|An inquiry Into The Currency Principle|
THE BANK OF ENGLAND HAS NOT THE POWER TO ADD TO THE CIRCULATION.
From the description which has been given (at p. 21.) of the employment of bank notes when issued and circulating out of the walls of the Bank, it must be evident that the uses of them are such, the purposes for which they are wanted so defined and limited, that in no case could the Bank, by its own volition, add one hundred thousand pounds, perhaps not one hundred pounds to the amount already in circulation among the public. I do not mean that the Bank might not enter into some spontaneous operation which should be of such a nature as to re- quire notes to pass out of its hands without being returned on the same or the following day in the shape of deposits or of a demand for bullion. The nature of the transaction might be such as to require a lodgement of the bank notes in the exchequer or in the hands of agents or of bankers for a few days. What I do mean to say is, that the notes would, in such case, inevitably return to the Bank as deposits, or, what comes to the same thing, be idle in the tills of the bankers, without having performed any of the functions of money in the transactions of purchase or of payment, distinct from that to which they had been specifically applied. I quoted on a former occasion an opinion, of Mr. Gurney's delivered in 1833, that while the transactions of London are abundantly sup- plied with notes, the effect of an additional 5,000,000 l. would be, that it would remain inoperative or rather idle in the tills of the bankers.
In the evidence before the Committee of 1840 on Banks of Issue, the question of the power of the Bank to increase the circulation is raised in a form which admits of a further illustration of the negative of the existence of such power. It is to be borne in mind that the following questions and answers involve a reference to the effect of the supposed operation of the Bank of England on prices, as well as on the amount of the circulation and on the rate of interest. My immediate object in the quotation is to show that the Bank could not add by the operation to the amount of its outstanding notes in circulation.
The following questions by Sir Robert Peel, and answers by Mr. Page, had been preceded by a question which assumed the Bank to have 20,000,000 l. of notes in circulation, and 10,000,000 l. of coin in its coffers.
Qu. 832. Supposing the 20,000,000 l. of notes issued upon the discount of bills of exchange or advances to government remained the same, and that the Bank were suddenly to throw 5,000,000 of sovereigns into active circulation, as advances upon landed securities, would there be no effect produced upon the currency of the country?
Yes, if they remained out there would be an effect on prices; but they would soon come back. There would in that case, in the first instance, be no alteration in the total quantity of money as administered by the Bank of England, but the Bank would do just what a private banker doeshe would employ the money he has in deposit in the purchase of securities without increasing his liabilities; but that state of things would never last; because either those sovereigns would be wanted in the circulation or they would not; they most certainly would not; because before that time they were never called for, and, not being wanted in the circulation, they would return to the Bank to increase the deposits, and then the Bank would be precisely in the situation I have mentioned before; they would increase their securities and increase their liabilities.
833. They would return to the Bank because they would have depreciated the currency; but would not they affect prices while they remained out?
They would not remain out for any length of time.
If Mr. Page had confined himself to that part of his answer which I have marked with italics he would have been correct. The sovereigns, not being wanted in the circulation, would return to the Bank to in- crease the deposits ; and then, if the following question, instead of "833. They would return to the Bank because they would have depreciated the currency; but would they not affect prices while they remained out?" which assumes that they would have entered into the circulation as currency if instead of this erroneous assumption, the question had been why or in what sense the sovereigns would not be wanted and would return to the Bank, the proper answer would have been, that the circulation of sovereigns is wanted chiefly, if not exclusively, for purposes of income, including wages, and of expenditure, and not as instruments for transfers of capital. It is in the retail trade between dealer and consumer that coins are principally used. Now, as it does not appear why any additional demand in the retail trade should be caused by this forced issue of sovereigns by the way of loan on mortgage, they would, in all probability, as being most inconvenient instruments for a mere advance of capital, return to the Bank as deposits.
By, the supposition it is a forced operation of the Bank. In effecting its purpose of making advances to that extent on mortgage, it would have to displace the existing capital (because the hypothesis assumes that things were in a sound and quiescent state, in other words, in equilibrio, there being no new circumstances to induce fresh borrowers on that description of securities at the existing rate of interest) which had been previously advanced and was absorbed in mortgages. This could not be effected without a great reduction in the rate of interest on that description of securities by way of a sufficient inducement to fresh borrowers, or to the existing mortgagees to pay off their loan and to borrow from the Bank at the reduced rate.
The mortgagees being unexpectedly, and to them inconveniently, paid off, would of course seek other investments;, but these they would not readily find, unless by offers of capital at a still lower rate of interest. This would only remove the difficulty of finding employment for the capital by a single step, or rather merely shift it; for whatever securities were purchased by the capitalists whose mortgages had been paid off and transferred to the Bank, would set afloat just so much capital as would be produced by the transfer of those securities.
The result would not be materially varied if the supposed advances made by the Bank on mortgage were to parties who were buying land speculatively or otherwise. There would, of course, while the operation was in progress, be a temporary rise in the number of years' purchase of landed property. In this case the sellers of the land would probably, after paying off incumbrances, seek investment for the remainder of the amount in securities at home or abroad, and would, in the first instance, with the mortgagees who were paid off, deposit the sovereigns so received at their banker's. In either or both cases, the deposits in the Bank of England or other banks would be increased. The deposits so accumulated would, by the operation of a greatly reduced rate of interest, gradually find employment as capital at home or abroad, without necessarily having in the mean time produced the slightest effect in increasing the amount of the circulation or depreciating the currency, as by the question was supposed, in any other sense at least than in reducing the rate of interest.
I have been the rather induced to remark upon the opinion of Sir Robert Peel, as conveyed by his question No. 832., because it should seem that the examinations of the Committee on Banks of Issue, of which he was a member and in which he took part, had not shaken his belief that it was in the power of the Bank, by an attempt at a forced issue, to in- crease the amount of the circulation either in gold or bank notes, and so to depreciate the currency. On the last day of the session of 1842, Sir Robert Peel, after remarking on the tendency of the improvements effected by his tariff to mitigate the existing distress, concluded with saying,
"I admit that there are modes by which a temporary prosperity might be created. I might create a temporary prosperity by the issue of 1 l. notes, and by encouraging the Bank to make large issues of paper; but such a prosperity would be wholly delusive. It is much wiser, in my opinion, to abstain from the application of the stimulus."
The effect of the issue of five millions being in 1 l. notes instead of sovereigns would be so far, and only so far different, that although they would not, provided they were issued on securities, form an addition to the amount of the circulation, there might be such a preference on the part of the public for 1 l. notes over sovereigns, that gold coin would go back to the Bank instead of the small notes.
It would appear from the conclusion of the speech just quoted, and from his examination of Mr. Page, that Sir Robert Peel is of opinion that a forced issue of sovereigns or of 1 l. notes would be most efficacious, but that large issues of paper generally by the Bank under encouragement from government, would in the next degree be effectual, and serve as a stimulus in creating a temporary prosperity.
Now, whatever may be the ultimate permanent effects of a fall in the rate of interest on the prosperity of the country, it is quite clear that temporary prosperity is not the necessary or immediate consequence of a greatly reduced rate. At the time when Sir Robert Peel made the remark which I have quoted, namely, in August, 1842, the rate of interest had fallen below what it had been for several years before, and most assuredly nothing like a return of prosperity, however short-lived, had yet manifested itself. He cannot, therefore, any longer have supposed, whatever may have been his impression when examining Mr. Page two years before, the rate of interest being then still comparatively high, that mere advances on securities, that is, loans or discounts by the Bank (always assuming that the securities are unexceptionable) could have the desired effect. How he would have proposed the extra issue to be made, with the view of creating temporary prosperity, does not appear.
The object of tracing thus far the operation, hypothetically suggested by Sir Robert Peel, is to show that the Bank of England cannot, any more than the country banks, at its pleasure, or for the purpose of employing productively, that is, in securities, a larger than usual proportion of its deposits or of its bullion, cause an enlargement of the circulation; and that the usual phraseology, by which the Bank of England and the country banks are said to enlarge their circulation as a voluntary act, is incorrect, so far as implying a power which they do not possess of directly adding to the amount of bank notes remaining out in circulation, passing from hand to hand among the public, and performing the functions of money in daily transactions.
It is possible that, coincidently with this operation of the Bank in a sudden forced advance of 5,000,000 l. on mortgage, there might be circumstances in progress, such as an extension of trade and a rise of prices, or a state of discredit of country bank paper, which might absorb a part of the extra sum issued by the Bank; in which case a part only of that extra sum would return to the Bank, some of it as deposits, and some of it to be exchanged for notes, the gold not being wanted for internal purposes. But, under the circumstances here supposed, an increased amount of bank notes would, but for this operation of the Bank, have been called forth, either by depositors or by discounts, or by an influx of bullion.
The conclusion from the view here presented is, that neither the country banks nor the Bank of England have a direct power (their advances being on securities, and the paper convertible) of enlarging their circulation; and that the inference, from the mere fact of an increase or diminution of the amount of bank notes in circulation, as being an indication of a designed enlargement or contraction of issue by the Bank of England to the extent of the difference, proceeds on a false analogy by neglecting a consideration of the distinction between issues used synonymously with advances "on securities," and issues of government bank notes or assignats. It is only the latter description of circulation of bank notes which admits of being increased in amount at the will of the issuers.