[Chapter 9 of Ernest Benn's Debt: Private and Public, Good and Bad, London: Ernest Benn Limited, 1938]
The year 1937 and thereabouts will stand out in financial history as a very remarkable period. It brought us to the end of one chapter, one might wish the last chapter, in the history of the political effort to control money. For five or six years previously the [British] government had succeeded in imposing a policy of cheap money, and by all the rules, cheap money having then served its purpose, the tide or pendulum should have swung in the opposite direction. But by 1937 the pundits and professors of the Treasury, for London as well as Washington has its brain trust, had secured so firm a hold upon the temporary occupants of political places as to persuade them that a continuance of cheap money was still desirable.
The circumstances can be stated in terms of domestic economy. A serious illness had overtaken the national family in 1929–1931; the household structure had been shaken to its foundations by threats of change and new sorts of ways of living if not indeed of total abolition. In 1931 the doctors, in the shape of a National Government,[1] took control and 1931–1936 was an anxious period of nursing and slow convalescence, ending by 1937 in a return of some of the old confidence. By that time however the chemists and dispensers, instead of working to the orders of the doctors, had themselves taken control of the situation. They insisted on continuing the supplies of pills, dopes, and injections and were in fact in a position to force these things down the throats of the family, in the place of the normal meat and drink for which the convalescents were more than ready.
Or, to change the metaphor, the 1937 position can be illustrated from the football field. It is not so very long since trade, the money trade with the rest, was supposed to carry on its affairs under the healthy stimulus of competition and desire for gain, and the government was supposed to hold the ring, to see fair play, and especially to provide for any of the victims or casualties of the competitive system. That was certainly the Victorian conception, and we have never wholly parted with it, although the first third of the 20th century has held it in small respect. The position reached in the money market by 1937 was that the old game in the old way was still recognized as more or less necessary, and more or less permissible, but that the rules had been changed to the extent that the goalkeeper of one of the most powerful of the teams had usurped the functions of the referee.
Nineteen thirty-seven was remarkable because the whole force and power of the Treasury were exerted to keep money cheap, and to maintain the machinery of control, while the natural forces did in fact come back into play and inflicted a spectacular defeat upon the dispensers of control. The rate of interest went up, in spite of all the endeavors of the Treasury to keep it down. The patient had actually declined to be fed entirely upon pills and had begun to enjoy a little natural nourishment. The struggle will no doubt continue, but it has at least become apparent that the science of control has not yet been perfected to the point when it can finally suppress the forces of nature.
In 1931 the disastrous effects of two or three years of political folly were weighing heavily upon us, and there was good reason for the application of political power to force cheap money and thus encourage trade and industry back to the healthy position of 1929. By 1937, justification of that policy was complete. The revival of trade, at least home trade, was quite extraordinary. The number of persons in gainful employment reached higher figures than ever before, and more important, reached a higher proportion of the total population than at any previous time in our experience.
"The struggle will no doubt continue, but it has at least become apparent that the science of control has not yet been perfected to the point when it can finally suppress the forces of nature."This great achievement was accomplished in spite of new devices in social amelioration that might have been expected to reduce the numbers in employment. The theory that necessity was the mother of invention, commonly held by our grandparents, was thought to make us need the spur of privation and hardship in order to drive us to work. By 1937 we had to revise somewhat the severity of that point of view, for while privation and hardship had been mitigated out of recognition of their former selves, we still went to work in numbers far exceeding any previous record.
In those circumstances money ought to have become dear. The 3 percent of the year of slump should have been the 5 percent of the year of prosperity. Good trade and employment had in fact pushed up the prices of everything — labor, commodities, and the rest — and should in the natural course have also pushed up the price of the commodity which we call money. Had that happened we should have heard nothing in 1937 of the risks of boom and the horrors of slump. The bank rate[2] would have saved us from either.
There has always been a certain amount of control of the money market. The Bank of England and its traditional ways of working illustrate our genius for doing things well without saying very much about them. The Bank is nominally a private institution. It acquires a definite status from being the Bank of the Government. It was established to take care of the national bank account, and passed on from that to being the bankers' bank, acting as the clearinghouse for all the trading banks which served the public.
Taking those responsibilities seriously, actuated by those high motives that are always, with us, associated with status and position, the Bank of England developed a moderate system of control of the money market which for a century and more kept us on an even keel and enabled money to become the universal civilizer. The rest of us, not only here but all over the world, were able to go about our business and do our share of the processes of modern civilization, confident that while other things might have their ups and downs, money would remain comparatively stable, steady, and reliable.
The Bank of England's control of the money market can be described in a few sentences. When lenders were more numerous than borrowers it put the bank rate down, thus discouraging the lenders and encouraging the borrowers. When the position was reversed it put the bank rate up with corresponding effects in the opposite direction.
Every Thursday morning a crowd of messengers could be seen standing at the corner of Prince's Street and Lothbury,[3] waiting for the decision of the Court of the Bank,[4] and the moment that the rate was posted on the Bank's doors those messengers would race to their respective offices, so that within a few minutes the whole world would know that the Bank of England rate was unchanged, or had moved up or down a ½ percent. Thus by midday on Thursday the world — and it is important to remember that we were responsible for the whole world under those arrangements — knew that money was in greater demand and could judge that orders were plentiful, trade was on the move, and prosperity was not in jeopardy.
It all sounds very simple, even paltry. Twenty or 30 messengers, most of them in top hats with brass buttons on their coats, standing about in the rain. A gorgeous beadle with a little piece of paper, pinning it up on the Bank door, and the 1 percent per annum alteration in the price of monetary accommodation. And yet on that very simple incident millions of commercial travelers spread over faraway lands would find buyers cheerful and depressed by turns, and trade and industry were able to resist the tendency to excess in either direction.
"The financial course of those days before 1937 was as smooth as glass compared with the stormy billows experienced since political control effaced the Bank of England."This is the sort of story that can be written with the period 1932–1937 in our minds. We must be fair and recognize that such a story could not have been written with the same enthusiasm in any period before the war, for notwithstanding the Bank of England and its gentle control of monetary forces, there were ups and downs, slumps and booms, periods of distress and periods of prosperity. Those inconveniences were very properly the subject of much discussion and criticism, but since then we are in a position to smile at that criticism, for we know from bitter experience that the application of exotic economic and political theories, so far from removing those inconveniences, has made them immeasurably worse.
But the control of the Bank of England over the money market was not limited to the adjustment of the bank rate. There was the further device of the sale and purchase of securities. Here again a highly complicated and very technical matter is capable of fairly simple general explanation. The Bank of England under the authority of Parliament issued bank notes. It was empowered to issue a limited number of notes known as the fiduciary issue without any backing. The fiduciary issue at the moment of writing is £200 million. Beyond that figure it could only issue notes if it held in its strong rooms either gold or securities to the amount of the notes so issued.
The traders of the world secured their money from the joint-stock and trading banks, but the banks could only lend a proper proportion of such money as was deposited by their customers with them. When therefore there were more demands upon the banks than the banks could satisfy, the Bank of England would buy securities, and in their place put money into the market.
To be specific, the National Provincial Bank,[5] holding a mass of securities bought with money for which a few weeks previously there had been no call, would sell those securities to the Bank of England, which under its powers would then issue to the National Provincial Bank notes properly covered, put the National Provincial Bank into funds, and enable it to satisfy the needs of its customers. When the customers had no further use for loans the money would return to the National Provincial Bank, which, finding itself with superfluous funds, would repurchase the securities from the Bank of England by returning the bank notes, and the currency in circulation would in that way be temporarily reduced.
These two devices, the sale and purchase of securities and the movement of the bank rate, sufficed between them to keep money comparatively steady, and although we used to get excited about a ½ percent one way or the other, the financial course of those days was as smooth as glass compared with the stormy billows experienced since political control effaced the Bank of England.
"The Bank of England has been reduced to the position of a part of the machinery for the manufacturing of political money in any quantity that may be required."The Bank of England might be compared with the brake of the motorcar or with the pedal on the piano, and worked much in the same way as those useful and harmless mechanisms. It worked with almost complete lack of personal interest, and there was never anything worth consideration in the makeup of the Bank which could be described as personal, selfish, or unsocial. Now, thanks to 1932–1937 and our Treasury brain trust, the Bank of England has for practical purposes almost gone out of business, and its beneficent control has been supplanted by a sinister mechanism which works, not for the benefit of the trade of the world, not with the object of keeping the course of money even, but with the deliberate purpose and almost the only purpose of facilitating the work and operations and machinations of governments.
This is an enormous change, a tremendous step towards socialism, a revolutionary alteration which has been accomplished in the name of a national government, and under an umbrella which was opened to shield us from socialism. Whereas the Bank of England served to keep a healthy respect for money in the mind of the government as in the minds of all the rest of us, now the bank has been reduced to the position of a part of the machinery for the manufacturing of political money in any quantity that may be required for any government purpose, and with a minimum of respect for the needs of the rest of us for genuine, satisfactory money on which the affairs of life can be founded with confidence.
We are inclined to be critical of the Fascists in Italy or the Nazis in Germany, who in the name of anticommunism have imposed upon those countries many of the worst of the horrors of the communistic system. We should in justice remember that we ourselves have adopted many of the errors of socialism in pursuance of an avowed purpose to defeat the socialists.
To justify these general charges it is necessary to bring evidence in some detail. We must proceed to inquire in individual cases how the money game has fared since the Treasury became both goalkeeper and referee.
The Commonwealth of Australia has been founded and financed with London money. By the rules Australian credit should be measured by the weight of Australian debt, that is to say, when Australia wants little money she should be entitled to have it cheaply, and when she requires a lot of money she should be required to pay a rather higher rate for it. The money lent is secured upon the wealth of Australia, and the debt should not increase at a greater rate than the increase in wealth.
If the proportion of wealth behind the debt is diminished, the debt is less secure and the rate of interest charged requires to include a larger sum for depreciation, so that in the end the 3 percent of true interest and the capital may be returned to the lenders. We must never forget that capital is always depreciating. Capital values are always being lost and always requiring to be renewed.
In the postwar period, Australia, following the example of the motherland, has rushed into political expenditure. By 1937 the total of the funded debt of the commonwealth had risen to £200 per head of the population, that is to say, to the amount of the average year's wages of a London bus conductor, for every man, woman, and child to be found in the backwoods anywhere on that extensive continent. The hope which the London bus conductor can reasonably entertain for the ultimate repayment of his Savings Bank account or his National Savings[6] certificate rests, in part, on the ability of some infant in the wilds of Western Australia to produce £200 on the maturity of the many spectacular Australian loans.
"We are inclined to be critical of the Nazis in Germany, who in the name of anticommunism have imposed upon their countries many of the worst of the horrors of the communistic system. We should remember that we ourselves have adopted many of the errors of socialism in pursuance of an avowed purpose to defeat the socialists."That was the situation when, in November 1937, the Australian government floated on the London market a loan for 11 millions of money. By any rules understood by anybody who knows anything about money, 5 percent would have been a generous rate at which this accommodation might have been granted. Instead we find the Australian loan foisted upon us at the absurd price of 3.5 percent.
The illustration helps our argument in another way, for it will be seen that the practice and theory of control have been extended beyond our own domestic needs. Started with the notion that it would solve our employment problem, it is now used to undermine the little estate of the London bus conductor, for the benefit of the political reputations of those who are seeking the suffrages of the Australian electors.
At the risk of being technical we must look a little more closely at the market situation in November 1937: employment, commodities, and trade, as we have noted, all up, security prices as a whole obeying the laws of nature and going down; great industrial concerns doing better and therefore being in a position to make a better return to the investor, but, standing out miles apart from this natural position, gilt-edged — which should be spelt "guilt" — actually rising, actually returning rather less to the investor than before. This wholly unnatural, entirely improper, position was forced upon us by the pooh-bah of modern finance for the benefit of the Australian politicians.
By recent operations Australia has saved £3 million per annum in interest. That, however, is not the whole story, for we have also adopted the curious notion that commodity prices should be managed; with the difference, however, that while interest rates are managed downwards, commodity prices are managed upwards. Thus, for the export of a given quantity of wealth to Australia, we have ourselves arranged to receive a smaller return of wealth on interest account, and also to reduce our rightful dues still further by bolstering up the money value of the smaller quantities. Such movements are inconvenient when they arise from the natural workings of the law of supply and demand, but in that case, at least they check and correct themselves. Our management of money is advocated as a way to save us from the rigors of the natural law, but it would appear that far more inequality, indeed injustice, may result from the strange modern conceptions of the proper functions of a national treasury.
We hold no brief against Australia, and if her managers have been wise enough, or clever enough, to take advantage of the folly of ours, she can hardly be blamed.
The money market is obliged to consider its daily needs, and being only the medium between the borrower and the permanent investor, may not always attach enough importance to the ultimate worth of a loan. Genuine long-term investors are in a very different position. Public borrowings are now of two kinds — borrowing for new requirements, and borrowings to replace maturing debts, and it is noticeable how, especially with our local authorities, old debts almost always seem to require to be renewed. One sometimes wonders what has become of the revenues which at the time of the original borrowing were held up as the certain means of repayment, and of the sinking funds arranged for the amortization of these loans.
A case in point is provided by the recent raising of £10 million at 31 percent by the government of the Dominion of Canada. Part of the excuse for this flotation was the maturity of the 3.5 percent loan of 1888. Under the influence of a cheap money policy, the Government of Canada thought it necessary to do no more than mention the simple fact that the loan of 1888 was about to mature.
On reference to the prospectus of 1888 a curious story unfolds itself. Messrs. Baring Brothers arranged a loan on 50-year land grant bonds of the Canadian Pacific Railway to be repaid out of the proceeds of lands.[7] The government of Canada guaranteed interest on the loan and accepted the position of trustees, the prospectus stating that,
The Trustees for the bondholders will be the Minster of the Interior for the time being, or such other Minister as the Dominion Government shall name, and two other persons approved by the Dominion Government.
It went on to say that
the net proceeds of the sales of the said lands shall from time to time be paid over to the Government … to constitute a fund to be set apart and held by the Government exclusively for the purpose of satisfying the principal of the said bonds.
Those very rigid conditions have been fulfilled and this money raised in 1888 has been repaid in full to the government of Canada, acting as trustees for the lenders who accepted Messrs. Baring's invitation 50 years ago. Under management, the public finances in Canada, as well as at home, are able to escape the obligations and safeguards common to ordinary finance, and so the dominion government, as trustees, having received the whole of the money on trust, and being under the most specific obligation to hand it over to the lenders, is able to come back to the same market and, without questions being asked, proceed to borrow fresh money, they having applied these trustee funds to other purposes in the meantime.
In justice to Canada it should be said that there is nothing exceptional about this particular loan. It is selected as a typical example of public borrowing, to show how the forcing of a borrowers' market tends to weaken the safeguards formerly thought to be appropriate to the high standing of public finance.
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Editor's Notes
[1] In August 1931, Prime Minister Ramsay MacDonald's Labour government resigned. King George V persuaded MacDonald to form a National Government, composed of members from all political parties, to address the ongoing financial collapse. This first National Government lasted about a month before opposition parties forced a dissolution of Parliament. MacDonald's coalition won the subsequent general election and formed a second National Government in November 1931.
[2] More commonly known as the "discount rate" in the United States.
[3] The Bank of England's building, officially located on Threadneedle Street.
[4] The Bank of England's board of directors. Today, the Bank's Monetary Policy Committee, rather than the Court, sets bank rates.
[5] A joint-stock company that operated independently from 1833–1970, when it merged with Westminster Bank to form NatWest (which is now a subsidiary of the Royal Bank of Scotland Group).
[6] Likely a reference to National Savings & Investments (formerly National Savings Bank), an agency of Her Majesty's Treasury that attracts savings accounts to fund government expenditures.
[7] Ironically, Baring Brothers, later renamed Barings Bank, collapsed in 1995 after an employee lost over £800 million speculating on futures contracts.
