called a bill-broker, but does not work on commission but buys bills outright, either from the running broker, or from the merchants and accepting houses, or from foreign correspondents, but nevertheless does not, as a rule, hold them himself until they mature, but sells them to the banks and other buyers, selecting the dates and classes of paper that the several buyers may happen to require. From the nature of his business, the retail dealer requires more capital and credit than the bill-broker pure and simple, because it may sometimes happen that his goods may remain on his counter for more or less time, until they happen to suit the fancy of a purchaser. His capital, however, is, as a rule, small when compared with the volume of his turnover, and he depends on credit, most of which is advanced by the banks, for the financing of the bills of which he daily remains the holder. It will be remembered that the banks habitually have consider able sums lent to bill-brokers "at call and short notice," and that these loans were described as their second line of defence, as being most easily called in. Their first line of defence, as need hardly be repeated, is their holding of "cash in hand and at the Bank of England."
(3) Out of the retail dealer in bills has grown the discount house, an institution which still does a certain amount of retail business, but is at the same time in a position, owing to larger capital and more extended credit, to "run a much bigger book," as the jargon of the craft would phrase it ; that is, the discount house is to a greater extent a permanent holder of bills and depends in a minor degree on the momentary fluctuations in the price of credit.
Nevertheless, the discount houses are very large users of borrowed money, and regularly announce rates which they allow to depositors, these being generally slightly above the rates offered by the banks. Owing to this fact, of the slightly better rate allowed by them, they generally have the control of a considerable amount, placed on deposit with them by merchants and financiers, but at the same time, though their dependence on credit supplied by the banks is not as great as in the case of the retail dealer in bills, it is still sufficient to make a serious difference to their operations, whenever the banks have occasion to reduce their loans. Having thus, for the sake of being perspicuous, classified and distinguished the three kinds of dealers in bills, we may proceed to eliminate the real bill-broker, the almost obsolete dealer on commission, and to apply the term bill-broker to the two classes who have grown out of him and are still called by his name, in accordance with the consistently illogical manner in which the City applies titles and descriptions.
As we have seen, the distinction between the other two classes is solely one of degree, the degree being the extent to which they hold bills permanently, and depend for financing their operations on credit obtained from the banks.: At the head of the body stand some few private firms of old standing, great wealth and first-rate credit, side by side with two big companies which have applied the joint-stock system with considerable success to the business of dealing in bills, and an old firm which has now been joint-stocked, but whose capital is held privately and in few hands. Under this leadership the market is compact and well-organized.
The business is one which requires exceptional abilities and alertness, and the market rate of discount in London is perhaps the most sensitive and trustworthy barometer of international monetary conditions.
It was stated in the last chapter that the market rate is regulated in normal times by the banks, and we have now seen more clearly why this should be so, having found that the bill-brokers depend to a great extent on the banks both to supply them with credit and to buy bills from them. Nevertheless, though the average level of the rate is thus regulated, the action of the bill-brokers themselves has an important influence on its daily fluctuations and so may make a considerable difference to the movements of the foreign exchanges.
In order to realize the complicated nature of the problem that has to be solved by a bill-broker whenever he buys or sells a bill, let us endeavour to enumerate some of the chief considerations which determine his judgment on the points that have to be borne in mind. We will suppose he is offered a line of first-class paper due in three months' time, the present date being the last week in June.
But first it will be necessary to try to get a clear understanding of the meaning of the terms in which the discount market expresses the conduct of its business.
We will suppose then that the bill is offered to the broker at 4 per cent., that is to say, that 4 per cent. per annum is the rate of interest which is deducted from the face value of the bill, which it will realize in three months' time, in order to induce him to give cash for it. In other words, he is asked to give £99 today for each £100 in the amount that he will receive on presentation of the bill on maturity. As the calculation of discounts is very puzzling to the uninstructed inquirer, perhaps it is better to be still more arithmetically elementary, and point out that as three months is a quarter of a year, the 4 per cent. per annum is divided by four to arrive at the discount for three months, and hence it is that since the current discount rate is 4 per cent., we must knock £1 off each £100 of the bill's face value on maturity in order to arrive at its cash value on this basis. This rough calculation is only an illustration, of course, and the bill-broker, or his clerks, will work the problem out much more finely on the actual number of days in the bill. What has to be made clear is the fact that a bill is a security with a price, just like the stocks dealt in and quoted on the Stock Exchange, but that, instead of quoting the cash price for it, the market quotes the discount or the difference between its cash price and its face value on maturity. It is quite reasonable and simple when one thinks it out, that an instrument that will realize £100 in three months' time should only be worth £99 at the present moment, if 4 per cent. per annum be a fair rate to cover the probable fluctuations in the value of money in the meantime. But the number of people who have never taken the trouble to work out this elementary but tiresome problem, and consequently flounder when they think or talk about the discount market, is a continual astonishment, and must be my excuse for giving so much space to a statement which is about as informing as 1 + 1 = 2.
Another frequent cause of confusion in this connection, though it also is dissolved by a moment's thought, arises out of the fact that the market is described as firm when discount rates go up, that is, when the price of the bill goes down. A firm discount market would result, we will suppose, in a rise in the discount rate from 4 to 4 1/4 per cent., and the result of this would be that the cash value of a bill with a year to run (for the sake of simplicity) would fall from 96 to 952. It is quite clear and reasonable that if money is more valuable the present price of a bill that will not mature for a year becomes less, because the buyer is giving immediate cash in return for the promise of cash a year hence. But to people who are accustomed to the expressions current on the Stock Exchange the notion of a firm market resulting in a fall in the price of the securities handled in it is often very confusing, for on the Stock Exchange, when they talk of a firm market, they mean one in which there ' is a strong demand for the securities handled by it and a consequent rise in prices. When the Consols market is firm Consols go up, when the discount market is firm bills go down, which is only another way of saying that discount, which is the commodity in which the market really deals, goes up.
All this is very platitudinous, but I have known an occasion on which a financial journalist was taken to task, by a man of high standing in the City, for stating in his money article that the discount market was weak, with easier rates, owing to the scarcity of bills. In this case a practical banker of many years' experience had fallen into this trap, so that I must be excused for giving a considerable amount of space to the endeavour to warn less well-informed inquirers against it. EA moment's thought shows that when bills are scarce and in demand, buyers who want them will have to take them at lower rates, that is, at higher prices, so that the newspaper statement objected to was perfectly correct.
Having done our best to put a fence round this tiresome pitfall, let us return to our bill-broker, who is still wondering whether to buy a parcel of three months' bills at 4 per cent. in the last week of June, and let us examine a few of the principal factors that will determine his decision.
In the first place he has to consider the immediate circumstances of the market and the prospect of his being able to resell the bills immediately at a profit, or to finance them comfortably if he be obliged to retain them. The last week of June is a most unencouraging period from this point of view. The close of the two halves of the year are habitually marked by two processes, both of which severely restrict the supply of credit and of cash. In the last week of June and the last week of December an enormous volume of actual payments is made throughout the country, increasing materially the demands on all the banks for cash, and, at the same time, a large number of firms and companies, including some of the banks themselves, are making preparations for their half-yearly balance-sheets, that is to say, reducing credits granted to customers, and so increasing the proportion of their holdings of cash.
As there is not enough cash to meet these two demands, it is nearly always necessary for the Bank of England to fill the gap ; and in the period immediately preceding the turn of the two half-years it is usual for borrowers to go to the Bank of England and obtain credits with it for sums which sometimes amount to fifteen or twenty millions. Part of these credits is used for the withdrawal of actual currency, notes and gold, for the cash payments that have to be made all over the country ; the rest is left to the credit of the borrower or some one to whom he transfers it in the books of the Bank of England, and the financial community is thus enabled to show a fine round sum of "cash in hand and at the Bank of England," a credit in the Bank of England's books being universally regarded as quite as good as, and much safer than, so many sovereigns in the pocket.
Our bill-broker, of course, has no need to think of all this ; it is all so well known to him that it is part of his being. But it is a very important factor in the problem that he is debating. For the first consequence that arises is the probability, or certainty, that he will be unable to resell the bills to the banks, or to other regular buyers. At such a season, the banks are most unlikely to increase the number of their bills, and will probably not even replace those that fall due and are paid off.
They will have a considerable stock of bills in their portfolios bought with a view to the cash demands at the end of the half-year and maturing within this very week ; and the maturity of this paper will be one of their weapons in providing the cash that they will require for their customers and themselves.
Since, then, the bills under consideration by the bill-broker will not be easily convertible into immediate cash, he is faced by the problem of having to finance them himself. And from what has been said above it is clear that during the next few days this is likely to be an expensive matter.
As we have already seen, the bill-brokers depend largely on a supply of credit from the banks for financing their business, and our friend has, in all probability, been already apprised by his bankers and other providers of credit that they have, at the present moment, other uses for their funds. For the advances to bill-brokers have been described as the banks' second line of defence, and when they wish to increase their first line, which is their cash in hand and at the Bank of England, or to maintain it when it is diminished by their customers' demand for currency, they at once do so by calling in these loans to bill-brokers. So that far from expecting to be able to obtain the where-withal, from ordinary sources, for financing the parcel that is offered, the bill-broker in question is probably already severely pinched in the matter of credit, and knows that if he takes these bills he will have to borrow from the Bank of England in order to pay for them. And borrowing from the Bank of England is an expensive operation, since it usually charges, for advances, 1 per cent. above its official discount rate, which, again, is almost always well above the loan rates current in the outside market. So much for the adverse aspect of the immediate conditions. Against them we have to set the keen- ness of the seller, which induces him to offer an exceptionally fine parcel of bills at a rate which is tempting to the buyer, a high rate, that is to say, which means a low price for the bills ; also the fact that as most buyers of bills are cramped in the matter of credit by the seasonal demands already alluded to, and so are not in a position to compete eagerly for them, the present moment is a time in which the bold bargain-hunter, prepared to face the inconveniences of the moment, can often reap fine profits by the exercise of a capacity for disregarding immediate loss.
The forbidding appearance of the immediate conditions thus works both ways. In order to take the bills the broker knows that he will have to borrow from the Bank of England for at least a week, and that the higher rate paid for this temporary accommodation will make a hole in the profit that he hopes to make on the bill during the course of its currency ; but if future prospects are inviting he will be willing enough to do this, and it is the future prospect that will sway his decision.
And now the vastness of the problem really begins to open itself out, and our broker, if of an imaginative turn of mind, may well fancy himself like a doubtful partisan, standing on a hill-top and vainly trying to peer through thick mists, with the aid of a somewhat inefficient spy-glass, into a great plain in which a battle is being waged by a number of forces of shifting and incalculable strength, and knowing that his life depends on throwing in his lot with the winning side.
In the immediate future there lies the probability of a spell of cheap money, when the usual reaction takes place after the satisfaction of the temporary demands at the end of the half-year, and after the distribution of the dividends on Government stocks early in July, which results in transferring to the hands of the ordinary banks some four or five millions previously held by the Bank of England on behalf of the Government. These millions then become available at the market rate for loans, instead of at Bank rate, or 1/2 per cent. above it. After that, according to the normal tendency of the year's monetary history, the demands of holiday-makers and harvesters at home ought to begin to tell ; while the great demand for currency all over the world, which generally shows itself during the autumn, when the crops of the chief agricultural countries are being gathered and garnered and shipped to the consumers' markets, ought just to be showing its force during the latter period of the currency of the bills offered, so that their date of maturity should be happy, enabling the holder to replace them on favourable terms.
According to the normal behaviour of monetary events, the buyer of a bill at a good price at the end of June ought thus to be able to reckon on a short spell of ease during which he would be able to finance his purchase on very favourable terms perhaps getting his money at 2 per cent, against the bill which we suppose him to have bought at 4 per cent.---and a gradually hardening tendency, which should not, however, reduce him to the necessity of giving more for his money than he was earning on his bill, or being obliged to sell his bill at a loss, owing to inability to provide the wherewithal to carry it.
But it need not be said that monetary events do not habitually move along the lines of normal behaviour, and even along these lines a little swerve in one direction or another may suffice to upset calculations that have to be reduced to the fine terms required by the keen competition of the discount market in London. The slackening of general trade may greatly reduce the demands of commercial customers on the banks, and so throw a mass of credit back on them which they will pour out among the bill-brokers at nominal rates; a quickening of trade may have an equally marked effect in the other direction and upset all expectations of the spell of easy money which was to have made the holding of the bills a profitable transaction. A cold, wet summer will check holiday travel and expenditure, while a brilliant season will send a shower of currency through tourists' pockets into the hands of hotel-keepers and others who provide for their wants; and the extent of this outward tide will be among the innumerable items that will affect the volume of what is called money in Lombard Street. The quality and date of the harvest is another matter that affects the monetary position, and in calculating its probabilities the weather has once more to be allowed for; for if at the harvest season something like an ideal English summer is reigning, and farmers think that they can rely on the continuance of favourable skies, they will proceed leisurely and gradually, and the supply of currency that they will require be so much the less ; but if the season is capricious, and a burst of harvesting weather arrives, everybody will want to save his crop at once, and each farmer will be pouring all the labour that he can get on to his fields and wanting money for wages, and for all the other expenditure that moving a crop entails.
And when he has balanced, as well as he can, the chances of trade, travel, and harvest requirements, the bill-broker must not forget the possible effects of an equally elusive factor, namely, the demands of Government finance; these do not, as a rule, count heavily at the period during which the parcel of bills offered is supposed to be current ; as we shall see in a later chapter, it is in the January to March quarter, when the income-tax is being gathered, that the money market is habitually pinched by the transfer of cash to the Government's balance at the Bank of England ; but throughout the year it is always possible that the Treasury will intervene with some unexpected demand in the shape of an issue of Treasury bills, or, on the other hand, may make money unexpectedly plentiful by allowing its balances to run below their normal level. For owing to the fact that the Bank of England is the Government's banker, the Government's money is in its hands, and consequently when the Government holds an unusually large sum, there is so much locked up, and not available in the outside market. So that the amount of the Government balances is always one of the items in the monetary problem, and the difficulty of calculating it is increased by the Olympian aloofness with which the Treasury conducts its operations far away from the chaffering and huckstering of the market which it often affects so profoundly and also by the Oriental mystery in which the movements of Government finance are shrouded.
And as if weather, trade, and Government finance were not sufficiently incalculable factors in the problem, there arises the purely psychological question of the possible extent of speculation on the Stock Exchange. We have seen that the banks, which supply the bill-broker with money, employ a considerable amount of the credit that they make and handle, in financing the requirements of those who buy stocks and shares and pay for them with borrowed money.
Consequently, if an unusually large number of people come to the conclusion that a purchase of securities with borrowed money is likely to be profitable, the supply of money available for the bill-broker may be curtailed. And the reasons which suddenly impel the public to indulge in one of its periodical outbursts of speculation are, perhaps, as complicated a psychological problem as anybody could ever be asked to solve.
And yet we are still only on the threshold of the bill-broker's difficulty.
For all these things happen, or do not happen, at home and more or less under his own eye, and when he proceeds, as he must, to consider the possibility of foreign demands, he is face to face with questions which are much more difficult to answer and much more important in their effects. The movement of currency into the country for harvesting and holiday purposes, or the piling up of the Government's balance at the Bank, or the demands arising out of an unexpected outburst of speculation, may cause inconvenience, and perhaps, if their effects are particularly unanimous and untoward, make a serious difference to the profit on a bill: but a sudden foreign demand and a considerable export of gold might easily be followed by a complete alteration in the whole aspect of the market a rise in Bank rate and a readjustment, for the time being, of the value of credit at home and abroad.
Having devoted so much space to the consideration of the bill-broker's problem, and having discovered that we have only touched the surface of it, it seems wiser on the whole to leave him with his problem and our sympathy. For any attempt to enter in detail into the innumerable causes which affect the demand for money abroad would lead us into a discourse of most formidable area. But it may be mentioned incidentally that the risks of foreign politics and of international friction, the mere hint of which is often sufficient to affect the sentiment of the money market, are among the items in the enigma which has to be solved, or guessed at, by our bill-broker before he arrives at his decision. And it need not be said that any serious shock to credit occurring in any part of the commercially civilized world might easily upset all his calculations.
It is not, of course, implied that all these matters are actually revolved by a bill-broker before he makes up his mind about any of the numerous transactions which make up his day's business. If this were so, the work of the discount market would never get itself done. But they, and many more, are the data on which he has to work, and a rough-and-ready view of the balance of all these possibilities and hypotheses has to be at the back of his head somewhere in his sub-conscious intelligence.
The essential difference between him and the banker lies in the fact that the banker makes credit, while the broker sells credit, relying on being able to buy it cheaper. The conditions most favourable to the broker are a high discount rate, which is the price of the credit that he sells, and a low rate for money, or short loans, which are the credit that he buys. The broker has need of keen and sensitive alertness as opposed to the level-headed sagacity which is the most necessary asset of the banker.
But the most important feature in the position of the bill-broker is that he constitutes the second line of the banker's defence, and consequently first feels the effect of any monetary pinch. If money is wanted suddenly by other customers whom bankers think fit to oblige, or if it is thought necessary to restrict the supply of money, the advances from bankers to bill-brokers are likely to be straightway curtailed. And this is an additional reason which makes a large supply of alert and open-eyed intelligence so necessary for his success.