Lombard Street: A Description of the Money Market
By Walter Bagehot
by Lauren Landsburg
When I was a graduate student in international monetary theory, my adviser and others occasionally suggested that I read Walter Bagehot some time. Because I was a graduate student, I doubted that any writer on “institutions” from the 1800s could be worth my time, so of course I didn’t even look the book up. My mistake!
When Walter Bagehot wrote Lombard Street: A Description of the Money Market, in 1873, he did the unthinkable: In language as fresh and clear today as it was over 100 years ago, he respectfully dissected the Bank of England’s foundations, economic incentives, goals, and functions. In the process, he illuminated in a mere few hundred brilliant pages what distinguishes a Central Bank from a commercial bank, both on a daily basis and during crises such as bank panics and recessions. The constitutions of most national Central Banks were reinvented and forever changed as a consequence. The U.S. Federal Reserve, founded in late 1913, and the Central Bank of Central Banks—the International Monetary Fund (IMF)—have ever since been influenced by the enduring independent thought and extraordinary clarity provided by Bagehot in this famous book.
Bagehot’s book was so readable and so remarkable that it was re-issued three times within a year, and was republished in many editions both during his lifetime and afterwards.
Our choice at Econlib, after studying several editions, is to provide the main text the way it was at the end of 1873 (in Bagehot’s third edition, printed within the first year of publication). In doing so, we hope we have caught any errors Bagehot himself may have noticed, while preserving the original language and authoritative care taken in the various quotations.
But: We are also adding some footnotes and a second Appendix provided later (that is, after Bagehot’s death in 1877): specifically, material from the 12th Edition (1906) and from the 14th Edition (1915). We believe that these later additions reflect the historical influence and popularity of this book during a period of time when the incipient Federal Reserve and other international Central Banks were founded and were, during their emergence, greatly influenced by it. The later footnotes are marked according to their editions. We have also included various prefaces, introductions, and Bagehot’s own “Advertisement,” to editions through the 14th, which explain who wrote which of the additions: E. Johnstone, A. W. Wright, and Hartley Withers all contributed.
We have preserved intact all of Bagehot’s original spellings, capitalization, and punctuation from the third edition, with the minor alteration that in a few cases we’ve indented long quotations from other sources for the sake of visual clarity. We’ve also preserved the punctuation and spelling of the additional material from later editions; thus, the observant reader will notice that punctuation differs in style in footnotes from later editions.
Editor, Library of Economics and Liberty
E. Johnstone; Hartley Withers, eds.
First Pub. Date
London: Henry S. King and Co.
Includes editorial notes and appendices from the 12th (1906) and the 14th (1915) editions.
The text of this edition is in the public domain. Picture of Walter Bagehot courtesy of The Warren J. Samuels Portrait Collection at Duke University.
- Introductions, by Hartley Withers
- Chapter II, A General View of Lombard Street
- Chapter III, How Lombard Street Came to Exist
- Chapter IV, The Position of the Chancellor of the Exchequer in the Money Market
- Chapter V, The Mode in Which the Value of Money is Settled in Lombard Street
- Chapter VI, Why Lombard Street Is Often Very Dull, and Sometimes Extremely Excited
- Chapter VII, A More Exact Account of the Mode in Which the Bank of England Has Discharged Its Duty of Retaining a Good Bank Reserve
- Chapter VIII, The Government of the Bank of England
- Chapter IX, The Joint Stock Banks
- Chapter X, The Private Banks
- Chapter XI, The Bill-Brokers
- Chapter XII, The Principles Which Should Regulate the Amount of Banking Reserve
- Chapter XIII, Conclusion
- Appendix I
- Appendix II
The Principles Which Should Regulate the Amount of Banking Reserve to be Kept by the Bank of England
There is a very common notion that the amount of the reserve which the Bank of England ought to keep can be determined at once from the face of their weekly balance sheet. It is imagined that you have only to take the liabilities of the Banking department, and that a third or some other fixed proportion will in all cases be the amount of reserve which the Bank should keep against those liabilities. But to this there are several objections, some arising from the general nature of the banking trade, and others from the special position of the Bank of England.
That the amount of the liabilities of a bank is a principal element in determining the proper amount of its reserve is plainly true; but that it is the only element by which that amount is determined is plainly false. The intrinsic nature of these liabilities must be considered, as well as their numerical quantity. For example, no one would say that the same amount of reserve ought to be kept against acceptances which cannot be paid except at a certain day, and against deposits at call, which may be demanded at any moment. If a bank groups these liabilities together in the balance sheet, you cannot tell the amount of reserve it ought to keep. The necessary information is not given you.
Nor can you certainly determine the amount of reserve necessary to be kept against deposits unless you know something as to the nature of these deposits. If out of 3,000,000
l. of money, one depositor has 1,000,000
l. to his credit, and may draw it out when he pleases, a much larger reserve will be necessary against that liability of 1,000,000
l. than against the remaining 2,000,000
intensity of the liability, so to say, is much greater; and therefore the provision in store must be much greater also. On the other hand, supposing that this single depositor is one of calculable habits—suppose that it is a public body, the time of whose demands is known, and the time of whose receipts is known also—this single liability requires a less reserve than that of an equal amount of ordinary liabilities. The danger that it will be called for is much less; and therefore the security taken against it may be much less too. Unless the quality of the liabilities is considered as well as their quantity, the due provision for their payment cannot be determined.
These are general truths as to all banks, and they have a very particular application to the Bank of England. The first application is favourable to the Bank; for it shows the danger of one of the principal liabilities to be much smaller than it seems. The largest account at the Bank of England is that of the English Government; and probably there has never been any account of which it was so easy in time of peace to calculate the course. All the material facts relative to the English revenue, and the English expenditure, are exceedingly well known; and the amount of the coming payments to and from this account are always, except in war times, to be calculated with wonderful accuracy. In war, no doubt, this is all reversed; the account of a government at war is probably the most uncertain of all accounts, especially of a government of a scattered empire, like the English, whose places of outlay in time of war are so many and so distant, and the amount of whose payments is therefore so incalculable. Ordinarily, however, there is no account of which the course can be so easily predicted; and therefore no account which needs in ordinary times so little reserve. The principal payments, when they are made, are also of the most satisfactory kind to a banker; they are, to a great extent, made to another account at his bank. These largest ordinary payments of the Government are the dividends on the debt, and these are mostly made to bankers who act as agents for the creditors of the nation. The payment of the dividends for the Government is, therefore, in great part a transfer from the account of the Government to the accounts of the various bankers. A certain amount no doubt goes almost at once to the non-banking classes; to those who keep coin and notes in house, and have no account at any bank. But even this amount is calculable, for it is always nearly the same. And the entire operation is, to those who can watch it, singularly invariable time after time.
But it is important to observe, that the published accounts of the Bank give no such information to the public as will enable them to make their own calculations. The account of which we have been speaking is the yearly account of the English Government—what we may call the Budget account, that of revenue and expenditure. And the laws of this are, as we have shown, already known. But under the head ‘Public Deposits’ in the accounts of the Bank, are contained also other accounts, and particularly that of the Secretary for India in Council, the laws of which must be different and are quite unknown. The Secretary for India is a large lender on its account. If any one proposed to give such power to the Chancellor of the Exchequer, there would be great fear and outcry. But so much depends on habit and tradition, that the India Office on one side of Downing Street can do without remark, and with universal assent, what it would be thought ‘unsound’ and extravagant to propose that the other side should do. The present India Office inherits this independence from the old Board of the Company, which, being mercantile and business-like, used to lend its own money on the Stock Exchange as it pleased; the Council of India, its successor, retains the power. Nothing can be better than that it should be allowed to do as it likes; but the mixing up the account of a body which has such a power, and which draws money from India, with that of the Home government clearly prevents the general public from being able to draw inferences as to the course of the combined account from its knowledge of home finance only. The account of ‘public deposits’ in the Bank return includes other accounts too, as the Savings’ Bank balance, the Chancery Funds account, and others; and in consequence, till lately the public had but little knowledge of the real changes of the account of our Government, properly so called. But Mr. Lowe has lately given us a weekly account, and from this, and not from the Bank account, we are able to form a judgment. This account and the return of the Bank of England, it is true, unhappily appear on different days; but except for that accident our knowledge would be perfect; and as it is, for almost all purposes what we know is reasonably sufficient. We can now calculate the course of the Government account nearly as well as it is possible to calculate it.
So far, as we have said, an analysis of the return of the Bank of England is very favourable to the Bank. So great a reserve need not usually be kept against the Government account as if it were a common account. We know the laws of its changes peculiarly well: we can tell when its principal changes will happen with great accuracy; and we know that at such changes most of what is paid away by the Government is only paid to other depositors at the Bank, and that it will really stay at the Bank, though under another name. If we look to the private deposits of the Bank of England, at first sight we may think that the result is the same. By far the most important of these are the ‘Bankers’ deposits’; and, for the most part, these deposits as a whole are likely to vary very little. Each banker, we will suppose, keeps as little as he can, but in all domestic transactions payment from one is really payment to the other. All the most important transactions in the country are settled by cheques; these cheques are paid in to the ‘clearing-house,’ and the balances resulting from them are settled by transfers from the account of one banker to another at the Bank of England. Payments out of the bankers’ balances, therefore, correspond with payments in. As a whole, the deposit of the bankers’ balances at the Bank of England would at first sight seem to be a deposit singularly stable.
Indeed, they would seem, so to say, to be better than stable. They augment when everything else tends to diminish. At a panic, when all other deposits are likely to be taken away, the bankers’ deposits, augment; in fact they did so in 1866, though we do not know the particulars; and it is natural that they should so increase. At such moments all bankers are extremely anxious, and they try to strengthen themselves by every means in their power; they try to have as much money as it is possible at command; they augment their reserve as much as they can, and they place that reserve at the Bank of England. A deposit which is not likely to vary in ordinary times, and which is likely to augment in times of danger, seems, in some sort, the model of a deposit. It might seem not only that a large proportion of it might be lent, but that the whole of it might be so. But a further analysis will, as I believe, show that this conclusion is entirely false; that the bankers’ deposits are a singularly treacherous form of liability; that the utmost caution ought to be used in dealing with them; that, as a rule, a less proportion of them ought to be lent than of ordinary deposits.
The easiest mode of explaining anything is, usually, to exemplify it by a single actual case. And in this subject, fortunately, there is a most conspicuous case near at hand. The German Government has lately taken large sums in bullion from this country, in part from the Bank of England, and in part not, according as it chose. It was in the main well advised, and considerate in its action; and did not take nearly as much from the Bank as it might, or as would have been dangerous. Still it took large sums from the Bank; and it might easily have taken more. How then did the German Government obtain this vast power over the Bank? The answer is, that it obtained it by means of the bankers’ balances, and that it did so in two ways.
First, the German Government had a large balance of its own lying at a particular Joint Stock Bank. That bank lent this balance at its own discretion, to bill-brokers or others, and it formed a single item in the general funds of the London market. There was nothing special about it, except that it belonged to a foreign government, and that its owner was always likely to call it in, and sometimes did so. As long as it stayed unlent in the London Joint Stock Bank, it increased the balances of that bank at the Bank of England; but so soon as it was lent, say, to a bill-broker, it increased the bill-broker’s balance; and as soon as it was employed by the bill-broker in the discount of bills, the owners of those bills paid it to their credit at their separate banks, and it augmented the balances of those bankers at the Bank of England. Of course if it were employed in the discount of bills belonging to foreigners, the money might be taken abroad, and by similar operations it might also be transferred to the English provinces or to Scotland. But, as a rule, such money when deposited in London, for a considerable time remains in London; and so long as it does so, it swells the aggregate balances of the body of bankers at the Bank of England. It is now in the balance of one bank, now of another, but it is always dispersed about those balances somewhere. The evident consequence is that this part of the bankers’ balances is at the mercy of the German Government when it chooses to apply for it. Supposing, then, the sum to be three or four millions—and I believe that on more than one occasion in the last year or two it has been quite as much, if not more—that sum might at once be withdrawn from the Bank of England. In this case the Bank of England is in the position of a banker who is liable for a large amount to a single customer, but with this addition, that it is liable for an
unknown amount. The German Government, as is well known, keeps its account (and a very valuable one it must be) at the London Joint Stock Bank;
*39 but the Bank of England has no access to the account of the German Government at that bank; they cannot tell how much German money is lying to the credit there. Nor can the Bank of England infer much from the balance of the London Joint Stock Bank in their Bank, for the German money was probably paid in various sums to that bank, and lent out again in other various sums. It might to some extent augment that bank’s balance at the Bank of England, or it might not, but it certainly would not be so much added to that balance; and inspection of that bank’s balance would not enable the Bank of England to determine even in the vaguest manner what the entire sum was for which it might be asked at any moment. Nor would the inspection of the bankers’ balances as a whole lead to any certain and sure conclusions. Something might be inferred from them, but not anything certain. Those balances are no doubt in a state of constant fluctuation; and very possibly during the time that the German money was coming in some other might be going out. Any sudden increase in the bankers’ balances would be a probable indication of new foreign money, but new foreign money might come in without causing an increase, since some other and contemporaneous cause might effect a counteracting decrease.
This is the first, and the plainest way in which the German Government could take, and did take, money from this country; and in which it might have broken the Bank of England if it had liked. The German Government had money here and took it away, which is very easy to understand. But the Government also possessed a far greater power, of a somewhat more complex kind. It was the owner of many debts from England. A large part of the ‘indemnity’ was paid by France to Germany in bills on England, and the German Government, as those bills became due, acquired an unprecedented command over the market. As each bill arrived at maturity, the German Government could, if it chose, take the proceeds abroad; and it could do so in bullion, as for coinage purposes it wanted bullion. This would at first naturally cause a reduction in the bankers’ balances; at least that would be its tendency. Supposing the German Government to hold bill A, a good bill, the banker at whose bank bill A was payable would have to pay it; and that would reduce
his balance; and as the sum so paid would go to Germany, it would not appear to the credit of any other banker: the aggregate of the bankers’ balances would thus be reduced. But this reduction would not be permanent. A banker who has to pay 100,000
l. cannot afford to reduce his balance at the Bank of England 100,000
l.; suppose that his liabilities are 2,000,000
l., and that as a rule he finds it necessary to keep at the Bank one-tenth of these liabilities, or 200,000
l., the payment of 100,000
l. would reduce his reserve to 100,000
l.; but his liabilities would be still 1,900,000
l., and therefore to keep up his tenth he would have 90,000
l. to find. His process for finding it is this: he calls in, say, a loan to the bill-brokers; and if no equal additional money is contemporaneously carried to these brokers (which in the case of a large withdrawal of foreign money is not probable), they must reduce their business and discount less. But the effect of this is to throw additional business on the Bank of England. They hold the ultimate reserve of the country, and they must discount out of it if no one else will: if they declined to do so there would be panic and collapse. As soon, therefore, as the withdrawal of the German money reduces the bankers’ balances, there is a new demand on the Bank for fresh discounts to make up those balances. The drain on the Bank is twofold: first, the banking reserve is reduced by exportation of the German money, which reduces the means of the Bank of England; and then out of those reduced means the Bank of England has to make greater advances.
The same result may be arrived at more easily. Supposing any foreign Government or person to have any sort of securities which he can pledge in the market, that operation gives it, or him, a credit on some banker, and enables it, or him, to take money from the banking reserve at the Bank of England, and from the bankers’ balances; and to replace the bankers’ balances at their inevitable minimum, the Bank of England must lend. Every sudden demand on the country causes, in proportion to its magnitude, this peculiar effect. And this is the reason why the Bank of England ought, I think, to deal most cautiously and delicately with their banking deposits. They are the symbol of an indefinite liability: by means of them, as we see, an amount of money so great that it is impossible to assign a limit to it might be abstracted from the Bank of England. As the Bank of England lends money to keep up the bankers’ balances, at their usual amount, and as by means of that usual amount whatever sum foreigners can get credit for may be taken from us, it is not possible to assign a superior limit (to use the scientific word) to the demands which by means of the bankers’ balances may be made upon the Bank of England.
The result comes round to the simple point, on which this book is a commentary: the Bank of England, by the effect of a long history, holds the ultimate cash reserve of the country; whatever cash the country has to pay comes out of that reserve, and therefore the Bank of England has to pay it. And it is as the Bankers’ Bank that the Bank of England has to pay it, for it is by being so that it becomes the keeper of the final cash reserve.
Some persons have been so much impressed with such considerations as these, that they have contended that the Bank of England ought never to lend the ‘bankers’ balances’ at all, that they ought to keep them intact, and as an unused deposit. I am not sure, indeed, that I have seen that extreme form of the opinion in print, but I have often heard it in Lombard Street, from persons very influential and very qualified to judge; even in print I have seen close approximations to it. But I am satisfied that the laying down such a ‘hard and fast’ rule would be very dangerous; in very important and very changeable business rigid rules are apt to be often dangerous. In a panic, as has been said, the bankers’ balances greatly augment. It is true the Bank of England has to lend the money by which they are filled. The banker calls in his money from the bill-broker, ceases to re-discount for that broker, or borrows on securities, or sells securities; and in one or other of these ways he causes a new demand for money which can only at such times be met from the Bank of England. Every one else is in want too. But without inquiring into the origin of the increase at panics, the amount of the bankers’ deposits in fact increases very rapidly; an immense amount of unused money is at such moments often poured by them into the Bank of England. And nothing can more surely aggravate the panic than to forbid the Bank of England to lend that money. Just when money is most scarce you happen to have an unusually large fund of this particular species of money, and you should lend it as fast as you can at such moments, for it is ready lending which cures panics, and non-lending or niggardly lending which aggravates them.
At other times, particularly at the quarterly payment of the dividends, an absolute rule which laid down that the bankers’ balances were never to be lent, would be productive of great inconvenience. A large sum is just then paid from the Government balance to the bankers’ balances, and if you permitted the Bank to lend it while it was still in the hands of the Government, but forbad them to lend it when it came into the hands of the bankers, a great tilt upwards in the value of money would be the consequence, for a most important amount of it would suddenly have become ineffective.
But the idea that the bankers’ balances ought never to be lent is only a natural aggravation of the truth that these balances ought to be used with extreme caution; that as they entail a liability peculiarly great and singularly difficult to foresee, they ought never to be used like a common deposit.
It follows from what has been said that there are always possible and very heavy demands on the Bank of England which are not shown in the account of the Banking department at all: these demands may be greatest when the liabilities shown by that account are smallest, and lowest when those liabilities are largest. If, for example, the German Government brings bills or other good securities to this market, obtains money with them, and removes that money from the market in bullion, that money may, if the German Government choose, be taken wholly from the Bank of England. If the wants of the German Government be urgent, and if the amount of gold ‘arrivals,’ that is, the gold coming here from the mining countries, be but small, that gold will be taken from the Bank of England, for there is no other large store in the country. The German Government is only a conspicuous example of a foreign power which happens lately to have had an unusual command of good securities, and an unusually continuous wish to use them in England. Any foreign state hereafter which wants cash will be likely to come here for it; so long as the Bank of France should continue not to pay in specie,
*40 a foreign state which wants it must of necessity come to London for it. And no indication of the likelihood or unlikelihood of that want can be found in the books of the Bank of England.
What is almost a revolution in the policy of the Bank of England necessarily follows: no certain or fixed proportion of its liabilities can in the present times be laid down as that which the Bank ought to keep in reserve. The old notion that one-third, or any other such fraction, is in all cases enough, must be abandoned. The probable demands upon the Bank are so various in amount, and so little disclosed by the figures of the account, that no simple and easy calculation is a sufficient guide. A definite proportion of the liabilities might often be too small for the reserve, and sometimes too great. The forces of the enemy being variable, those of the defence cannot always be the same.
I admit that this conclusion is very inconvenient. In past times it has been a great aid to the Bank and to the public to be able to decide on the proper policy of the Bank from a mere inspection of its account. In that way the Bank knew easily what to do and the public knew easily what to foresee. But, unhappily, the rule which is most simple is not always the rule which is most to be relied upon. The practical difficulties of life often cannot be met by very simple rules; those dangers being complex and many, the rules for encountering them cannot well be single or simple. A uniform remedy for many diseases often ends by killing the patient.
Another simple rule often laid down for the management of the Bank of England must now be abandoned also. It has been said that the Bank of England should look to the market rate, and make its own rate conform to that. This rule was, indeed, always erroneous. The first duty of the Bank of England was to protect the ultimate cash of the country, and to raise the rate of interest so as to protect it. But this rule was never so erroneous as now, because the number of sudden demands upon that reserve was never formerly so great. The market rate of Lombard Street is not influenced by those demands. That rate is determined by the amount of deposits in the hands of bill-brokers and bankers, and the amount of good bills and acceptable securities offered at the moment. The probable efflux of bullion from the Bank scarcely affects it at all; even the real efflux affects it but little; if the open market did not believe that the Bank rate would be altered in consequence of such effluxes the market rate would not rise. If the Bank choose to let its bullion go unheeded, and is seen to be going so to choose, the value of money in Lombard Street will remain unaltered. The more numerous the demands on the Bank for bullion, and the more variable their magnitude, the more dangerous is the rule that the Bank rate of discount should conform to the market rate. In former quiet times the influence, or the partial influence, of that rule has often produced grave disasters. In the present difficult times an adherence to it is a
recipe for making a large number of panics.
A more distinct view of abstract principle must be taken before we can fix on the amount of the reserve which the Bank of England ought to keep. Why should a bank keep any reserve? Because it may be called on to pay certain liabilities at once and in a moment. Why does any bank publish an account? In order to satisfy the public that it possesses cash—or available securities—enough to meet its liabilities. The object of publishing the account of the banking department of the Bank of England is to let the nation see how the national reserve of cash stands, to assure the public that there is enough and more than enough to meet not only all probable calls, but all calls of which there can be a chance of reasonable apprehension. And there is no doubt that the publication of the Bank account gives more stability to the money market than any other kind of precaution would give. Some persons, indeed, feared that the opposite result would happen; they feared that the constant publication of the incessant changes in the reserve would terrify and harass the public mind. An old banker once told me: ‘Sir, I was on Lord Althorp’s committee which decided on the publication of the Bank account, and I voted against it. I thought it would frighten people. But I am bound to own that the committee was right and I was wrong, for that publication has given the money market a greater sense of security than anything else which has happened in my time.’ The diffusion of confidence through Lombard Street and the world is the object of the publication of the Bank accounts and of the Bank reserve.
But that object is not attained if the amount of that reserve when so published is not enough to tranquillise people. A panic is sure to be caused if that reserve is, from whatever cause, exceedingly low. At every moment there is a certain minimum which I will call the ‘apprehension minimum,’ below which the reserve cannot fall without great risk of diffused fear; and by this I do not mean absolute panic, but only a vague fright and timorousness which spreads itself instantly, and as if by magic, over the public mind. Such seasons of incipient alarm are exceedingly dangerous, because they beget the calamities they dread. What is most feared at such moments of susceptibility is the destruction of credit; and if any grave failure or bad event happens at such moments, the public fancy seizes on it, there is a general run, and credit is suspended. The Bank reserve then never ought to be diminished below the ‘apprehension point.’ And this is as much as to say, that it never ought very closely to approach that point; since, if it gets very near, some accident may easily bring it down to that point and cause the evil that is feared.
There is no ‘royal road’ to the amount of the ‘apprehension minimum’: no abstract argument, and no mathematical computation will teach it to us. And we cannot expect that they should. Credit is an opinion generated by circumstances and varying with those circumstances. The state of credit at any particular time is a matter of fact only to be ascertained like other matters of fact; it can only be known by trial and inquiry. And in the same way, nothing but experience can tell us what amount of ‘reserve’ will create a diffused confidence; on such a subject there is no way of arriving at a just conclusion except by incessantly watching the public mind, and seeing at each juncture how it is affected.
Of course in such a matter the cardinal rule to be observed is, that errors of excess are innocuous but errors of defect are destructive. Too much reserve only means a small loss of profit, but too small a reserve may mean ‘ruin.’ Credit may be at once shaken, and if some terrifying accident happen to supervene, there may be a run on the Banking department that may be too much for it, as in 1857 and 1866, and may make it unable to pay its way without assistance—as it was in those years.
And the observance of this maxim is the more necessary because the ‘apprehension minimum’ is not always the same. On the contrary, in times when the public has recently seen the Bank of England exposed to remarkable demands, it is likely to expect that such demands may come again. Conspicuous and recent events educate it, so to speak; it expects that much will be demanded when much has of late often been demanded, and that little will be so, when in general but little has been so. A bank like the Bank of England must always, therefore, be on the watch for a rise, if I may so express it, in the apprehension minimum; it must provide an adequate fund not only to allay the misgivings of to-day, but also to allay what may be the still greater misgivings of to-morrow. And the only practical mode of obtaining this object is to keep the actual reserve always in advance of the
minimum ‘apprehension’ reserve.
And this involves something much more. As the actual reserve is never to be less, and is always, if possible, to exceed by a reasonable amount the ‘minimum’ apprehension reserve, it must when the Bank is quiet and taking no precautions very considerably exceed that minimum. All the precautions of the Bank take time to operate. The principal precaution is a rise in the rate of discount, and such a rise certainly does attract money from the Continent and from all the world much faster than could have been anticipated. But it does not act instantaneously; even the right rate, the ultimately attractive rate, requires an interval for its action, and before the money can come here. And the right rate is often not discovered for some time. It requires several ‘moves,’ as the phrase goes, several augmentations of the rate of discount by the Bank, before the really effectual rate is reached, and in the mean time bullion is ebbing away and the ‘reserve’ is diminishing. Unless, therefore, in times without precaution the actual reserve exceed the ‘apprehension minimum’ by at least the amount which may be taken away in the inevitable interval, and before the available precautions begin to operate, the rule prescribed will be infringed, and the actual reserve will be less than the ‘apprehension’
minimum. In time the precautions taken may attract gold and raise the reserve to the needful amount, but in the interim the evils may happen against which the rule was devised, diffused apprehension may arise, and then any unlucky accident may cause many calamities.
I may be asked, ‘What does all this reasoning in practice come to? At the present moment how much reserve do you say the Bank of England should keep? state your recommendation clearly (I know it will be said) if you wish to have it attended to.’ And I will answer the question plainly, though in so doing there is a great risk that the principles I advocate may be in some degree injured through some mistake I may make in applying them.
I should say that at the present time the mind of the monetary world would become feverish and fearful if the reserve in the Banking department of the Bank of England went below 10,000,000
l. Estimated by the idea of old times, by the idea even of ten years ago, that sum, I know, sounds extremely large. My own nerves were educated to smaller figures, because I was trained in times when the demands on us were less, when neither was so much reserve wanted nor did the public expect so much. But I judge from such observations as I can make of the present state of men’s minds, that in fact, and whether justifiably or not, the important and intelligent part of the public which watches the Bank reserve becomes anxious and dissatisfied if that reserve falls below 10,000,000
l. That sum, therefore, I call the ‘apprehension minimum’ for the present times. Circumstances may change and may make it less or more, but according to the most careful estimate I can make, that is what I should call it now.
It will be said that this estimate is arbitrary and these figures are conjectures. I reply that I only submit them for the judgment of others. The main question is one of fact—Does not the public mind begin to be anxious and timorous just where I have placed the apprehension point? and the deductions from that are comparatively simple questions of mixed fact and reasoning. The final appeal in such cases necessarily is to those who are conversant with and who closely watch the facts.
I shall perhaps be told also that a body like the Court of the Directors of the Bank of England cannot act on estimates like these: that such a body must have a plain rule and keep to it. I say in reply, that if the correct framing of such estimates is necessary for the good guidance of the Bank, we must make a governing body which can correctly frame such estimates. We must not suffer from a dangerous policy because we have inherited an imperfect form of administration. I have before explained in what manner the government of the Bank of England should, I consider, be strengthened, and that government so strengthened would, I believe, be altogether competent to a wise policy.
Then I should say, putting the foregoing reasoning into figures, that the Bank ought never to keep less than 11,000,000
l.. or 11,500,000
l. since experience shows that a million, or a million and a half, may be taken from us at any time. I should regard this as the practical minimum at which, roughly of course, the Bank should aim, and which it should try never to be below. And, in order not to be below 11,500,000
l., the Bank must begin to take precautions when the reserve is between 14,000,000
l. and 15,000,000
l.; for experience shows that between 2,000,000
l. and 3,000,000
l. may, probably enough, be withdrawn from the Bank store before the right rate of interest is found which will attract money from abroad, and before that rate has had time to attract it. When the reserve is between 14,000,000
l. and 15,000,000
l., and when it begins to be diminished by foreign demand, the Bank of England should, I think, begin to act, and to raise the rate of interest.