CHAPTER II


BANKING MACHINERY

Capital, then, is wealth invested in industry, finance is the machinery
by which this process of investment is carried out, and international
finance is the machinery by which the wealth of one country is invested
in another.

Let us consider the case of a doctor in a provincial town who is making
an annual income of about ?800 a year, living on ?600 of it and saving
?200. Instead of spending this quarter of his income on immediate
enjoyments, such as wine and cigars, and journeys to London, he invests
it in different parts of the world through the mechanism of
international finance, because he has been attracted by the advantages
of a system of investment which was fashionable some years ago, which
worked by what was called Geographical Distribution.[2] This meant to
say that the investors who practised it put their money into as many
different countries as possible, so that the risk of loss owing to
climatic or other disturbances might be spread as widely as possible. So
here we have this quiet country doctor spreading all over the world the
money that he gets for dosing and poulticing and dieting his patients,
stimulating industry in many climates and bringing some part of its
proceeds to be added to his store. Let us see how the process works.
First of all he has a bank, into which he pays day by day the fees that
he receives in coin or notes and the cheques that he gets, each half
year, from those of his patients who have an account with him. As long
as his money is in the bank, the bank has the use of it, and not much of
it is likely to go abroad. For the banks use most of the funds
entrusted to them in investments in home securities, or in payday loans and
advances to home customers. Part of them they use in buying bills of
exchange drawn on London houses by merchants and financiers all over the
world, so that even when he pays money into his bank it is possible that
our doctor is already forming part of the machinery of international
finance and involving us in the need for an explanation of one of its
mysteries.

A bill of exchange is an order to pay. When a merchant in Argentina
sells wheat to an English buyer, he draws a bill on the buyer (or some
bank or firm in England whom the buyer instructs him to draw on),
saying, "Pay to me" (or anybody else whom he may name) "the sum of so
many pounds." This bill, if it is drawn on a firm or company of well
known standing, the seller of the wheat can immediately dispose of, and
so has got payment for his goods. Usually the bill is made payable two
or three, or sometimes six months after sight, that is after it has been
received by the firm on which it is drawn, and "accepted" by it, that is
signed across the front to show that the firm drawn on will pay the
bill when it falls due. These bills of exchange, when thus accepted, are
promises to pay entered into by firms of first-rate standing, and are
held as investments by English banks. Bills of exchange are also drawn
on English houses to finance trade transactions between foreign
countries, and also as a means of borrowing money from England. When
they are drawn on behalf of English customers, the credit given is given
at home, but as it is (almost always) given in connection with
international trade, the transaction may be considered as part of
international finance. When they are drawn on behalf of foreign
countries, trading with other foreigners, or using the credit to lend to
other foreigners, the connection with international finance is obvious.
They are readily taken all over the world, because all over the world
there are people who have payments to make to England owing to the wide
distribution of our trade, and it has long been England's boast that
bills of exchange drawn on London firms are the currency of
international commerce and finance.

Some people tell us that this commanding position of the English bill
in the world's markets is in danger of being lost owing to the present
war: in the first place because America is gaining wealth rapidly, while
we are shooting away our savings, and also because the Germans will make
every endeavour to free themselves from dependence on English credit for
the conduct of their trade. Certainly this danger is a real one, but it
does not follow that we shall not be able to meet it and defeat it. If
the war teaches us to work hard and consume little, so that when peace
comes we shall have a great volume of goods to export, there is no
reason why the bill on London should not retain much if not all of its
old prestige and supremacy in the marts of the world. For we must always
remember that finance is only the handmaid of industry. She is often a
pert handmaid who steals her mistress's clothes and tries to flaunt
before the world as the mistress, and so she sometimes imposes on many
people who ought to know better, who think that finance is an
all-powerful influence. Finance is a mighty influence, but it is a mere
piece of machinery which assists, quickens, and lives on production.
The men who make and grow things, and carry them from the place where
they are made and grown to the place where they are wanted, these are
the men who furnish the raw material of finance, without which it would
have to shut up its shop.

If they and their work ceased, we should all starve, and the financiers
would have nothing behind the pieces of paper that they handle. If
finance and the financiers were suddenly to cease, there would be a very
awkward jar and jolt in our commercial machinery, but as long as the
stuff and the means of carrying it were available, we should very soon
patch up some other method for exchanging it between one nation and
another and one citizen and another. The supremacy of the London bill of
exchange was created only to a small extent by any supremacy in London's
financial machinery; it was based chiefly on the supremacy of England's
world-wide trade, and on our readiness to take goods from all nations.
The consequence of this was that traders of all nations sold goods to
us, and so had claims on us and drew bills on us, and bought goods from
us, and so owed us money and wanted to buy bills drawn on us to pay
their debts with. So everywhere the bill on London was known and
familiar and welcome. If the Americans are able and willing to develop
such a world-wide trade as ours, then the bill on New York will have a
vogue all over the world just as is enjoyed by the bill on London. Then
London and New York will have to fight the matter out by seeing which
will provide the best and cheapest machinery for discounting the bill,
that is, turning it into cash on arrival, so that the holder of it shall
get the best possible price at the present moment, for a bill due two or
three months hence.

In this matter of machinery London has certain advantages which ought,
if well used and applied, to stand her in good stead in any struggle
that lies ahead of her. London's credit machinery has grown up in almost
complete freedom from legislation, and it has consequently been able to
grow, without let or hindrance, along the lines that expediency and
convenience have shown to be most practical and useful. It has been too
busy to be logical or theoretical, and consequently it is full of
absurdities and anomalies, but it works with marvellous ease and
elasticity.

In its centre is the Bank of England, with the prestige of antiquity and
of official dignity derived from acting as banker to the British
Government, and with still more practical strength derived from acting
as banker to all the other great banks, several of them much bigger, in
certain respects, than it. The Bank of England is very severely and
strictly restricted by law in the matter of its note issue, but it
luckily happened, when Parliament was imposing these restrictions on the
Bank's business, that note issuing was already becoming a comparatively
unimportant part of banking, owing to the development of the use of
cheques. Nowadays, when borrowers go to the Bank of England for loan,
they do not want to take them out in notes; all they want is a credit in
the Bank's books against which they can draw cheques. A credit in the
Bank of England's books is regarded by the financial community as
"cash," and this pleasant fiction has given the Bank the power of
creating cash by a stroke of its pen and to any extent that it pleases,
subject only to its own view as to what is prudent and sound business.
On p.33 ("A BANK RETURN", below) is a specimen of a return that is published each week
by the Bank of England, showing its position in two separate accounts
with regard to its note issuing business and its banking business: the
return taken is an old one, published before the war, so as to show how
the machine worked in normal times before war's demands had blown out
the balloon of credit to many times its former size.

If the commercial and financial community is short of cash, all that it
has to do is to go to the Bank of England and borrow a few millions, and
the only effect on the Bank's position is an addition of so many
millions to its holding of securities and a similar addition to its
deposits. It may sometimes happen that the borrowers may require the use
of actual currency, and in that case part of the advances made will be
taken out in the form of notes and gold, but as a general rule the Bank
is able to perform its function of providing emergency credit by merely
making entries in its books.

A BANK RETURN

ISSUE DEPARTMENT.

Notes Issued ?56,908,235 Government Debt ?11,015,100
Other Securities 7,434,900
Gold Coin and Bullion 38,458,235
Silver Bullion ---
----------- -----------
?56,908,235 ?56,908,235
----------- -----------

BANKING DEPARTMENT.

Proprietors' Capital ?14,553,000 Government Securities ?11,005,126
Rest 3,431,484 Other Securities 33,623,288
Public Deposits 13,318,714 Notes 27,592,980
Other Deposits 42,485,605 Gold and Silver Coin 1,596,419
Seven Day and other
Bills 29,010
----------- -----------
?73,817,813 ?73,817,813
----------- -----------

With the Bank of England thus acting as a centre to the system, there
has grown up around it a circle of the great joint stock banks, which
provide credit and currency for commerce and finance by lending money
and taking it on deposit, or on current account. These banks work under
practically no legal restrictions of any kind with regard to the amount
of cash that they hold, or the use that they make of the money that is
entrusted to their keeping. They are not allowed, if they have an office
in London, to issue notes at all, but in all other respects they are
left free to conduct their business along the lines that experience has
shown them to be most profitable to themselves, and most convenient for
their customers. Being joint stock companies they have to publish
periodically, for the information of their shareholders, a balance sheet
showing their position. Before the war most of them published a monthly
statement of their position, but this habit has lately been given up. No
legal regulations guide them in the form or extent of the information
that they give in their balance sheets, and their great success and
solidity is a triumph of unfettered business freedom. This absence of
restriction gives great elasticity and adaptability to the credit
machinery of London. Here is a specimen of one of their balance sheets,
slightly simplified, and dating from the days before the war:--

LIABILITIES.

Capital (subscribed) ?14,000,000
----------
Paid up 3,500,000
Reserve 4,000,000
Deposits 87,000,000
Circular Notes, etc. 3,000,000
Acceptances 6,000,000
Profit and loss 500,000
-----------
?104,000,000
-----------

ASSETS

Cash in hand and
at Bank of England ?12,500,000
Cash at call and
short notice 13,000,000
Bills discounted 19,000,000
Govt. Securities 5,000,000
Other Investments 4,500,000
Advances and loans 42,000,000
Liability of customers
on account of
Acceptances 6,000,000
Promises 2,000,000
-----------
?104,000,000
-----------

On one side are the sums that the bank has received, in the shape of
capital subscribed, from its shareholders, and in the shape of deposits
from its customers, including Dr. Pillman and thousands like him; on the
other the cash that it holds, in coin, notes and credit at the Bank of
England, its cash lent at call or short notice to bill brokers (of whom
more anon) and the Stock Exchange, the bills of exchange that it holds,
its investments in British Government and other stocks, and the big item
of loans and advances, through which it finances industry and commerce
at home. It should be noted that the entry on the left side of the
balance sheet, "Acceptances," refers to bills of exchange which the bank
has accepted for merchants and manufacturers who are importing goods and
raw material, and have instructed the foreign exporters to draw bills on
their bankers. As these merchants and manufacturers are responsible to
the bank for meeting the bills when they fall due, the acceptance item
is balanced by an exactly equivalent entry on the other side, showing
this liability of customers as an asset in the bank's favour.

This business of acceptance is done not only by the great banks, but
also by a number of private firms with connections in foreign countries,
and at home, through which they place their names and credit at the
disposal of people less eminent for wealth and position, who pay them a
commission for the use of them.

Other wheels in London's credit machinery are the London offices of
colonial and foreign banks, and the bill brokers or discount houses
which deal in bills of exchange and constitute the discount market. Thus
we see that there is in London a highly specialized and elaborate
machinery for making and dealing in these bills, which are the currency
of international trade. Let us recapitulate the history of the bill and
see the part contributed to its career by each wheel in the machine. We
imagined a bill drawn by an Argentine seller against a cargo of wheat
shipped to an English merchant. The bill will be drawn on a London
accepting house, to whom the English merchant is liable for its due
payment. The Argentine merchant, having drawn the bill, sells it to the
Buenos Ayres branch of a South American bank, formed with English
capital, and having its head office in London. It is shipped to London,
to the head office of the South American bank, which presents it for
acceptance to the accepting house on which it is drawn, and then sells
it to a bill broker at the market rate of discount. If the bill is due
three months after sight, and is for ?2000, and the market rate of
discount is 4 per cent. for three months' bills, the present value of
the bill is obviously ?1980. The bill broker, either at once or later,
probably sells the bill to a bank, which holds it as an investment until
its due date, by which time the importer having sold the wheat at a
profit, pays the money required to meet the bill to his banker and the
transaction is closed. Thus by means of the bill the exporter has
received immediate payment for his wheat, the importing merchant has
been supplied with credit for three months in which to bring home his
profit, and the bank which bought the bill has provided itself with an
investment such as bankers love, because it has to be met within a short
period by a house of first-rate standing.

All this elaborate, but easily working machinery has grown up for the
service of commerce. It is true that bills of exchange are often drawn
by moneylenders abroad on moneylenders in England merely in order to
raise credit, that is to say, to borrow money by means of the London
discount market. Sometimes these credits are used for merely speculative
purposes, but in the great majority of cases they are wanted for the
furtherance of production in the borrowing country. The justification of
the English accepting houses, and bill brokers, and banks (in so far as
they engage in this business), is the fact that they are assisting
trade, and could not live without trade, and that trade if deprived of
their services would be gravely inconvenienced and could only resume its
present activity by making a new machinery more or less on the same
lines. The bill whose imaginary history has been traced, came into being
because the drawer had a claim on England through a trade transaction.
He was able to sell it to the South American bank only because the bank
knew that many other people in Argentina would have to make payments to
England and would come to it and ask it for drafts on London, which, by
remitting this bill to be sold in London, it would be able to supply.
International finance is so often regarded as a machinery by which paper
wealth is manufactured out of nothing, that it is very important to
remember that all this paper wealth only acquires value by being
ultimately based on something that is grown or made and wanted to keep
people alive or comfortable, or at least happy in the belief that they
have got something that they thought they wanted, or which habit or
convention obliged them to possess.

FOOTNOTES:

[Footnote 2: All this imaginary picture is of events before the war. At
present Dr. Pillman, being a patriotic citizen, is saving much faster
than before, and putting every pound that he can save into the hands of
the British Government by subscribing to War Loans and buying Exchequer
bonds. He is too old to go and do medical work at the front, so he does
the next best thing by cutting down his expenses and finding money for
the war.]