Money - Accepting Houses And Foreign Banks
( Originally Published 1909 )
IT ought by this time to be clear, unless the proportion of the perspicuity of this work to its tediousness has been most lamentably inadequate, that what we call money generally means credits with a bank, and that most of these are created either out of loans made by the bank or by some other bank, or by the discounting of a bill, which is only a special form of loan.
Further, the bill has been shown to have advantages over any other form of security, because the shortness of its currency ensures a speedy return of his cash to the holder, and because it is drawn, or ought to be, against actual produce moving into consumption, so that, as is claimed by those who deal in it, a good bill of exchange pays itself.
It will also be remembered that the original bill of exchange was an order drawn on the purchaser of the produce by the seller, instructing him to pay its price to himself or some other party at the end of a period during which the purchaser might be expected to have disposed of the produce, either in its original form or worked up for consumption by some process of manufacture. And the purchaser of the goods accepted the bill by signing his name across it that is, acknowledged that he would be liable for the sum named at the due date, and so became the acceptor of the bill. After which the bill, drawn by a good name and accepted by a good name, and with the necessary documents in order showing that goods had been duly shipped and insured, was as sound and attractive a security as the most sceptical money-lender could require, and could readily be discounted and advanced against.
It is necessary to pick up these threads which we left flying loose when we turned from the consideration of the forms of money to that of the principal wheels in the machine which produces money. Of these we have found that the banks are the chief, since they provide the right to draw cheques, which are the currency of English commerce, and give credits against indebtedness, which is called into being by the fact that trade habitually lives on the profits which it is in process of realizing, and could not proceed with its present unceasing velocity if it had to wait for their realization before it went on to its next task. Next we examined the operations and responsibilities of the bill brokers, the retail dealers in bills, who are, as it were, an offshoot of the banks specializing on the selection of bills to suit the requirements of the bankers as to date, etc., and keeping them in stock with the assistance of credits chiefly furnished by the banks. It is now necessary to consider the functions of those who manufacture the bills, against which the banks and discount houses jointly or severally provide credits.
In describing the bill of exchange in Chapter IV. we took the simplest possible case in order to keep the ground as clear as might be of confusing obstructions, and imagined an American farmer, Mr. Silas P. Watt, selling wheat to a London merchant, Mr. John Smith, and drawing a bill on him for the value of the produce. By so doing we not only attained a measure of clearness which would otherwise have been impossible, but also got down to the ultimate facts of the case. For the real manufacturers of real produce bills are still the grower of the produce and the merchant who handles it in its ultimate market. Without them the produce could not come into existence, and without produce there could be no bills, except of the kite-flying order, as drawn by Mr. Micawber on Mrs. Micawber.
Nevertheless, modern processes of specialization have introduced certain intermediaries between the producer and the merchant in the ultimate market.
As matters are arranged now Mr. Watt would sell his wheat to a merchant in his own country, and it would probably pass through many hands on paper before it was finally shipped. It would be financed in the mean time by advances from American banks, and the bill drawn against it, when finally shipped, would be drawn by an American bank or finance house on its correspondents in London, who would be a firm devoting much if not most of its time and attention to this specialized industry of acceptance.
Since this inquiry is confined to the machinery of money in London, we can leave out the producer and the American merchant and their bankers and confine ourselves to the London end of the bill, that is, the London name which is written across it, and so marks it as accepted.
It is easy to understand how a distinct class of accepting houses grew up out of the merchant importers who originally accepted bills in the course of their importing business, that is, accepted orders on themselves to pay for goods which were in process of being forwarded to them. The readiness with which the acceptances of the different merchants would be discounted and turned into cash would vary considerably with the difference in their reputation and standing, and the caution with which they were credited in the matter of conducting their business. And the varying readiness with which certain acceptances were discounted would inevitably express itself in varying rates at which their bills could be placed. It would thus naturally follow that it would profit merchants of second-rate standing to give a commission to those whose reputation was more exalted in order to secure a more attractive signature than their own, and so get back the commission and a little more by being able to finance their operations more cheaply than by means of their own acceptance.
The merchants of first-class credit would thus find that they could let out the use of their reputations on profitable terms, and proceed to specialize in this branch of business, which consisted in examining into the bills put before them for acceptance, keeping themselves well acquainted with the means and standing of the drawers of them, and giving their acceptance, for a commission, to such paper as fulfilled the requirements of their discrimination.
The foreign connections arising out of the original trading operations, with which they laid the first foundations of their mercantile position, naturally led these houses into providing monetary accommodation for the governments of the countries with which they traded, and there thus grew up out of the ranks of successful City merchants a class of merchant bankers, financiers and accepting houses, which, along with the old private banking houses, constituted a sort of aristocracy in the City, which still survives to some extent. They are often described as merchant bankers, but it is important to remember that they are not bankers in the strict sense of the term that is, they do not pay cash across the counter against cheques drawn on them because it is from their ranks that the directors of the Bank of England are chiefly recruited, and as we shall see in a later chapter, a director of the Bank of England must not be a banker.
The importance of the function of the accepting house need not be emphasized. If the producer of the produce is the original creator of the bill, it is the acceptor who, by his signature, gives it currency and hall-marks it for the purposes of the London market. A banker or broker who discounts a bill and parts with cash or credit in exchange for it, cannot be expected always to know the position and trustworthiness of the drawer, and must often rely on the name of the acceptor as his sole guide in appraising its merit. So that it is by the judicious and properly regulated use of their names that the accepting houses put into circulation an enormous mass of credit instruments, the supreme merits of which as liquid investments have already been insisted on with damnable iteration."
Nevertheless, the office of the accepting houses is still dependent on that of the banks, because the bills that they accept, though thereby greatly furthered in their progress towards becoming cash, do not actually become cash until they have been discounted. And this is done either by a banker or by a bill-broker, who works with credit, generally furnished to him by a banker. A bill that cannot be discounted is of no use to the holder until its day of maturity, and is not until then a credit instrument in any sense. And we thus come back once more to the supreme importance of the banks in London's monetary polity.
For the power of the accepting houses to give currency, by their acceptance, to paper concerning the merits of which they are best in a position to discriminate, is one that is obviously liable to dangerous abuse, and in their case the check of publicity is absent, since the private nature of their business keeps it free even from the ceremony of a half-yearly published balance-sheet. A very little carelessness, and very little error on the side of optimism, and a very little neglect of the principle that the basis of a real bill should be real produce moving into consumption, and there are all the materials for a dangerous inflation of credit. And the banks, which ultimately provide the means by which acceptances are turned into cash or credit, have thus an important responsibility thrown upon them, and one which is not apparent to the general public, to which the whole machinery of acceptance is more or less a mystery.
The question is complicated by the fact that, as has already been mentioned, the banks have them- selves undertaken the business of acceptance to an extent that has increased rapidly in recent years.
The excellent sanity with which the banks conduct their business makes this complication more ap- parent than real; and the dependence of the accepting houses on the good opinion of the cheque-paying banks concerning their paper is modified by the fact that they can ultimately have recourse to the Bank of England, through a bill broker. The Bank of England requires two London names on bills that it discounts, and a bill accepted by a London firm and endorsed by a London bill-broker fulfils its requirements. And the Bank of England has before now intervened with effect when the paper-of an accepting house has been unreasonably considered too plentiful by the other banks.
Nevertheless, the opinion of the banks concerning the paper of an accepting house is very impor- tant to it; and the position is curious which makes the banks at once the watch-dogs over the volume of acceptance, and large, increasingly large, acceptors themselves. It is possible that, in the early days of their experience in this line of business, the banks gave their acceptance too cheaply, and it is natural that the accepting houses should regard their intrusion into it with an unfavourable eye.
It is also very essential that the banks should remember that the least irregularity or carelessness on their part in the selection of the paper that they hall-mark with their acceptance might have very far-reaching effects, if it came to light and were the subject of City comment, because the general body of their customers and depositors would be extrembly likely to misunderstand it; and that what would be a mere indiscretion in an accepting house, which does not depend for its existence on the confidence of the uninstructed multitude, might mean disaster to a bank, which does.
At the same time, if watched over with due care, the growing interest of the banks in acceptance business seems to be a perfectly natural process arising out of the increasing requirements of the expanding trade of the world. It is difficult for the ranks of the old accepting houses to be recruited; it has lately been done with success, but a firm that enters on the business has to have capital and credit at its command, such as are rarely to be found in the hands of folk who are prepared to risk them in a new enterprise, the technicalities of which have to be acquired with patience, and perhaps through costly experience. The extent to which the old houses can accept is restricted by the obvious limits which are imposed on the amount of business, especially of business in credit, that can be done by any one firm. And the reputation and position of the banks seem to qualify them naturally to fill the gap.
An important part of the machinery of acceptance is also furnished by the Indian and Colonial banks, which, naturally again, give a large part of their attention to providing exchange between London and the country with which they are connected, and to handling the paper which its trade calls into being. The high reputation of the Indian banks, and the skill with which the bills endorsed by them are marketed, makes the prices fetched by their bills often a leading factor in the quotations of the discount market.
Finally, in considering the main springs which feed the flood of acceptance, we come to the London agencies of the chief Continental banks, which play a very important part both as sellers and buyers of bills. Foreign financiers were quick to detect the advantages of the English credit system, and to turn them to their own profit and to the furtherance of the trade of the countries that they represent. It is often contended that the rapid expansion of German trade, which pushed itself largely by its elasticity and adaptability to the wishes of its customers, could never have been achieved if it had not been assisted by cheap credit furnished in London, by means of which German merchants ousted English manufactures with offers of long credit facilities to their foreign customers.
An instructive example of this system of pushing business on credit, and of its disastrous results to all parties when carried too far, was lately furnished by the embarrassments of German traders with Japan. A letter from the Tokio correspondent of the Economist, dated May 8, and published on May 30, 1908, dealt with the financial and commercial strain and depression then ruling in Japan, and its adverse effect on foreign (non-Japanese) merchants, and proceeded, in the following passage :---
" Almost all the foreign firms thus far affected are German, and the reason is not far to seek. Years ago, the Japanese import trade was chiefly carried on upon a cash basis. A Japanese merchant gave an order for goods, against which he deposited bargain money, and when the merchandise arrived he took delivery only after paying the balance. The German merchants, however, gradually introduced a credit system. First the goods were permitted to be taken away, and payment deferred until they reached the go-downs of the Japanese purchaser, this concession being made on the quite reasonable plea that, as soon as the latter had the goods in his possession, he would be able to get advances on them from the native banks, and liquidate his account. But the time limit was gradually extended . . . until delivery was permitted to be taken against promissory notes for as long as from three to six months. Though the British merchants stood out against the practice as long as possible, they were compelled to follow suit to some extent ; but, holding that such an extension of credit was dangerous in Japan, they never went so far as their German competitors. So long as things went well in this country the credit system worked satisfactorily, and during the boom after the war, there can be no doubt that the business handled by the Germans went ahead more rapidly than that in the hands of British merchants, who preferred to work on the old conservative lines. As soon, however, as a period of stringency in money and contraction in trade took place, difficulties began to arise . . . Very heavy losses have been suffered. It is not too much to say that in the last six months the German merchants have lost far more than they gained during the two years of the boom by the extension of the credit system. Once more it has been shown that unsound methods of doing business, whatever advantage they may bring for the moment, are disastrous in the long run."
This instructive message is an example of much that has been happening in many other countries besides Japan, Morocco having been another field in which seed of this sort is believed to have been plentifully sown. No one can quarrel with the Germans for making use of the credit weapon in extending their trade, though their over-extension of credit facilities has had results which fall on others besides themselves ; still less can they be blamed for their cleverness in taking full advantage of London's monetary machinery, and providing themselves in London with the credit with which they wheedled away England's customers in countries where credit facilities were an attractive novelty, over-indulgence in which has since proved unwholesome both for the giver and the taker.
It is very probable that the extent to which they did so is much exaggerated, since in a case of this kind, in which figures are necessarily not available, an active imagination roams at large. But it is at least interesting to note that England, having done so much to establish the foundations of German military and political greatness at the time of Frederick the Great, when it subsidized the young kingdom of Prussia at a critical period in its Titanic struggle,* has also given a helping hand to German trade with the facilities so cheaply offered by the London discount market.
Let us hope that our German friends are duly grateful, and let us avoid the mistake of imagining that we have done ourselves any permanent harm by this assistance. It is to the economic interest of humanity at large that production should be stimulated, and the economic interest of humanity at large is the interest of England with its mighty world-wide trade. Germany has quickened production with the help of English credit, and so, it may be remarked, has every economically civilized country in the world. The fact that all or most of them, including our own colonies, develop their resources with the help of English capital and credit, and then do their utmost to keep out our products by means of tariffs, makes it appear to superficial observers that England provides capital for the destruction of its own business. But, in practice, the system works quite otherwise. For all these countries that develop their resources with our money, aim at developing an export trade and selling goods to us, and as they have not yet reached the point of economic altruism at which they are prepared to sell goods for nothing, the increase in their production means an increasing demand for our commodities and services. And in the mean time the interest on our capital and credit, and the profits on working the machinery of exchange, are a comfortable addition to our national income.
This digression is not quite as irrelevant as it seems, for there is a strong feeling among the manufacturing classes that the facilities given by the London money market to foreign borrowers arc detrimental to English trade. This contention cannot be set aside as lightly as it sometimes is by the defenders of our banking system. The obvious answer to it is that England makes profits out of its credit factory which very much more than compensate it for any handicap imposed on its manufactures of other commodities. But it must be admitted that this is only a partial answer, and that if the handicap were real and persistent, its working would tend to make England a banking, discounting and exchange-dealing nation rather than a manufacturing nation ; in other words, it would tend to turn our energies into financing, calculating, and book-keeping, rather than producing and working on commodities., This process would not necessarily be an evil, but is a matter which might have important economic and social results, and ought not to be ignored if it were really at work.
The organization of foreign banking which places credit facilities, borrowed in London, at the disposal of foreign manufacturers, is a matter which calls for respectful imitation in England. There ought to be no possible ground for the assertion, which is sometimes heard, that English traders cannot borrow in their own market as cheaply as foreigners. A remedy for this evil, if it really exists, would be merely a matter of organization and co-operation between our mercantile and banking communities, and its further discussion is obviously out of place in a merely explanatory work.
This excursion into complicated questions of international trade was necessitated by the appearance of the agencies of foreign banks as an important item, among the institutions whose acceptances give currency to bills of exchange and enable them to be discounted or sold for cash. They also at times have an important influence on discount rates by dealing on the other side of the market and buying English bills. And both these operations, whether they raise credits on this side by selling their own bills, or obtain a credit due at a later date by buying and holding English bills, give them a hold on London's gold. In fact, their holding of English bills is arranged with this direct object. Some Continental institutions always keep a portfolio stocked with bills on London, constantly replaced as they mature, so that in time of need they may take gold from London to replenish the basis of their note issues. And this fact is one that obviously has to be continually remembered and allowed for by the directors of the Bank of England, which has London's store of gold in its keeping. And moreover, the dealings of foreign houses in bills of exchange have an important effect on the foreign exchanges, and bring us face to face with the necessity for an explanation of that formidable subject.