Century of Bank Rate

Ralph Hawtrey

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136921056
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

First Published in 1995. In the present volume the statistical material, which is set out in detail in the Appendices, provides the basis for a historical survey of the period from 1858 to 1914, the Antonine age of Bank rate.

CHAPTER I

THE ORIGINS OF THE TRADITION

INTRODUCTION

IN the years preceding the outbreak of war in 1914 the reliance of the Bank of England on its discount rate or “Bank Rate” as the means of regulating its reserve had come to be universally accepted. The Bank was responsible for the currency of the country, and its responsibility was centred in the reserve of the Banking Department. Under the Bank Charter Act of 1844 the fiduciary issue of Bank of England notes was a fixed quantity, and the reserve represented the margin of surplus currency which the Bank was free to pay out without transgressing the limit so imposed upon it. If the reserve showed signs of falling to a dangerously low level, the Bank would raise the Bank rate till the reserve was restored. If the reserve rose unnecessarily high, the Bank rate was reduced.

This procedure had become a firmly established tradition—so firmly established that the reasoning on which it had been founded had been clean forgotten. When it was dug up in the course of the inquiries of the Cunliffe Committee in 1918 and the Macmillan Committee in 1930–1, it was regarded rather as an academic exercise than as a serious practical doctrine.

In recent years the traditional Bank rate policy has been frequently challenged. It has been challenged on the ground that it is injurious to trade and industry and sacrifices their interests to a pedantic monetary correctitude. It has been challenged on the contradictory ground that its supposed efficacy is a fiction based on fallacious reasoning.

The object of the present work is to show how the Bank rate tradition grew up, what was in the minds of those who originated it, to what extent their intentions were realized in the experience which followed, and what is its virtue in the circumstances of the present day and the future.

The opening chapter deals with the period in which the policy was enunciated and took form. The century covering the history of Bank rate begins with the amendment of the usury laws in 1833, but a preliminary account of the proposals and of the experience that gradually led up to that measure is necessary to make the story complete.

This first period covers the Parliamentary inquiries of 1832, 1840–1, 1848 and 1857–8. Here we have the authoritative representatives of the Bank of England first explaining why they desired power to raise their discount rate without the restraints imposed by the usury laws, and then at subsequent inquiries subjected to examination and criticism in regard to the manner in which this power, when it had been granted, was used.

It becomes clear that the policy was throughout regarded as a device for regulating the currency; it was a monetary application of a form of credit control. It is also revealed that the authorities of the Bank of England embarked on the policy with their eyes open to its dangers and drawbacks. They were aware of the injurious consequences of deflation, but they believed them to be unavoidable if the paramount object of a currency unit fixed beyond all doubt in terms of gold was to be gained.

In Chapters II and III we pass to the history of Bank rate in the period from 1858 to 1914. We no longer have the assistance of Parliamentary Committees as a guide to the interpretation of policy. That of 1875 on Banks of Issue hardly touched the subject. The Royal Commission on the Depression of Trade in 1885–6 and that on Gold and Silver in 1886–8 elicited no significant pronouncements from the Bank of England, though the evidence received by the latter is noteworthy for the formulation of the theory of credit regulation by Marshall.

Consequently in these chapters we have to go straight to the facts, and to interpret them in the light of the pronouncements of policy recorded up to 1858. Chapter III sets out the statistical material in chronological sequence. Chapter II serves as an introduction to Chapter III, indicating the principles illustrated by the statistical data, so as to supply a theoretical basis for the interpretations suggested in the latter chapter. These chapters are mainly concerned with the movements of gold, exports and imports and interior demand, which are set out in detail in Appendices I and II.

Chapter IV carries on the story from 1914 to 1932.

Chapter V passes to the statistical investigation of another aspect of the subject, the relation of the long-term rate of interest to Bank rate. Appendix I records the price of Consols (or, from 1879 to 1888, the price of 2 1/2 per cent, annuities) on the day preceding every change in Bank rate from 1844 to 1932. Chapter V analyses the data thus presented, and Chapter VI supplies a theoretical discussion of this part of the subject and generally of the relations between the long-term and short-term rates of interest. Chapter VII is concerned with the relations of the rate of interest to movements of the price level and to monetary conditions, with special reference to events since the War.

Chapter VIII is devoted to a number of pronouncements throwing light on the Bank rate tradition from Bagehot in 1873 to the Macmillan Committee in 1931.

Finally, Chapter IX contains a general survey of the subject with reference to the future as well as to the past.

HENRY THORNTON

The practice of using the Bank of England's discount rate as an instrument of monetary regulation may be said to start from the Bank Charter Act of 1833. The exemption of the discount on bills up to three months from the operation of the usury laws by Section 7 of that Act permitted the Bank for the first time to raise its discount rate above 5 per cent.

The idea was thirty years older. It was originated, I believe, by Henry Thornton, who, when giving evidence before the House of Lords Committee on the Bank Restriction in 1797, remarked on “the unnaturally low rate of interest resulting from the usury laws, which confine the rate of discounting at the Bank to 5 per cent.” “There might be,” he said, “a much greater disposition to borrow of the Bank at 5 per cent, than it might become the Bank to comply with.” He recurred to the subject in his Enquiry into the Nature and Effects of the Paper Credit of Great Britain, which appeared in 1802. “The Bank,” he wrote, “is prohibited by the state of the law from demanding, even in time of war, an interest of more than 5 per cent., which is the same rate at which it discounts in a period of profound peace.” The demand for loans from the Bank depends, he said, “on a comparison of the rate of interest taken at the Bank with the current rate of mercantile profit.” “At some seasons an interest of 6 per cent, per annum, at others of 5 or even of 4 per cent., may afford that degree of advantage to borrowers which shall be about sufficient to limit, in the due measure, the demand upon the Bank for discounts.”

Only by limiting discounts was it possible to limit the Bank's note issue, and so to prevent inflation.

THE CREDIT SYSTEM OF THE EARLY NINETEENTH CENTURY

To make clear the commercial and financial organisation which elicited Thornton's comments, it will be necessary first to enter into a brief description of the credit system of the early nineteenth century, and especially to show the part played in it by bills of exchange.

A bill of exchange is an instrument for assigning the rights in a debt from one creditor to another. It is an order to the debtor to pay to the new creditor. It is written or “drawn” by the old creditor, and, to become binding, must be acknowledged or in technical language “accepted” by the debtor.

Under medieval conditions, as soon as the trade between any two distant places (even within the boundaries of one country) developed beyond casual and occasional adventures, and assumed some degree of regularity, the merchants in one such place would have agents to transact their business in the other. The agent would sell his principal's goods and hold the money received at the latter's disposal. The merchant would direct his agent whether to use the money to buy more goods or to apply it to any other purpose. The earliest commercial bills of exchange were drawn by merchants on their agents, and were simply directions for the disposal of money in the agents' hands. But by the eighteenth century the agent was beginning to drop out. The merchant sending goods to a distant place would draw a bill on the purchaser himself, instead of on an agent. That necessitated a prior agreement by the latter both to purchase the goods and to accept the bill, but, as communications improved, such agreements became more practicable. Nevertheless the functions of the agent could not be wholly dispensed with. The bill, when accepted by the purchaser on whom it was drawn, became the vital evidence of his debt to the seller, and someone had to take charge of it on behalf of the latter. It was to render these services in respect of the bills drawn for the internal trade of the country that the English banking system of the eighteenth century had grown up. The country banks of that time were primarily an organisation for dealing with bills, not only for discounting them, but for presenting them for acceptance, holding them in safe keeping, and collecting payment on maturity. Their note issues and deposits were originally incidental to these functions; traders made their bills payable to the banks, and were willing to leave the proceeds of discount or collection on deposit, or to draw them out in the convenient form of bank notes.

The merchant in any part of England would usually pay for his purchases by accepting bills drawn upon him by the sellers, and would receive payment by drawing bills on his customers. Payment might also be made by means of bills already in the possession of the purchaser and endorsed by him to the seller, or it might of course be made in cash. When a bill was drawn, the foundation of the bargain was that the purchaser should make payment at an agreed future date. The bill was merely an instrument for assigning the debt so created to another creditor.

If a merchant's purchases and sales were paid for exclusively by the drawing of three months bills, his payments and receipts would be a perfect trace of his purchases and sales three months in arrear. He would at any time be paying for what he bought three months before, and receiving payment for what he sold three months before. There would be an excess of payments over receipts equal to the value of the goods bought and not yet sold up to three months before. This excess (along with the expenses incurred in his business) might be met out of his own capital. But it would be a widely fluctuating amount, and if his capital was sufficient to cover the maximum excess of payments over receipts, then at times when the excess was below the maximum he would hold a balance of idle cash, Idle cash is a loss. And this loss could be avoided if the merchant so limited the capital employed in his business that it was just enough when the excess of his payments over his receipts was at a minimum, and relied on getting some of his bills discounted whenever the excess rose above the minimum. In effect he might be increasing his business and supplementing his capital to the requisite extent by the discounting of bills; or, if his business did not expand to this extent, he might build up a private fortune in securities or property outside the business. The private fortune being withdrawn, the capital remaining in the business would be no more than the essential minimum; so equally in this case the usual practice would be to provide for the fluctuating excess of payments over receipts beyond the minimum by getting bills discounted before maturity.

A wholesale dealer selling to retail dealers would probably draw bills on them, but many of the bills would be small and local, and he would not rely on getting them discounted. He would assume the burden of financing the retailers from his own capital. The retailers would need the credit accorded to them by the bills in some instances to enable them to give credit to customers and in others to allow for the time taken to sell off each consignment of goods bought.

Manufacturers, like merchants, would be financed by bills. A manufacturer who drew bills for the goods he sold, and accepted bills drawn on him for the materials he bought, would have to pay wages and other expenses of production in cash. But that did not necessarily mean that he would depend to a greater extent than the merchant on getting bills discounted, for he might meet this cash outlay from his own capital. Like the merchant he would cover the variable margin in excess of his minimum working capital by getting bills discounted. For the manufacturer the variable margin would include the goods he has produced but not yet delivered and those he has delivered but has not been paid for.

BILLS ON LONDON

Bills might be drawn on traders in any part of the country, but from the early days of the credit system there was a marked tendency for bills drawn on London to predominate. The more substantial merchants, those whose transactions were not merely local in character, would nearly always have either a head office or an important agency in London, and to all such the centralisation of receipts and payments was a great convenience. Even traders who had no London establishment tended in course of time to arrange with their bankers to have the bills drawn on them made payable in London.¹

In consequence of the monopoly of joint-stock banking enjoyed by the Bank of England till 1826, the banking system was in the hands of numerous banks most of which were small and none could have a capital exceeding the fortunes of six partners. Few banks had any branches, and none had an extensive branch system. One of the principal functions of the banks in any locality was to act as correspondents of banks in other places for the purpose of presenting bills drawn on that locality for acceptance and payment. A bank would need to have correspondents in all the places with which its customers ordinarily did business, and above all it would need a London correspondent. Every country bank would hold a reserve of London funds composed partly of a balance with its correspondent bank and partly of accepted bills payable in London.

The accepted bills might be left in London with the correspondent bank to be presented for payment on maturity, or sold in the discount market should funds be needed earlier, or they might be returned to the country bank to be available in local dealings. The country bank would employ these London funds to meet the needs of customers arising from liabilities for the purchase of goods or investments or for maturing bills in London. The reserve would be fed by the London receipts of country customers, by maturities of bills, and by the sale of bills in the London discount market. One country bank would acquire London funds from another in exchange for local bills or in settlement of balances. Any country bank would possess a considerable amount of local assets, not only local bills, but also advances to customers. Even in those days advances were a substantial item.

London was also the principal centre for foreign trade. The system of merchants' agencies persisted longer in international trade than in domestic trade. In the early nineteenth century the great merchants had not yet been transformed into merchant banke...