PROMISE TO PAY
CHAPTER IIECONOMIC LAW
THE banker was able to congratulate himself now on the steps he had taken. His IOU’s had never stood higher in the regard of his fellow citizens. He was able, in the cases in which he felt justified in renewing a loan, to ask for a higher rate of interest, as much as 8 per cent. Thus, although his loans were fewer in number, his income, all things considered, remained wonderfully steady.
His case, indeed, was in striking contrast to that of his fellow citizens. As the result of the withdrawal of one-half of the IOU’s—that is to say of one-half of their accustomed buying power—they found themselves with tumbling markets and slumping prices. The mass of goods created during the boom had become largely unsaleable except at ruinous prices. Firms were closing down and discharging their work-people, or close cutting wages to the bone in an attempt to keep going. There were riots which had to be put down with force. There was hunger in the middle of overflowing plenty. There was bankruptcy of once-prosperous and honoured families. Masters were horrified to find that their men resisted a reduction of wages which, as these men ought to have seen, had become urgently necessary ; men stood aghast at the “ savagery ” of masters who desired, it appeared, to take the bread out of their children’s mouths.
Nobody, meanwhile, could account for the disaster. What had happened ? Why had prices fallen ? What blight had descended on their wonderful prosperity ? In their deep perplexity men turned to the banker. He, at any rate, had ridden out the storm. In a world where everything was falling in ruins he stood like a rock.
The banker received a deputation of the chief citizens and entered with them into a consultation about the sickness of the community. The Mayor, who was a business man, expressed the view that there had been a gross over-production of goods. But one of the Aldermen, a Labour leader, called this opinion in question.
“ How can there be over-production when half the town is starving, without decent clothes or boots ? ” the Alderman asked.
The Mayor could not answer him. A doctor in the deputation proposed the inauguration of relief-works for the unemployed. But the Mayor shook his head.
“ The town is in debt to our friend the banker,” he said. “ We could scarcely ask for a new loan at present.”
“ There are the rates.”
“ My dear doctor, we are finding the greatest difficulty in collecting the rates.”
They all turned to the banker. He waited for silence and then addressed them.
“ Need I say, Gentlemen,” he began, “ that I have given the most anxious thought to the sad plight in which we all find ourselves ? Believe me that, if I speak plainly, I do so only from a sense of duty. In my opinion there has been over-production. There has also been over-spending by the public authority. You built a swimming bath, a new school, a play-pond.”
The banker watched the Mayor as he spoke. That official looked guilty.
“ These are luxuries, gentlemen, luxuries ; delightful and most proper if one can afford them. You see, when the public authority sets an example of . . . lavishness, plain citizens are likely to lose their heads. Men dream dreams. They build too many houses, too many factories, too many workshops. A great mass of goods is thrown upon the market. Has anyone asked himself : ` Where is the money to come from to buy all these delightful things ? ’ ”
The banker glanced about him. Nobody spoke.
“ I address you,” he went on, “ as the custodian of the savings of my fellow citizens. These hard-earned savings have been entrusted to my care and I regard the trust as a sacred one. My first duty, clearly, is towards my clients. Very well, then, I say that further expenditure by the municipality would certainly not be justified. Where is the money to come from ? Capital as you know is derived from savings, it is produced by saving by thrift, by the exercise of frugality and honesty. Are these savings, the provision men and women have made for their old age, to be risked in enterprises which, in any case, are unlikely to achieve their object ? Gentlemen, I have a different plan to propose.” The banker leaned across the table.
“ We, too,” he said, “ must save. We must build up more capital resources. We must cut down every item of expenditure, public and private, which cannot be justified. If we do that we shall be able to pay the interest on our debt.”
The Alderman: “ To you.”
“ Certainly to me, as the custodian of the savings of your fellow townsmen. Let me add, Gentlemen, that I believe that many of our public services are over-staffed. . . .”
“ Would you take the loaf off the table when the children are sitting down to tea ? ” the Alderman exclaimed.
A growl of anger went round the room. The Mayor called the Alderman to order.
“ There’s no escaping economic law,” the Mayor said.
“ Ah,” the banker cried, “ that’s it. Economic law. Inexorable economic law. We are all the servants of economic law. Yes, my friends, we must deny ourselves, tighten our belts. . . .”
“ Why should we tighten our belts when there’s been over-production ? ”
“ We have been living beyond our means.” “ What do you mean by that ? ”
“ The swimming bath, the new school. . . .” “ We built them. How can it help anybody if we don’t use them ? ”
“ They can be sold.”
“ Only at ruinous sacrifice.”
“ My dear sir, the value of anything is what it will fetch. If we have lived beyond our means, can we go on enjoying luxuries which we cannot afford ? ”
“ I say that it’s ridiculous to tighten your belt in the middle of overflowing plenty.”
“ Our prosperity was fictitious.”
“ What, bread isn’t bread, is it ? Leather isn’t leather ? Cloth isn’t cloth ? We’ve got them, I tell you ; why can’t we make use of them ? Look at the unemployed. How can you say a town is poor when it has hundreds of idle craftsmen and masses of raw material ? Is an army poor when it has great numbers of reserves ? Does a general surrender before he has called up his reserves ? And while his supply services are bulging with goods ? Surely it’s madness in such circumstances to talk about cutting down ? Why not use what we’ve got ? Why not set our people to work ? ”
The banker shook his head.
“ Where is the money to come from ? ” he asked, and added: “ What would you say to me if you brought me one of my IOU’s only to find that I did not possess the means of cashing it ? Ask yourself that question. I could create IOU’s in unlimited quantities—by a stroke of the pen. Would you accept them in payment ? Would you wish to feel that you had entrusted the fruit of your frugality and hard work to such scraps of paper ? Why are my promises-to-pay valuable ? Because I can redeem them in gold and silver. If you insist on my issuing IOU’s which cannot be redeemed what will happen ? Prices may rise for a time. What then ? Wages also will rise. That, my dear sir, is what a banker calls inflation.”
The last word came in tones which conveyed an impression of finality. The Mayor nodded vigorously.
“ Oh, no, no,” he cried. “ No inflation please. No inflation on any account what ever. I return thanks every day that, whatever else may be weak, our financial system is sound. Sound as a bell.” He wiped his brow. “ There’s no doubt that the banker is right. We have been living above our means. Both profits and wages have been too high. Our prosperity was unreal, fictitious, a bubble. The bubble has burst. Well, we must be men. We must tighten our belts and pay our debts no matter at what price. Those of us who are more happily situated must try to help our less fortunate brethren.”
He wiped his brow again. A faint smile appeared on his lips.
“ Meanwhile,” he declared, “ I know that I shall be expressing all our thoughts when I say that we feel grateful to our banker for his courage and for the clear and definite manner in which he has explained our trouble and prescribed the appropriate remedy. Our banker, as many of us know, has gone to the extreme limit of safety in order to help us. He has done what he could to temper the wind to the shorn lamb. But there is a limit, the limit set by economic law. No prudent man, no honest man, can go beyond that. I, for one, wish to say that I am thankful that our banker has shown himself both prudent and honest, a worthy custodian of our savings. Our hearts may be troubled ; they are troubled. But at least we can say: `There has been no inflation.’ ”
The banker spent that evening over his ledger. He saw that he had become possessed of a very large number of business houses and shops, because the owners, who had owed him IOU’s, had gone bankrupt in the slump. He reached the conclusion that if, in the near future, he could see his way to extending his loans once more, all this property would inevitably rise in value. He decided to hold the property against that happier day.
His conscience had ceased to trouble him. But he couldn’t help thinking that whereas when he had spread out his loans in the first instance, and so raised prices, every buyer had been compelled to pay him tribute, now, when he had called in his loans and so caused prices to fall, tribute had come to him from the sellers. It was a case, evidently, of heads I win, tails you loose. His earlier fears seemed absurd in the light of what had actually happened. He had begun operations with £10,000, all of which belonged to other people. But here he was now the owner of half the houses and businesses in the town, and therefore of a large proportion even of the gold and silver in his own vaults. Whereas formerly his income had been derived solely from the small fees he charged for keeping other people’s money in his strong-room it was derived now from a long list of investments, from rents and from the profits of business. He was the richest man in the town and also the most powerful. And every one of his fellow citizens held him in honour.
THE “ CREDIT CYCLE ”
FURTHER consideration showed the banker that he had been able to exert so great an effect upon the lives of his fellow townsmen because he had given them buying power, in the form of his promises-to-pay, when they had no need of it and had taken that buying power away at the moment when their need of it was greatest. At the time when he had begun to lend his IOU’s there had not been a great quantity of goods in the town’s markets. There had not, therefore, been great need of money to distribute these goods. The sudden flooding of the empty markets with money—a true inflation—had, in consequence, sent prices soaring up and made it worth everybody’s while to produce more goods. Soon the markets had become glutted with goods, so that large quantities of money were needed to distribute them. The sudden draining away of the money, in these circumstances, had necessarily brought all prices down with a thud. His IOU’s had given him control of the price-level.
But he comforted himself with the idea that, even if money had never been invented something of the kind would probably have happened. After all, it was human nature to produce to excess any article for which a brisk demand seemed to exist. And excessive supply is bound, sooner or later, to extinguish demand and so to leave producers with their goods in their hands. He made that point to a friend who had offered some criticism of his methods ; his friend shook his head, objecting :
“ They have no money.”
The banker did not pursue the subject. He assured himself that, in any case, his loans had had the effect of developing the town and all its industries. They had acted like a stream of water in a desert.
“ You’ll admit that we’ve got a move on. Look at the expansion. The progress !”
The methods adopted by the banker were, naturally, adopted very soon by other keepers of strong-rooms in other parts of the country and, indeed, throughout the world, with the result that there was witnessed a sudden and violent expansion of production and then an equally sudden and violent contraction. This alternating boom and slump became a permanent feature of the whole world’s trade and was called “The Trade Cycle”, or “The Credit Cycle”. What was not generally realized about this “ credit cycle ” was that the bankers were making profits both ways, by compelling buyers to pay them tribute during the booms and by compelling sellers to pay them tribute during the slumps—and all this by means of their loans of promises-to-pay what none of them possessed. Our banker delivered an address to his fellow townsmen on “ The Credit Cycle ”.
“ This movement of prices up and down,” he declared, “ is inherent in human nature. It belongs, too, to the nature of things as well as to the nature of men. Look at the seasons. Out of winter darkness emerges the sunlight of spring. That is transformed soon into the glory and happiness of summer. But all too soon the days begin to draw in. Comes the fall of the leaf and then, once more, winter darkness. Believe me, my friends, in the pessimism which now infects our spirits we see only a reflection of Nature herself. But let us lift up our hearts :
‘ If winter comes
Can spring be far behind ? ’ ”
The good man pointed to the skies.
“ What is it,” he asked, “ which causes a revival in trade ? Surely it is confidence. Confidence in ourselves. Confidence in our fellows. Confidence in the future. Because we feel confidence returning to our spirits we begin to plan, to look ahead, to devise new means of production. Such a change of heart, believe me, cannot be produced artificially by any banker. Can a banker, by some act of financial wizardry, induce farmers to expect harvests at seed time ? There is a time to sow and there is a time to reap. How can a banker lend when no man wishes to borrow ? How can he refuse to lend when substantial and credit-worthy borrowers approach him ? Never forget that a banker’s first duty is towards his clients, the honest and frugal folk who have entrusted to him the savings of their lifetime. Would you have him risk these savings in loans that no man desires ? Would you have him make use of your savings to attempt to change the laws of Nature, to try to sow in the time of reaping ? Again, would you hold him back from affording you the chance to help yourself and all your fellows by granting aid to the masters of the harvest when their fields are white and their trees heavy with fruit ? It is confidence which begins a boom, my friends ; and it is lack of confidence which brings it to an end. There is no financial conjuring trick, believe me, which can change by an iota that law of nature, that economic law, that inexorable economic law.
“ A banker, indeed, can only follow where wisdom and prudence lead. If he does not expand his loans when there is genuine need of them, he will be failing in his trust : if he does not contract his loans when confidence has begun to ebb away he will be wanting in common sense.”
In private, however, the banker was less happy than he had been. A cloud of a most unlooked-for kind had begun to darken his horizon. This cloud was in the form of another banker, living in the capital city of the country, who had developed the business of lending his IOU’s to the merchants engaged in trade with foreign countries. The International Banker was concerned, above everything else, to see that the volume of foreign trade was well maintained, that is to say that a brisk demand for his loans continued to exist. He had noticed that when booms occurred in the home market the volume of foreign trade tended to diminish because people were able to buy their own goods and did not wish to export them. He was anxious, therefore, to prevent the Home Bankers from lending too much in the home markets.
When Our Banker understood what was a-foot he became very angry and declared that he would tolerate no interference with the conduct of his business. He would lend his IOU’s when and to whom he chose and he would withdraw them only at such times as seemed good to him. He defied the International Banker to do his worst.
But he was uneasy, nevertheless. For in his heart of hearts he knew that the promises-to-pay in which he dealt were promises he could not possibly fulfil if any large number of his clients asked for their money at the same time. He decided that, in future, he must be more careful than ever before to “ keep his position liquid”, that is to say to invent smaller quantities of his IOU’s and to lend them only to borrowers of the most trustworthy, substantial kind.
The International Banker, however, had another plan to propose. Why not, he suggested, bury the hatchet and co-operate instead of quarrelling ?
“ I am in need, often,” he said, “ of sums of money to lend to shippers and merchants. I am prepared to borrow for short periods of time, a night, or a week-end even, so that your money will always be within your reach if you want it. Why not lend me the IOU’s for which, at the moment, you cannot find good borrowers in your own town ? ”
The banker thought over this proposition ; and the more he thought about it the better he liked it. It was true that he often had difficulty in making a new loan immediately. Good, sound borrowers were none too easy to find, especially in times of slump. Consequently he was often in the position of having IOU’s to lend and not being able to lend them—a most distressing state of affairs seeing that his unlent promises were earning no interest. The International Banker offered him what was, evidently, a way out of his difficulty. He could hand over to the International Banker all his unlent IOU’s with the comfortable assurance that the loans were for very short periods of time. It would be a matter of hours only to call up any of these loans, so that if a good borrower came along he could always accommodate him by withdrawing IOU’s from the International Banker.
He accepted the offer therefore and began to re-organize his system of lending. He was still in possession of gold and silver to the amount of £10,000. Consequently he could still, in favourable circumstances, lend promises to pay £100,000. But in future he would not lend the whole of these promises in his own town. He would divide his loans into short loans and long ones. He would lend, say, £20,000 to the International Banker and £80,000 to his fellow townsmen. When business was very bad in the town he might even lend £40,000 or £50,000 to the International Banker and only £50,000 or £60,000 to the town. In booms on the contrary his loans to the town would be increased and his loans to the International Banker diminished. In that way all his IOU’s would be kept at work earning interest and he would be in a position to shorten sail overnight if need be. He would be holding a substantial part of his IOU’s in a very “ liquid ” state.
The plan worked exceedingly well and the banker found his income increased by it. When he thought that conditions in the town were ripe for a new boom—when the old stocks of goods had been sold off at rubbish prices and the bankrupt businesses disposed of to fresh owners—he withdrew some of his IOU’s from the International Banker and put them, cautiously, into circulation at home. Prices at home then began to rise. People saw a chance of profit and production was speeded up. More and more of his IOU’s were now withdrawn from the International Banker—who only paid about 2 per cent.—and entrusted to fellow townsmen who paid 5 or 6 per cent. Then, when the new goods which the boom had created began to come on the markets he took in sail again by calling up some of his loans to his fellow townsmen and returning these IOU’s to the International Banker until such time as the slump had developed and so prepared the way for another boom.
Since rates of interest rose while he was withdrawing his loans from the town and did not fall again until the slump had touched bottom he obtained an income from his own clients which varied very little. In addition he got another, smaller income from the International Banker. The International Banker, on his side, obtained IOU’s over and above those which he was able to create for himself, just when he had most need of them—that is to say during the periods of slump when manufacturers, who could not sell their wares at home, were shipping them out of the country into foreign markets and so were in need of the International Banker’s services.
“ What I do,” the International Banker explained, “ is to lend IOU’s to merchants who have cargoes to export or import. I take the cargoes as security for my loans. The merchants, of course, pay me interest.”
Our banker understood very well what this meant. The International Banker, like himself, was engaged in inventing promises-to-pay. He was lending these at interest and thus obtaining tribute from his clients for nothing. The danger he had to fear was that his clients might demand the fulfilment of the promises—might demand that is to say gold or silver in exchange for the IOU’s.
This demand for gold was likely to occur when outgoing cargoes did not balance, and so pay for, incoming cargoes, because, in that case the difference would have to be paid in gold. Bills of exchange, in other words, which are the IOU’s of international trade, would no longer serve as the means of payment. The International Banker would be forced to honour his signature upon these bills by giving gold for them. As he, too, was lending promises-to-pay ten times the amount of gold in his possession he could not do this to any great extent.
Our banker realized all the dangers involved in such a system. But he was growing accustomed to dangers. He fixed his thoughts on his own business and began to interest himself in the development of railways. He lent considerable sums of his IOU’s for the building of lines to his home town. A boom in consequence developed and very soon the whole of his available IOU’s were in the hands of home borrowers.
As a consequence of this flooding of the home market with money, large numbers of people became possessed of buying power. More goods, therefore, were sold at home and the export trade began to languish. Very soon there were not enough exports to balance, and so pay for, imports. What had been foreseen now occurred. The International Banker found himself faced by demands that he should fulfil his promises to pay gold, and became panic-stricken lest the demands should exceed his holding of that metal. When the drain of gold had continued for some days he lost his nerve. What was he to do ? The answer seemed to be that he must shut his doors. He stopped lending abruptly and tried to call up as many of his loans as possible. Foreign trade, in consequence, came to a standstill.
The effect was to throw goods designed for export on to the home market and so to cause prices at home to break. At the first sign of this danger all the Home Bankers also began to call up their loans. The boom had been violent ; the slump was equally violent. Our banker gazed at his ledger with terrified eyes. Hundreds of accounts had been opened with him. Would he be able to call up his loans before the panic which was spreading over the whole country brought his clients to his door ? People who owned gold were hoarding it. He demanded his IOU’s from every borrower and so compelled borrowers in their turn to put pressure on their debtors. But day by day, in spite of these drastic methods, his holding of gold leaked away. He began to sell the houses and shops of borrowers who could not repay their loans. The slump was so widespread that neither houses nor shops fetched even moderately good prices. They had to be sold at a ruinous sacrifice. He watched his counter. All his clients who had credit balances seemed to want gold. Everybody wanted gold. His shelves were growing emptier and emptier and still there were thousands of claims, thousands of his promisesto-pay, outstanding against him. In his despair he rushed off to the capital city. Would the great National Bank help him ? He would pay anything, anything at all, for some gold and silver to tide him over the crisis. The National Bank, when he reached it, was besieged by a crowd of Home Bankers all of whom were as frantic as himself. He was told that there was no gold to be had. The public was hoarding it.
He had to return home. He proceeded to sell everything that he possessed, all the wealth that had come to him in other days, his horses, his country house, his plate—for within the limits of his system he was an honest man. Thanks to these extreme sacrifices he was able for another week, to keep his doors open. But at the end of that time his vault was empty and the demands for gold had not ceased. He made up his mind, as he lay abed, that he would not open his doors on the morrow.
He did not sleep. His morning letters were brought to him. One of them announced the declaration by the Government of a Moratorium for debt and the issue, by the National Bank, of notes to replace the vanished gold. He need not pay out another gold or silver coin. He was saved.