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Home -> Orville Marcellus Powers -> Commerce and Finance -> Chapter XIX

Commerce and Finance - Chapter XIX

1. Chapter I

2. Chapter II

3. Chapter III

4. Chapter IV

5. Chapter V

6. Chapter VI

7. Chapter VII

8. Chapter VIII

9. Chapter IX

10. Chapter X

11. Chapter XI

12. Chapter XII

13. Chapter XIII

14. Chapter XIV

15. Chapter XV

16. Chapter XVI

17. Chapter XVII

18. Chapter XVIII

19. Chapter XIX

20. Chapter XX

21. Chapter XXI

22. Chapter XXII

23. Chapter XXIII

24. Chapter XXIV

25. Chapter XXV

26. Chapter XXVI

27. Chapter XXVII

28. Chapter XXVIII

29. Chapter XXIX

30. Chapter XXX

31. Chapter XXXI

32. Chapter XXXII

33. Chapter XXXIII

34. Chapter XXXIV

35. Chapter XXXV

36. Chapter XXXVI

37. Chapter XXXVII

38. Chapter XXXVIII

39. Chapter XXXIX

40. Chapter XL

41. Chapter XLI

42. Chapter XLII

43. Chapter XLIII

44. Chapter XLIV

45. Chapter XLV

46. Chapter XLVI

47. Chapter XLVII

48. Chapter XLVIII

49. Chapter XLVIX

50. Chapter L

51. Chapter LI

52. Chapter LII



The banking department of the Bank of England is sub-
stantially the equivalent of an extensive banking house, with all
banking functions except that of issue. It receives deposits, dis-
counts commercial paper, loans on collateral and buys and sells
exchange precisely the same as any other bank. In addition to this
it acts as the banker of the government, in the management and
payment of interest on the public debt, the issue and withdrawal
of Exchequer bills and bonds, the issue of government loans,
and all other financial operations affecting the government.
Like other banks it must as a matter of ordinary
prudence keep on hand a cash reserve against its
liabilities. It is bound to meet all its demand lia-
bilities in cash, consisting of notes or coin, like other banks, and
if it has need for a greater quantity of notes than that on hand, it
may procure them from the issue department in exchange for
gold the same as any other bank.

Every deposit bank must retain constantly on hand, or
within easy reach, a sum of legal tender money, equal to a safe
and proper proportion of its liabilities, in order to meet unex-
pected demands of depositors. This is a universal rule the
world over, and is based upon the supposition, which experience
has shown to be generally true, that all depositors will not call
for their deposits at the same time, but under disturbed con-
ditions, an unusual number may make such demands, and the
bank must at all times be in readiness to meet such calls. This



reserve is the safety fund over and above the daily requirements
of cash to transact the ordinary volume of business, held by the

bank to meet extraordinary and infrequent de-
Reserve mands. The banks all over England keep their

reserves in London. The same reasons which in-
duce a merchant to keep a bank account, viz., convenience, safety,
etc., act as incentives to a bank to deposit its reserve in whole
or in part with another bank or banker. In order to conduct
exchange transactions and have facilities for rediscounting time
bills, every bank and banker in the United Kingdom, not located
in the metropolis, find it necessary to carry an account with
some London bank or banker, and as the latter, as well as the
bill brokers of Lombard Street, who are really bankers under
another name, allow interest on such deposit accounts, the result
is that practically all of the reserve of the country is carried in
these accounts. "Owing to the fierce competition for practical
profits/'* nowhere more severe than in the field of banking, the
London joint-stock and private banks maintain no coin reserve
of their own, but deposit with the Bank of England all cash
not needed for ordinary transactions from day to day. The
Bank of England does not pay interest upon these deposit ac-
counts but the willingness of smaller banks to place their re-
serves in the Bank of England is due to the fact that they are
relieved of the care and risk of such large sums, and by showing
their funds in their balance sheets thus deposited they command
public confidence. Another reason is that the London clearing
house settlements are made through the Bank of England, which
practically compels the members of the clearing house to keep
their reserve cash with that institution. The Scotch and Irish
banks keep their surplus money in London. A portion of it is
loaned out or invested in securities and the remainder deposited
in the Bank of England. It will thus be seen at once that the
Bank of England holds not only its own reserve, but the reserve

*Conant, Modern Banks of Issue, p. 130,


of all London, and not only of all London but of all England,
Ireland and Scotland.

This great responsibility of the Bank of England makes it
the basis of the credit system of the kingdom. Upon the manage-
ment of the Bank of England depends the solvency or insolvency
of England, for all business is dependent upon the banks, and
all banks are dependent upon the one great bank, "The Old
Lady of Threadneedle Street." While the Bank of England is
immense a P r i va t e corporation carried on for the benefit of

Responsibility its stockholders, who alone share the profits and
direct its management, it is in a sense a public in-
stitution, for to it is confided the safety of the commercial
public and credit of the kingdom, and it is morally bound in
time of stress to sustain the entire financial fabric.

There is no law requiring the bank to maintain a stated re-
serve in proportion to its liabilities, and since the management
is expected to earn as large dividends as possible for the stock-
holders, the tendency would naturally be to reduce the volume
of idle cash to the lowest point consistent with safety. Like
other banks, the Bank of England loans out a portion of its
deposits, consisting largely of reserves of other banks, and the
effect of this is to cause the reserve to be much smaller in pro-
portion to the liabilities of all the banks than it would be were
each bank to hold its own reserve. But the fact that under
the English system the bank reserve is reduced to a compara-
tively small proportion of the liabilities is not the only objection
which can be, and often is, urged against it. This reserve, all
important as it is, is given over to one board of directors, and
upon their wisdom its control depends. If they
One Reserve commit indiscretions the entire financial and com-
mercial system may be seriously injured. Having
a smaller balance to meet liabilities, any error in the manage-
ment of that balance becomes proportionately serious.

The natural method would appear to be that each bank


should keep its own reserve. Each, would then be most anxious
to keep a sufficient reserve, because its own life and existence
would depend upon it. The reserve of the entire country would

then be guarded and controlled by the total banking
Many Reserves wisdom of many boards of directors, and the loss of

interest occasioned by the amount of dead capital
locked up in the banks as reserves, would be more than offset by
the added security. In no other country than England could the
one reserve system exist as it does there. The system was not
deliberately founded there, but grew up as a consequence of many
events. As the system grew, confidence in the bank also grew,
until the stability of the bank is beyond question and supports
the system of one reserve. It is the absolute faith of the people
in the stability of the Bank of England that takes the place of
a large reserve.

But the reserve in the Bank of England is subject to a still
further strain occasioned by the necessities of foreign commerce.
London is the center of English commerce, and in case the
balance of trade* goes against England and in favor of any other
country, that balance must be paid by London, and this is
equivalent to saying that it must be paid by the Bank of En-
gland. When, during our civil war, the supply of cotton to
England by the United States was cut off and exports to America
greatly reduced, immense sums of money had to be sent to
Australia and Egypt to pay for cotton to keep the looms of
London the Manchester supplied. Of course no foreigner can
clearing House take away the cash of England without giving a

value therefor, but that value may be in produce
or manufactures, represented by bills of exchange which the
foreigner discounts in Lombard Street, and then he may

*The phrase "Balance of Trade" is usually taken to mean the differences
between imports and exports of merchandise, but strictly the balance is
caused quite as often through movements of capital in the form of loans
or investments, as of merchandise. These movements not being "visible"
through the records of the custom houses, are often very difficult to follow.


take away a part or all of the proceeds of his bills in bullion.
No other city in the world cashes as many foreign drafts as
London. No other city in the world receives as many remit-
tances or pays as many drafts as London. No other city holds
as much foreign money on deposit as London, for wherever the
people have payments to make, at that place they must keep
money on deposit. Formerly Paris was a European clearing
house to a considerable extent, and divided the business and
responsibility with London, but the changes in government in
France have had the effect of greatly reducing the confidence of
foreigners in the stability of the Bank of France, while the
volume of mercantile business finding its natural settlement in
London compelled banks all over the world to keep accounts
there. As it is more convenient to keep one foreign account
than several, and most convenient to keep this in the city with
which transactions are largest and most numerous, there was
thus placed upon merchants all over the world the effective
pressure of more favorable exchange rates when bills could be
drawn upon and payments made in London. Very large banks
can keep accounts in all the European centers, but it would
neither be profitable nor possible for small banks to keep such ac-
counts, because of the amount of cash that would be locked up.
Moreover the most favorable terms can be obtained upon large
accounts only, and it is a custom, the world over, except in the
United States, for banks to exact commissions on all services
rendered. These considerations have tended to centralize the
financial transactions in the Bank of England,* which has
established a record for stability and uniformity of dealing
through long generations.

As the commerce of a nation increases the reserve on hand

*When the volume of exchanges on some other city, New York, for ex-
ample, becomes so great relatively, that banks the world over find it cheaper
to effect settlements there rather than in London, the prestige of London
must surely begin to wane. There are other factors in the case, however,
such as the amount of free capital available for discounting time bills of
exchange, etc., but the foregoing is the chief one.


to settle the balance of that commerce must likewise increase.
A single bad harvest in any important country with which
England trades, may seriously affect the balance of trade with
England, by reducing the demand for English manufactures. A
sudden increase of imports or a cessation of exports causes a
A Reserve for balance of trade to become due, which must be paid
Foreign in bullion. Within a country, paper currency may

be used in settlement of obligations, but in inter-
national trade the only cash is metal. The Bank of England
must therefore keep a reserve which can be used for foreign
payments either in bullion or legal tender notes which can
be converted into bullion on demand by passing them over the
counter of the issue department. The requirements of foreign
commerce are often sudden and fluctuating, and must be met
promptly. Therefore it is of the greatest importance that the
reserve upon which this commerce depends should be both
ample and ready, at all times, to satisfy the demands upon it.

Foreseeing the need for an increase in the reserve in anticipa-
tion of large foreign payments, soon to be made, the question at
once arises, "How are the bank directors to secure the additional
bullion?" They may reduce the volume of discounts, and this
would in a measure help to accomplish the purpose, but would
not afford a sufficient increase in the reserve to meet a large or
continuous drain on the reserve. They may sell securities, but
in a very large number of instances this would merely mean the
transfer of a credit from one account to another on the bank's
ledger, as the buyer of the securities would in all probability
be an individual or bank having a deposit account with the Bank
of England. What then is the means employed to increase the

reserve? The answer is, raising the rate of dis-
mscount count If the directors of the Bank of England

vote to raise the rate of discount, it is proved by
experience that money flows to Lombard Street and from the
other banks it flows to the Bank of England. Money (i. e. capi-


tal) goes where it is wanted most and commands the highest rate
of interest.

An increase in the bank rate has an immediate effect on
foreign exchange transactions, making it unprofitable, or tending
to make it unprofitable, to withdraw gold for export, and at the
some time tending to make it profitable to ship gold from other
financial centers to London. The bankers there pay a higher
rate of interest and charge borrowers a higher rate of discount.
The effect of the operation of raising the rate of discount even
slightly is to swell the reserve in the vaults of the Bank of
England, and at the same time to diminish loans by discouraging
borrowers. With money a little "tighter," imports are dimin-
ished and exports are increased, thus tending to change the bal-
ance of trade in England's favor and reduce the necessity for
large foreign payments. The raising and lowering of the rate
of discount by the directors of the Bank of England, then, acts
as a lever of control to the financial and commercial systems of
England. When the bank is "flooded" with money, and no
prospects are visible of a drain upon the reserve, the rate of dis-
count is lowered. Money now flows from Lombard Street into
other channels both in England and on the Continent, where it
can be more profitably employed; with a lower rate of discount,
borrowers are more plentiful, and more goods are imported.

Many persons believe that the Bank of England has some
peculiar power which enables it arbitrarily to fix the rate of in-
terest, whereas the truth is the bank merely gives expression to
the market value of money, as fixed by the laws of supply and
demand. The value of money is settled, like that of all other
Effect of commodities, by the inexorable law of demand and

supply and supply, and the bank merely takes the lead in fix-
ing or establishing that value in the form of a
discount rate. If the bank vaults are full, the bank lowers the
rate to attract borrowers, the same as a merchant lowers the
price of his goods in order to effect sales and reduce his stock,


and the contrary policy is pursued to increase the cash in the
bank vaults.

The government of the Bank of England is confided in a
board of twenty-four directors, a governor and a deputy gov-
ernor, who each serve one year. In theory a portion of the di-
rectors go out annually, remain out for a year and are then
subject to re-election, but as a matter of fact they are nearly
always re-elected at the end of the year, unless other members
of the board oppose. All the directors in turn serve as deputy
governor and governor, in rotation, and it is not until a director
Management nas keen u P on the board perhaps twenty years
of the Bank that he succeeds to the position of governor.
When a vacancy occurs in the board by death or
resignation, the directors usually select some promising young
business man for the place. In order to reach the governorship
within the period of a lifetime, it is necessary that new directors
should be young men. The position of director of the Bank of
England is considered a highly desirable one, as it gives a con-
siderable status to both the individual and the house to which he
belongs. By a long-established usage the directors cannot be
connected with any other bank, in any official capacity. They
must be merchants, brokers or capitalists of experience, and
men presumed to possess information as to the present and future
course of trade. The reason for the discrimination against bank-
ers as members of the directory of the Bank of England no doubt
arose out of the narrow-minded jealousy of former times, which
regarded all other banks as rivals to be feared and opposed.

In theory the system of management of the Bank of England
would seem to be very objectionable. A governor, the chief
executive officer of the bank, allowed to hold the office but one
year, a directory made up of merchants, a portion of them young
men, and not a trained banker in the entire board,* would not or-

*There is no better school for the education of bankers in the larger lines
of their profession, in a firm grip on guiding principles and a wide outlook
over the whole commercial and linancial world, than service . on the board
dinarily be regarded as a very competent or safe board. Indeed,
were such a system of management proposed at the present time
for the conduct of a new and important banking house in En-
gland or elsewhere, it would instantly be rejected as crude if
not absurd. And yet the Bank of England, which holds the
nation's reserve, is managed in this way. Banking is now re-
garded as a profession to which men should be trained by years
of constant experience and familiarity with financial questions.
And yet the Bank of England has been singularly well managed.
Its directors have always seemed to appreciate the large re-
sponsibility resting upon them, as managers of the bank which
sustains the credit system of England, and while at times they
have erred in policy the great institution stands to-day as solid,
in the estimation and confidence of the people, as the government
of the Bank of England. As nearly all of the board have been many years
in office, they are as a lot, men of ripe experience, and as the new men
are always in the minority and are constantly being educated by their en-
vironment and responsibilities, a tremendous force is thus developed in the
line of conservative action. Technically they may not be bankers; prac-
tically they are very good ones.

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