Questions of Finance

London, May 19. According to the optimists of the press here the economic crisis in England has now ended, and commerce and industry are once again taking, an upward course. They draw this consoling conclusion from the fact that there has been an easing of the money market. For on the one hand there has been an increase in the gold reserve in the vaults of the Bank of England, and on the other the bank has lowered its rate of interest. Whilst on January 20, 1855, the value of the gold holdings was only £12,162,000, on May 12, 1855, it had risen to £16,045,000—an increase of £3,883,000. The rate of interest, which stood at 5 per cent on January 20, 1855, was lowered by the Bank to 4½ per cent on March 31, and to 4 per cent on April 28. However, those gentlemen have overlooked the fact that an accumulation of gold in the vaults of the Bank and a fall in its rate of interest can be caused by something other than an economic boom—namely the very opposite: stagnation of business and, linked with that, a falling-off in the demand for capital. That the latter is really the cause on this occasion is shown by the tables published every week by the Bank of England. Only one should not, like those optimists, look exclusively at two columns contained in the tables, gold holdings and rate of interest. One has to compare two other columns—those showing reserve bank-notes and discounted bills. As is generally known, the Bank of England is split into two different departments, the Issue Department[a] and the Banking Department. We can describe the former as the mint of the Bank of England. It is engaged solely in manufacturing bank-notes. Robert Peel's Act of 1844 laid down legal limitations on the issue of bank-notes. That is to say, above the sum of £14 million, which is the amount of capital it is owed by the state, the Bank can issue no more bank-notes than there is gold in its vaults. If then, for example, the Bank issues bank-notes to the value of £20 million there has to be gold worth £6 million in its vaults. The Issue Department of the Bank is engaged solely in manufacturing and issuing bank-notes in accordance with the restrictions described. It transfers all the bank-notes it manufactures in this way to the Banking Department, the actual Bank, which does business with the public like any other deposit and discount bank, and which puts bank-notes into circulation by discounting bills, advancing money on interest-bearing papers, paying dividends to state creditors, paying off deposits it holds, etc. Robert Peel cleverly devised both this division of the Bank of England into two self-contained departments and this method of regulating the amount of notes to be issued, because he fancied this would make it possible to guard against any future monetary crisis arising, and to adjust the amount of paper currency to that of metallic currency by means of an automatic and mechanical law. What the celebrated statesman overlooked was the not insignificant fact that his restriction only regulated circulation between the Issue Department and the Banking Department, between two offices of t he Bank of England, but by no means determined circulation between the Banking Department and the outside world. The Issue Department of the Bank transfers to the Banking Department as many bank-notes as it is allowed by law to manufacture, for example £20 million if there are £6 million gold in its coffers. However, what proportion of these £20 million actually goes into circulation depends on the state of business, and on the requirements and demand in the world of commerce. The remainder, which the Bank cannot dispose of and which is thus left in the coffers of the Banking Department, appears in the accounts rendered by the Bank under the heading of reserve bank-notes.

Seeing, as we have, that, from January 20, 1855, to May 12, 1855, the gold holdings of the Bank increased by £3,883,000, we also find that during the same period the quantity of bank-notes held in reserve rose from £5,463,000 to £9,417,000, i.e. by £3,954,000. The greater the quantity of reserve bank-notes, i.e. the notes left in the coffers of the Banking Department, the smaller is the quantity of notes actually circulating amongst the public. However, from the figure just quoted it follows that the accumulation of gold in the vaults of the Bank has been accompanied by a decline in the quantity of bank-notes circulating amongst the public. What is the reason for this contraction in circulation? Simply a decline in trade and a fall in business transactions. Any doubt as to the accuracy of this view will be dispelled when one sees from the same accounts rendered by the Bank that the value of bills discounted by the Bank was £25,282,000 on January 20, 1855, whereas on May 12, 1855 it had fallen to £23,007,000—a decrease of £2,275,000. But the value of bills discounted by the Bank is the most reliable gauge of the quantity of business transacted between the Bank and the world of commerce. The evidence is even more conclusive if one considers that the Bank lowered its rate of interest to 4 per cent on April 28, and thus offered its commodity—capital—20 per cent cheaper than in the previous January. And from April 28, when the Bank lowered its rate of interest, to May 12 the quantity of bank-notes spent on discounting bills fell instead of rising—proof that under the present state of the economy capital is still too expensive at 4 per cent to find even the demand it found at the beginning of January at 5 per cent; proof that the fall in the rate of interest cannot be ascribed to a greater influx of capital but rather to a reduced demand on the part of commercial and industrial enterprises; proof, finally, that the increase in the metal held in the vaults of the Bank is only an increase in idle capital which, at this moment, cannot be utilised.