History of the London Discount Market

W. T. C. King

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136921339
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

First Published in 1972. The London Discount Market is unique, and its existence has contributed more than any other single factor to the elaboration of what may legitimately be called the Anglo-Saxon tradition in Central Banking technique. The bill of exchange has existed for centuries in its classical late Victorian form by many decades. This book assesses how in no other country in the world did the same relationships evolve between the Central institution and the Money Market.

CHAPTER IV

CONSEQUENCES OF THE ACT OF 1844—(1) THE BANK'S “NEW DISCOUNTING” POLICY

IN less specialized histories of banking than the present inquiry, the year 1844 is rightly considered as marking the beginning of a new epoch: in many respects the banking structure after that date had to contend with, and was moulded by, forces completely different from those which had operated in earlier years. Bill market evolution, on the other hand, presents no real counterpart of this experience. With few exceptions, the factors which made for the steady growth in the importance and size of the various members of the market after 1844 had emerged before that date. If it were possible adequately to trace the growth of discount business in vacuo, so to speak, without detailing the many various (and obviously relevant) contemporary developments in the general banking sphere, there would be little justification for any break in the narrative from 1825 until about 1858. For over the whole of this period the major influences upon market technique and development were those, already fully discussed, which arose shortly after the crisis of 1825—the only difference was that in the later years their importance steadily increased. Nevertheless, the year 1844 brought so complete a change in the general background against which bill market trends must be viewed, that to treat this date as a landmark in market history is no mere subservience to the convention established by other writers.

THEORY OF THE ACT OF 1844

The difficulties of 1836–9, as has been shown, had directed attention once again to two major problems—that of preventing banking excesses in general and the abuse of bill credit in particular, and that of ensuring a “sound” control of credit by the Bank of England. For the first of these problems no direct solution was proposed; but the question of credit control, in a quantitative sense, received serious and prolonged attention. Unfortunately, it was construed by most contemporary economists and bankers solely as a problem of currency control, the predominant opinion being that if only note issues (of the private issuers, as well as of the Bank) could be properly regulated, credit in the form of cheques and bills could be left to take care of itself. This, as events have subsequently proved repeatedly, was a vain hope.

To examine the course of the note-issue controversy, and detail the manner of its denouement, would be to extend quite unreasonably the scope of the present work, although the temptation to do so is strong. It is sufficient to explain that the critics of Bank of England policy, generally grouped as the “Currency School”, triumphed over the opposition “Banking School”; and that the “Currency”theory, that note issues should be controlled so as to ensure that their volume fluctuated automatically with the bullion holding, and, therefore, more or less automatically with the foreign exchanges, was embodied in the Bank Charter Act of 1844. Under the terms of this Act, the Bank's note issue was to be segregated from its other business; all Bank of England notes above a fiduciary £14,000,000 were to be backed by their equivalent in bullion¹; existing private issues were to be limited; and new banks of issue absolutely prohibited.² This legislation thus finally and firmly consolidated the Bank's monopoly, and thereby laid the foundation of its evolution into the all-powerful central bank of modern times. The close connection between that evolution and the Act of 1844 is now universally recognized; yet, paradoxical as it must seem to-day, the first effect of the Act was to make the Bank less of a central bank than it had been previously.

In the light of contemporary theory there was no paradox. The question of the Bank's right to operate freely as a commercial bank and earn profits for its proprietors had always been one of acute controversy; but, even of those who recognized the special position of the Bank, few had ever suggested that its freedom as a trading bank was limited by anything more than its duty to preserve the safety and convertibility of its note issue. Actually, as has been demonstrated, the board after the late 'twenties had professed to work within much narrower limits than this principle alone would have demanded. Its policy of aloofness from the discount market, and its laudable intention to refrain from “forcing” its issues, had, in their essentials, much in common with the central bank technique of far more enlightened times. These principles, however, were evolved more from a conviction, partly intuitive and partly reasoned, that some restraint in the Bank's “banking” business was necessary to ensure at all times the convertibility of the note issue, than from a recognition that there was anything inherently undesirable in active commercial banking by an institution which was the ultimate source of credit. And it has been seen that the board frequently failed to live up to the high canons by which it was avowedly guided.

The Act of 1844, by providing an apparently fool-proof mechanism for regulating the note issue, completely destroyed this theory of credit control. Power to manipulate the issue, or to vary its gold backing, was entirely lost to the directors, who in this respect became merely “mechanical instruments”.¹ “The issue department might be in Whitehall, and the banking department in Threadneedle Street,” said the Governor in 1848.² In other words, the one circumstance which, according to the prevalent theory, had restricted the Bank as a trading bank had been removed. The Bank was therefore free to act in precisely the same fashion as any other privately-owned bank. “The functions of banking, as regards the Bank of England,” said Newmarch, explaining the principle of the Act, “should be carried on by the directors precisely in the same way as the functions of banking are carried on by any of the large houses in Lombard-street”.³ Sir Robert Peel himself had expounded this, the underlying theory of the Act, even more explicitly⁴:

The principle of competition, though unsafe in our opinion when applied to issue, ought, we think, to govern the business of banking. After the issue of paper currency has once taken place, it is then important that the public should be enabled to obtain the use of that issue on as favourable terms as possible … banking business, as distinguished from Issue, is a matter in respect to which there cannot be too unlimited or unrestricted a competition….

The only logical interpretation of these statements was that the Bank's only duty, so long as it maintained a reserve adequate for the repayment of deposits—the primary obligation of any banker—was to its proprietors.¹ Actually, the Governor and Deputy Governor admitted a duty also to the public, inasmuch as they felt bound “to take care … not to interfere generally with the monetary affairs of the country”.² But they also argued, in effect, that the change of viewpoint wrought by the Act was more apparent than real, in that the true interests of the proprietors of the Bank and of the public were identical. In this they were supported, and even complimented, by the Commons' Committee of 1848, which, while pointing out that the magnitude of the Bank's resources, its exclusive privileges, and peculiar relationship to the Government imposed upon it a duty to consider the public interest—a duty “which the Bank has never disclaimed”—declared that the identity of interests made it unnecessary to impose any obligation in law.³ It is to the credit of the Lords' Committee that it was able to take a more detached view, noting that the principle of identity of interest, though possibly true, “does not appear to have been practically recognized in all cases”,¹ In other words, the Lords' Committee was prepared to agree that the ultimate interest of Bank proprietors might be identical with the public interest; but was implying that the board had failed to recognize that a policy of maximum activity (and profits), though clearly beneficial to the proprietors in the short run, might be disadvantageous for them in the long run.

COMPETITIVE DISCOUNTING BY THE BANK

At all events, the Bank was not slow to utilize its newly gained freedom, and, immediately after the Act became operative, it began to compete for commercial business more aggressively than at any other time in its history. Indeed, there is evidence to show that the directors considered such competition not merely as their right, but also as their public duty.² Peel had declared that Bank of England notes, once created against gold, must be made available on terms as favourable as possible, which, as Tooke pointed out,³ meant their issue at as low a rate of interest as possible. Thus the Bank directors argued that they were obliged “to look to the amount of our deposits, and the amount of the reserve that we have for meeting them”,⁴ and that it was incumbent upon them immediately to employ all notes in reserve which were not required as normal backing for liabilities.⁵ If the directors were to pursue the same Bank rate policy as had been followed in the previous twenty years, there was only one means by which a surplus reserve could be employed—by purchases of Government or similar securities. This method was not favoured. “The practice of buying securities when money was abundant and the price high, and of selling securities when money was scarce and the price low,” said Morris, explaining the procedure before 1844, “caused a loss to the Bank and inconvenience in the money-market which it was desirable to avoid.” ¹ The only alternative was investment in bills of exchange, involving a competitive discount rate; and the board, in deciding to adopt this course, then recalled ² an advantage of bills which appeared to have been ignored by the Bank directorate for nearly a quarter of a century—the advantage that money employed in bills returned automatically to the lender at the end of a fixed an...