Of all deposits in our market, the most dangerous
and disturbing are those held for purposes of inter-
national financiering. Some banks decline to hold
accounts of this character, but it cannot be doubted
that others are not so precise. It is matter of
notoriety that the magnitude and audacity of modern
finance operations have greatly increased of late, and
that these operations are necessarily international in
their range. Thus our liability to sudden and violent
monetary disturbance, to " bolts from the blue," is
greater than it ever was. This is a kind of liability
which calls for a much more substantial reserve pro-
vision than we have yet made.
I come last to what seems to me the greatest danger
that threatens our credit, I mean the position we
should find ourselves in in case of war between two
first-class Powers, especially if this country were itself
actively engaged. To quote Mr. Pownall in 1899 :
"It is quite possible, with our attenuated gold re-
serve, that a foreign government might strike its
most effective blow by aiming at our financial supre-
macy. The power to act on our few millions of
gold might be acquired by an enemy able to deplete
THE BANKING RESERVE 153
the Bank, and bring on a crisis." Sir Felix Schuster
has also called attention to this matter on several
occasions. In March, 1908, Sir Robert Giffen read
a valuable paper, at the United Service Institute,
on The Necessity of a War Chest in this Country, or
a Greatly-Increased Reserve. In the course of the
interesting debate which followed, Sir Felix Schuster,
who was in the chair, remarked that " an efficient
gold reserve in time of war, at the commencement
of hostilities, is infinitely more important than food
supplies " ; and it was generally admitted that this
was a vulnerable point in our resources for defence.
We should certainly be in a very weak position to
withstand an attack of this sort. When I look at
the huge reserves held in some foreign countries I
can hardly doubt that they are largely held in view
of contingencies of this kind. What sort of provision
is made here for this most dangerous of all liabilities ?
THE RESERVE INSUFFICIENT.
If I conclude, then, that our reserve is inadequate,
it is not so much on the basis of the small ratio it
holds to total liabilities as on the consideration of
the very dangerous character of some of these lia-
bilities. There are other reasons for this conclusion.
*
Much larger reserves are held in other countries,
whose markets are not exposed to anything like the
same strain as our own. The Bank of France the
154 PAPERS ON CURRENT FINANCE
other day held 145 millions of gold and thirty-five
millions of silver say, the equivalent, even for
external purposes, of 160 millions of gold. The
Bank of Russia held nearly 130 millions, the Reichs-
bank over fifty millions, to say nothing of the enor-
mous holdings by the United States banks and their
Treasury. Three times, too, in seventeen years we
have only been saved from crisis by the friendly
assistance of stronger banks. I am far from assum-
ing that this assistance was entirely disinterested ;
yet I can conceive political situations in which it might
have been withheld. Surely it is not wise to leave
our solvency dependent upon the goodwill of our
neighbours. Let me remind you of what we risked
on one of those three occasions, the one known as
the Baring difficulty of 1890. I give you Lord
Goschen's account in his famous Leeds speech of
28th January, 1891 : "No fertile imagination could
exaggerate the gravity of the crisis I doubt whether
the public has thoroughly realised the extent of the
danger I tell you what was at stake, you risked
the deposition of London as the banking centre of
the universe, you risked the supremacy of English
credit, you risked the transfer of the business of this
country to other European centres, if such a catas-
trophe had occurred as you were on the eve of
witnessing. You have escaped from a catastrophe
to which the famous catastrophe of Overend
& Gurney would have been child's play." How
THE BANKING RESERVE 155
did we escape ? By borrowing three millions from
France, one and a-half millions from Russia, and
some smaller sums from other quarters say, five
millions altogether, or just half of 1 per cent, of
our total bank liabilities. A story like this defies
comment.
But we need not go to extreme cases like these
to show the insufficiency of our reserves. They are
insufficient in ordinary times. I think the main
ground for holding that our reserves are inadequate
is the extreme sensitiveness of our market and the
discount rate to relatively small movements of gold.
The Governor of the Bank said a few years ago that
an unexpected export of two millions of gold would
generally put up the rate of discount one per cent.,
and, perhaps, two, according to the circumstances.
This means a very heavy tax on trade. I suppose
there must be about 600 millions usually on loan, in
the way of discounts and advances ; one per cent,
on that is six millions. But that is only a small
part of the tax. We have also to take account of
the general disturbance of trade and employment.
It is hardly possible to exaggerate the losses suffered
by such rises in the rate as took place in 1907. There
are scores of people to-day who could move a million
or many millions of gold if they chose to do so. Is
it right that our trade should be exposed to a tax
of this kind by reason of such casual operations ?
Compare the case of France and England in 1907.
156 PAPERS ON CURRENT FINANCE
Our rate was 7 per cent, in the last quarter of that
year, and it was, I believe, an effective market rate.
The French rate did not rise above 4 per cent. Quite
apart from the question of unemployment, what an
advantage is given to the French manufacturer com-
peting with us in a neutral or in our own market !
A larger reserve would make our market less sensi-
tive, and this, in brief, is the main reason why a larger
reserve must be formed.
Those on whom the expense of providing such an
increased reserve would fall are naturally inclined
to suggest that our difficulties may be met by other
expedients. What possible courses are open in case
of monetary stringency ? I need not speak of a con-
traction of accommodation, for this is admittedly
bad banking, and the very danger to be avoided.
Modern banking has substituted for that the received
method of raising the discount rate. This is usually
effective, but it is always costly, and these rises in
the rate are just what efficient banking arrangements
would prevent. Moreover, this device has sometimes
failed, and we are not entitled to place absolute
reliance upon it. Take the Overend & Gurney crisis.
I shall never forget the consternation caused by that
collapse, even in a quiet Somersetshire country town.
We then had a Bank rate of 10 per cent. The Paris
rate was never above 4 per cent. There was a six
per cent, difference between the two rates for three
months. Yet this failed, for a long time, to attract
THE BANKING RESERVE 157
gold to London, no doubt because the crisis had
caused a general distrust of all English securities.
When Gurneys had gone, whose name was good ?
They did not think that our paper at that time was
good enough to lend upon ; so that the discount rate
had no attractive power, and this example should
warn us that we cannot always rely upon drawing
or keeping money by this method. 1
Foreign banks frequently resort to another expe-
dient. They buy gold at a premium. Our Bank
rarely does this. It is often said that the Bank
is buying gold at a premium when it buys above
3 17s. 9d. an oz., the price fixed by the Act of 1844.
But it is not really buying at a premium unless it
pays over 3 17s. 10|d. In this latter case, of course,
it incurs a loss for the public good. Foreign banks
constantly resort to this method. A State bank may
well be willing to incur such a loss in order to avoid
penalising trade by a rise in the rate of discount.
It would not be so reasonable, all things considered,
p Not long before the crisis of 1907, a Governor of the Bank was
reported to have said that " 10 per cent, would draw gold out of the
earth." It may be doubted whether this panic rate has ever attracted
gold. It certainly did not at the time of the War crisis. Mr. Thomson
Hankey, a generation earlier, showed a sounder grasp of the real
position. " The Bank knows," he said, " that there may be moments
of sudden alarm, when no one is willing to part with ready money on
any terms whatever" Mr. Hankey, who was for fifty-one years a
Director of the Bank, had just steered the market through the 1866
crisis, and spoke from experience. The fact is, that it is just when a
reserve is most wanted that the pull of the discount rate is least
effective.]
158 PAPERS ON CURRENT FINANCE
to expect the Bank of England to make similar
sacrifices. At any rate, it rarely does.
I need not allude to our power of drawing gold
by the sale of bills and securities. I have said that
our market is relatively weak in this respect. We
are also debarred from placing an export duty, or
any other obstacle, legal or moral, on the export of
gold. The tradition of the City does not regard this
as an open question. But most of the Continental
banks can, if they wish, and do, not infrequently,
protect their reserves by measures of this sort. They
have also, sometimes, resorted to the expedient of
gold loans. Of course, that is bad finance ; but in
emergency it is as open to us as to others. It
would, however, only operate slowly ; and to make
it really effective the money so imported would
have to be guaranteed against re-export, as in
the very remarkable case of the United States
in 1893.
Another expedient, often used in the United States,
is the method of collective guarantee by associated
banks and collective certification of cheques. We
have no regular machinery for such operations here,
and Ldo not think we have ever had cheques collec-
tively certified, though the Baring case illustrates
collective guarantee. We might extemporise mea-
sures of this sort, but they are open to grave objections.
Moreover, they do not always provide the sort of
money most needed. There are soaps, I believe,
THE BANKING RESERVE 159
which " will not wash clothes." These forms of
bankers' money " will not pay wages."
Lastly, there is the resource of elastic or emergency
note issues, of which the German system provides an
excellent example. This may, in certain cases, prove
of the greatest service. The peculiar virtue of a
note issue, as contrasted with other forms of currency,
consists in its elasticity, by which it can be safely
used to relieve many periodic and other demands
upon our gold resources. But I need not discuss
that here, because we are completely cut off from
any relief of this kind by the effect of the mechanical
Act of 1844. As long as that Act is in force, our
note issue is absolutely inextensible, except by the
machinery of a Chancellor's letter. Nobody defends
the Act now, but to discuss it would raise many
issues ; and the question of reserve may, at least in
the first instance, be best considered apart from the
very debatable question of the regulation of the bank
note. 1
On the whole, then, it is clear that our power of
dealing with emergencies other than by a rise in the
rate of discount is more restricted than that of our
neighbours, while our market is infinitely more ex-
posed to attack. Hence, our market is increasingly
1 It is, of course, true that within the limits of payments made by
cheque, an extension of accommodation by the Bank of England may
serve the same purpose here as an elastic or emergency note issue does
elsewhere. But only within these limits. It cannot replace gold for
wages or other payments usually made in cash, or for foreign remittance.
160 PAPEKS ON CUKRENT FINANCE
sensitive, and the variations in the discount rate
so wide in their range as to impose an unnecessary
burden on trade. On economic grounds alone, on
the mere basis of s. d., a substantial increase of the
reserve seems required. The economy of cash has
been overdone. " We have refined our methods of
working until we are spinning a top on a needle-
point," as Mr. Pownall tells us. 1 Our present
system is not only too expensive, but doubtfully
safe.
PRACTICAL MEASURES INDICATED.
So far I have spoken with considerable confidence.
There is high authority for the statements I have
made, and I do not think they will be seriously dis-
puted, at least by experts.
When I come to the question, What practical
measures may be taken for improving the situation ?
I speak with more diffidence. What I will venture
to say is only in the way of suggestions, general in
their form, leaving details to be arranged by those
whose interests are more immediately concerned.
One word may be said, in the first place, on the
need of more publicity. Publicity is a great econo-
miser of legislation. Many difficulties would arrange
themselves, if the public had access to the facts.
This has been recognised as regards company and
railway legislation ; it is probably equally true of
1 Econ. Jour. Sept. 1899. It is all right as long as the top continues
to spin !
THE BANKING RESERVE 161
banking. There are those who think that if the
essential figures were published, public opinion would
ensure that the necessary reserve provisions were
made. Even those who are not so sanguine will
agree that fuller returns are essential. Lord
Goschen held, in 1891, that we have an undoubted
right to this information, and this right becomes
all the stronger, because it is conceivable that the
larger banks might trade upon the conviction that
they were " too big to be let go." This gives the
public a locus standi, because it practically throws
the burden of responsibility upon the general market.
We have no annual report from the Bank itself. 1
The returns under the Act, invaluable as they are,
are more meagre than they used to be, and leave
much to be desired. Since 1877 we have no infor-
mation on a most vital point, the amount of, and the
variations in, the bankers' balances. The joint-stock
banks give no real information as to the nature of
their cash holdings. Cash in hand should be dis-
tinguished from money with the Bank, and if there
are any sums held in reserve, over and above till
money, this might be stated. I need hardly say that
the return of the reserve should be an average, not
a figure for a particular day. The existing practice
is a cause of disturbance in the money market, and
1 The Bank of France publishes an admirable Report, full of
instructive detail, of about 100 pp. 4to. All the great foreign national
banks issue similar reports.
F.C.F. L
162 PAPERS ON CURRENT FINANCE
not a very creditable proceeding. It would be a
great gain if a common form of balance sheet could
be adopted, and if we could have more definite
specification of the large entry under discounts,
advances, and loans. Such information would be of
extreme value, and we ought to have it ; but, even
so, I doubt if publicity alone would meet present
requirements. A new departure seems necessary.
I think I may assume that any reserve, to be
effective, must be publicly and centrally held, and
under single or unified direction. When I say it
must be public, I mean that secret hoards have no
effect in steadying the market. They cannot inspire
confidence in a sceptical world. Again, our main
liabilities are central. They fall on the London
market, and the resources to meet them must be
kept there. I think the control must be in some
way unified, because I do not see how you can have
a definite and steady discount policy carried out by
conflicting and possibly in some degree rival autho-
rities. Hitherto the Bank of England has borne all
the brunt, and therefore the question of control has
hardly arisen. This is a state of things which can
scarcely continue. It was perhaps reasonable when
the Bank towered above all the other banking in-
stitutions of the country as a cathedral towered above
the cottages of a medieval town. But now, just as
the cathedrals are often walled up by the surround-
ing warehouses, so the Bank is almost overlooked by
THE BANKING RESERVE 163
the soaring joint-stock banks which surround it.
Out of the 1,000 millions of liabilities nearly one-
half are held by twelve of these banks, some of which
hold sixty or seventy millions of deposits. 1 Now,
the actual deposits in the Bank of England are not
much above fifty millions. How can it be con-
tended that in these new conditions the whole burden
of holding an adequate national reserve should be
thrown upon the Bank ? The question becomes
more pertinent when we find that the Bank only
divides some 9 per cent., and that its dividend rather
declines ; whereas some of the joint-stock banks
declare much higher dividends, rising in some cases
to over 20 per cent. In the face of these figures,
and remembering that the Bank does not seriously
compete for the profitable country business, nor
attempt to attract deposits by allowing interest on
them, I think the Bank has done its share in con-
tributing as it does to the national reserve.
On the other hand, the joint-stock banks may
fairly demur to leaving more money with the Bank
on present lines. Money so left in excess of clearing-
house and other current exigencies will not increase
the Bank reserve by the sum so left, but only by,
say, 45 per cent, of that sum, and it will increase
the resources of an institution which they regard as
a competitor. This is an argument for constituting
p Five clearing banks now hold considerably more than half the total
deposits of the United Kingdom.]
164 PAPERS ON CURRENT FINANCE
a second or emergency reserve out of the contribu-
tions of the joint-stock banks. There are, of course,
other and very strong arguments for a reserve of this
type.
What I feel, then, is that we cannot ask the Bank
to do much more than it already does. We may
fairly ask it to continue to do as much. But beyond
the Bank reserve, our first line of defence, we want
a second or emergency reserve, formed by the other
banks in the United Kingdom ; and I should also like
to see a third reserve, against our more serious lia-
bility, formed at the expense of the nation. This
might be called the war reserve, though its use need
not be absolutely limited to war liabilities.
The second or emergency reserve of, say, twenty
millions sterling, should only be used in times of
pressure. It is hardly for me to suggest the basis
on which contributions to it should be assessed.
Those concerned are the best judges of such a point.
The question of control may well give rise to differ-
ence of opinion. It might be under the regulation
of a joint committee representing the contributing
banks and the Bank of England. It would be far
simpler, if the banks saw no objection, to substitute
an automatic arrangement. The Bank of England
might be allowed to have access to the money in the
second reserve on payment of a tax, the proceeds
of which would go to the contributing banks. Thus
for the first five millions so withdrawn the Bank
THE BANKING RESERVE 165
might pay a 5 per cent, tax, for the second 6 per
cent., for the third 7 per cent., for the fourth 8 per
cent. Thus the Bank would only draw from this
reserve on condition of establishing successive rises
in the rate of discount, otherwise the operation would
result in loss. I have long been persuaded that some
arrangement of this sort is desirable. On the single
reserve system you can never be sure that you will
find your reserve when you want it. You cannot
prevent those who hold it from trading with it in
ordinary times. A second reserve on this system
would not be touched till we had a 5 per cent, rate
at least, and would not be exhausted till the rate
was at least 8 per cent. Opinions may differ as to
when relief should begin. The scale suggested was
determined by my belief that a rate above 5 per cent,
begins to put serious pressure upon trade.
Coming to the Government or national contribu-
tion, which we may put, say, at ten millions, I
may say that I have always resisted the contention
that Government was bound to hold a reserve on
savings bank account. I have gone into that ques-
tion very carefully, and it seems to me that these
banks are amply provided against any banking risks.
Their operations might conceivably involve the nation
in loss, but that is an entirely distinct question.
Even in case of a run upon them, due, say, to pro-
longed depression of trade, the money would only
run round the banks ; it would not be taken out of
166 PAPERS ON CURRENT FINANCE
the market. Lord Goschen says emphatically : " The
savings banks deposits are of a totally different
character to banking or mercantile deposits. There
has never been a case that I can remember of the
least difficulty, or of having to sell any large amount
of securities to meet a run or anything of that kind." 1
It would be more reasonable to tax the insurance
companies for such a purpose. The San Francisco
fire of 1906 caused demands on our insurance com-
panies, all honourably met, of no less than ten
millions sterling. You may search the whole annals
of the world's savings bank operations before you
will find a disturbance of the money markets which
is to be compared with this.
But though it seems to me absurd to suggest that
Government should hold a reserve of ten millions
against savings bank risks, the cost of which would
fall on a class of depositors who are generally of very
limited means, I think that such a reserve might very
fairly be held against the extraordinary risks of war.
I can imagine no greater disturbance than that to
which our market would be exposed in the event of
war between two first-rate Powers, more especially if
this country was itself involved. There would be
an enormous creation of new securities, a very heavy
fall in existing securities, and a general rush for money.
P Even in the War crisis, the net withdrawals only reached 5,000,000,
an amount amply covered by Government balances ; and the Govern-
ment always has the resource of making Postal Orders legal tender.]
THE BANKING RESERVE 167
Not improbably a special attack would have been
prepared upon our reserves. Success in the campaign,
too, might depend largely upon the quantity of cash
we had available at the outset. There would be no
question of credit at such a time. Gold, cash down,
would be essential. You will remember the purchase
of the Chilian ironclads at the time of the Russo-
Japanese war. The purchase might conceivably
have affected the issue of the naval contest. Pur-
chases of this sort will play an important part on the
outbreak of a big war. For this and many other
reasons adequate reserves of cash at such a time
will be of the very first importance.
Is it too much to ask the nation to hold a reserve
of ten millions against an emergency of this kind ?
The annual loss by way of interest would be 275,000.
But there are very considerable offsets to be made
against that. The existence of such a fund would
help to steady the market, even if it were strictly
reserved for war risks. But it is quite possible that
in the event of a serious crisis in times of peace, the
Bank might be allowed, by Chancellor's letter, to
have recourse to this fund as a third reserve. The
condition might be the payment of a tax of not less
than 9 per cent. Such a resource would have been
useful in 1866. In any case the losses caused by
money market disturbances are incomparably greater
than the cost of the reserves which would prevent
these losses. The Government would recover more
168 PAPERS ON CURRENT FINANCE
than the cost of such a modest reserve out of in-
creased tax revenue.
I have quoted Lord Goschen so often in support
of what has been said to-night that it is only fair
to say that he was opposed to both the new forms
of reserve which I advocate. As regards the second
reserve, he objects that there might be difficulties
in apportioning the assistance to be given from this
fund. Would not banks expect to be helped in
proportion to their contributions ? With respect,
I think not. The objection cuts at the root of
every form of insurance. If the assessment were
equitable, the relief afforded might be left to adjust
itself in the ordinary way through the rise in the
discount rate. Banks, like other people, would thus
obtain assistance in proportion to the urgency of
their need, measured by the rate they were willing
to pay. As regards the third or national reserve,
Lord Goschen, of course, spoke as Chancellor of
the Exchequer, and would primd facie object to any
further burdens on the Consolidated Fund. His
objection does not take very tangible or definite
shape. He says that such a suggestion is " contrary
to all our ways. It would be a dangerous power to
entrust to any political minister," etc. But observe
that the system of relief by a Chancellor's letter
exists already, and in a much more questionable
form. Why should the proposed scheme be more
dangerous ? If the intervention of an individual is
THE BANKING RESERVE 169
not desired, access to the third reserve might be
automatic, fixed beforehand, on the principle of a
graduated tax. But as the question of war risk is
eminently one for the Cabinet, it would seem more
natural to leave the control of what was primarily
a war reserve to the Minister.
I have merely offered suggestions, rough sketches
of arrangements which I think would conduce to
greater security, and, for that very reason, to greater
economy. It will be said that the contemplated
reserve provision is excessive. Yet, all told, the
three reserves would be only about equal to that
held by the Keichsbank, and no one will pretend
that the liabilities of Germany are as great and as
pressing as our own. I am well aware, however,
that schemes of this magnitude would require very
careful criticism from many different points of view,
and that any kind of action in this matter is con-
fronted by obstacles not easy to turn. But I must
not presume longer on your patience. I will only
repeat that the real reserve problem is not merely
the bare avoidance of bankruptcy, but the mini-
mising of financial strain. Even the simpler ideal
is not always realised, as witness the United States
in 1907, and our very narrow escape from a similar
collapse in 1890. But our real aim should be to be
prepared to meet any probable demand for cash,
whether on home or foreign account, in peace or
in war, without causing any undue or injurious
170 PAPEKS ON CURRENT FINANCE
pressure on the money market, with the consequent
disturbance to trade and employment. We are not
in sight of this latter ideal at present ; it is doubtful
if we are even secured against insolvency. Can we
afford to go on in our present happy-go-lucky way,
merely on the chance that we shall somehow worry
through ? Is it quite certain, if we continue to
allow our reserves to dwindle in proportion to those
of other countries, that we shall retain our position
as the international clearing-house, and preserve the
high reputation of the London bill, on which so much
of our financial pre-eminence depends ?
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