PROMISE TO PAY

THE GOLD STANDARD

THE Home Minister’s letter brought a reply from a Bishop which was published a few days later.

“ It must,” the Bishop wrote, “ be a matter of regret to many Christian people that the former Home Minister should have chosen to mingle religion with his politics.  He has accused us all, and notably perhaps, by implication, the Churches, of having surrendered both faith and morality in obedience to those whom he calls our financial masters.  An accusation so sweeping and so violent must always be difficult to refute but it may be allowed to one who has no expert knowledge of finance and but little knowledge of politics, to say that a cause is scarcely likely to be advanced in public regard by methods which, in effect, cast a doubt upon the sincerity of all who oppose it.  Is our Chief Minister, are his colleagues, then, mere dupes of the financial interest ?  Is the Parliament of the Nation, likewise, a dupe ?  Does the whole body of public opinion in this, and all other lands, incline fatuously towards what is, according to the former Home Minister, at best a swindle and at worst a crime against God and man ?

“ It is only necessary, as I believe, to state the question in this way in order to reach a sound conclusion.  It is easy for the former Home Minister to write that the foreign exchanges ought to be allowed to take care of themselves ; but that means that those among our people who may have invested their savings abroad are to receive a premium over those who, on grounds possibly of conscience, have chosen to invest at home.  If I buy French rentes when £1 is worth 100 francs and sell them when 50 francs are able to purchase £1 I have doubled my capital.  But my gain is being paid for surely by those of my fellow countrymen who are compelled to buy French goods.  A fixed exchange, as it seems to me, guarantees that justice shall be done as between buyer and seller, the owner of investments and the purchaser of goods.

“ It has now, as I understand, been agreed that when gold leaves this country a corresponding amount of money in the form of notes shall be removed from circulation.  This is likely to cause a fall of prices and so of wages.  But the wage-earner ought to remember that his present sacrifice will be made good to him in cheaper foodstuffs.  The value of a wage, after all, consists in its buying-power.  To suggest therefore that a fall in the wage-level means a fall in the standard of living is both unfair and untrue.  It need mean nothing of the sort.

“ We enjoy to-day, in this our beloved land, the inestimable blessings of an ordered liberty.  The fact that the former Home Minister is able to write as he has done about those whom he calls ` conquerors ’ and `tyrants ’ seems to me to disprove his accusations.  Do conquerors and tyrants permit criticism of their actions ?  Our Press is free; we are entitled to express our opinions openly and freely ; we can come and go as we choose.  Have ` slaves’ ever, anywhere, enjoyed such advantages ?  I say, without hesitation or fear of contradiction, that this land of ours is governed according to Christian principles.  Our people are immeasurably better off than any other people have ever been at any earlier time.  In sobriety and peace they are leading lives which, from year to year, are being enriched by the good gifts of science and of education.  A Christian, even in days of anxiety, cannot but rejoice at these manifestations of Providence.  Sursum Corda.  It is so fatally easy to criticize ; but the critic, as a very wise man has reminded us, reveals himself.”

The Home Minister, on reading this letter, went to the Bishop’s palace.  He laid a copy of the paper containing the letter on the Bishop’s desk.

“ I’ve come to answer you,” he declared, “ as man to man.  These letters to the newspapers are futile.”

The Bishop looked startled.  But he extended a welcoming hand.

“ By all means,” he said in tones that were not free from anxiety.

“ This question of a fixed exchange ?  You say it guarantees justice as between buyer and seller, the owner of investments and the purchaser of goods.”

The Home Minister paused.  An inclination of the Bishop’s white head answered him.  “ That is exactly, believe me, what a fixed exchange does not guarantee.  Let us take buyer and seller first.  If the exchange is fixed and the price-level allowed to fluctuate their contracts with one another may be changed in the sense that one or other may obtain an uncovenanted benefit.  If I buy an article at £1 and, before the article can be delivered to me, the cost of producing it has fallen to 10s., the seller will get the advantage.  Had the cost risen to 30s.  instead of falling, the advantage would have come to me.  This is, more or less, exactly what happens when the exchange is allowed to fluctuate and prices are fixed.  In other words buyers and sellers suffer under either system.  If it is not the exchange that they have to watch it is the price-level ; and if it is not the price-level it is the exchange.  This applies to investors in foreign businesses who buy ordinary shares in these businesses.  But it does not apply when exchanges are fixed to the holders of rentes and other Government bonds.”

The Home Minister leaned forward.

“ What is the difference between an ordinary share in a business and a debenture ?  ” he asked.

“ The debenture is safer than the ordinary share, isn’t it ? ”

“ Why is it safer ? ”

The Bishop shook his head.

“ I’m afraid,” he said, “ that I am not well up in these matters.”

“ I’ll tell you.  Because a debenture is not a share at all.  The shareholder in a company is a partner in the business.  He takes risks.  If the company earns no profits he gets no dividend; if the company goes bankrupt he loses his whole investment.  Compare this with the position of the debenture holder.  A debenture holder has no share in the business.  He has merely lent money to the business.  If the company loses, he does not share in the loss.  If the company goes bankrupt, he seizes its lands, its buildings, all it has.  In other words a debenture-holder is a money-lender.  ,He takes security for his loans just as a banker does.  In consequence what he is interested in is not the price-level but the value of money.  He wants goods to be cheap so that his money may buy more and more of them.  He wants his money to be dear.

“ There are many kinds of debentures.  By far the most important kind are loans made to Governments on the security of the national income.  These gilt-edged securities, as they are called, carry a fixed rate of interest.  If Governments are poor, weak, desperate, they are still under the necessity of paying the same sums of money to their bondholders as in more prosperous days.  And these bondholders will, if they can, wring out of those Governments the very last drop of blood.

“ It is obvious, therefore, that bondholders, debenture-holders and also mortgage-holders stand in an entirely different category from ordinary shareholders.  They are moneylenders whereas shareholders are merchants.  Merchants, as we have seen, have nothing to lose from a free exchange.  Changes as between the values of, say, French and German money or English and French money, need not trouble them more than changes as between the values of money and goods.  If you give them a guarantee that the £1 will maintain a more or less constant buying-power in the home market, they can make allowances for ups and downs as between the home markets and foreign markets.  Under a fixed foreign exchange they have to watch price-movements; under a controlled price-level they will have to watch foreign exchange movements.  It is six of one and half-a-dozen of the other.

“ But the position of the holders of debts (government debts, debentures, mortgages) is different.  If the exchange is fixed these people can invest where they choose and rest assured that when they bring their money home again it will have lost nothing of its value. . . .”

“ And gained nothing. …”

“ Quite.  It works both ways, of course.  The point I am coming to is that the bankers of the world are money-lenders and not merchants.  They lend their promises-to-pay not as partners, but as creditors.  The securities which they hold against their IOU’s are, generally speaking, Government bonds, debentures or mortgages.”

The Bishop held up his hand.

“ But surely, my dear sir,” he exclaimed, “ that is only reasonable ?  A banker, as the trustee of other men’s savings, cannot take risks.”

“ Bankers take such risks all the time as is not dreamed of by one in a million of their clients.  What you have mentioned is, of course, the official explanation of the banker’s preference for debts as opposed to partnerships.  But there is another explanation which nobody ever hears about.  These bonds and debentures and mortgages have one supreme merit in the eyes of money-lenders.  They have to be repaid in full and they carry a fixed rate of interest.  In other words they are, more or less, independent of the price-level.  If prices fall shareholders may be ruined; but bondholders will be better off than before because their money will buy more.  They will go on gaining until a point is reached at which payment of interest by borrowers can no longer be made.  At that point the bondholders are able to seize the lands or buildings which have been pledged to them.  In the case of Governments they are able to demand increased taxation and diminished expenditure on public services and works.”

“ A debt is a debt, you know.”

“ Quite.  I am not denying that.  If a debt has been incurred it ought, certainly, to be repaid.  That is not what I am driving at.  What I am concerned to show you is that the bondholders, the financial system, is in a position, when and if it chooses, to ruin its debtors and seize their property.  Let me give you an example.  I am a banker.  I lend John Smith £1,000 on the security of his factory and the land on which it is standing.  Next I call up some of my other loans and so diminish buying-power in the area in which John Smith conducts his business.  In consequence of this shrinkage of buying-power, or 'demand’, prices fall and John Smith can no longer earn a profit.  As he must pay me the interest on my loan, he now proceeds to cut down his staff of employees and to instal labour-saving machinery.  But I continue, day after day, to call up loans and to refuse to make new loans.  Prices go on falling and, at last, John Smith comes to the end of his resources.  He cannot reduce his staff any further without closing down.  And he cannot afford to close down.  He has to intimate to me that he will be unable to meet the interest on his debentures.

“ I now seize his business and put it up for sale.  The best bid is £800.  So I take the business myself as payment for my loan.  A little later I begin to lend again and prices begin to rise.  John Smith’s factory and plant are now worth having because there is a growing demand for the kind of goods he used to make.  So I sell the business for £5,000 and put £4,200 in my own pocket.  Do you follow ? ” The Bishop’s face wore a new, anxious expression.

“ It cannot be as bad as that,” he exclaimed in a whisper.

“ It’s quite as bad as that.  But my example does not present the whole picture.  An important element has been omitted.  I have spoken as if the banker, in such a deal, was a free agent.  He is not.”

“Oh!”

“ The free agent is not the Home Banker but the International Banker.  It is when the International Banker finds that he can get higher rates of interest in some foreign country that the procession of disasters which I have described begins.  For, unless exports increase to keep pace with the outflow of IOU’s . . .”

“ Forgive me, I don’t follow you.”

“ When a loan of money is made abroad that is equivalent to an increase of imports into the country from which the loan has been made.”

“ Why? ”

“ A loan does not pay for imports.”  The Bishop shook his head.

“ I never could understand these extremely complicated ideas,” he declared hopelessly.

“ It isn’t difficult if you remember that under the present system every country tries to balance, and so pay for, its imports with its exports and thus to avoid sending money, in the form of gold, abroad.  The point about a loan made to foreigners is that it upsets the balance of trade.  If the loan goes out in the form of goods all will be well ; but if it goes out in the form of gold . . .”

“ It can’t go out in the form of goods unless the foreigners want the goods.”

“ Quite so.  But the foreigners would not borrow unless they wanted goods.  The real question is : are our goods as cheap as other people’s goods ?  If not, the foreigner who has asked for the loan will take gold and use it to buy goods elsewhere.  In that case exactly the same position will have arisen as arises when exports do not balance and so pay for imports.  The bankers making the foreign loan will be asked to pay, not IOU’s, but money, gold.  As they possess only one-tenth of the money they have promised to pay they cannot, of course, meet such a demand.  In fact, however, the mere threat that gold may be asked for is enough to bring prices down—for at this threat all lenders at once begin to shorten sail.  Consequently the loan to the foreigners which was made because better terms were offered abroad than were being offered at home, has, as its first effect, enforced a fall of prices in the home market and so—of course—a fall of wages.  Exports are thus increased and the loan goes abroad not in the form of gold but in the form of goods ; the loan, in other words, acts like an import.  It has to be ` met ’ by exports.  Hence, the name `invisible import’ which is usually applied to it.  There is no import in actual fact ; on the contrary there is danger of an export of gold.  That danger is avoided by so far reducing wages that a larger volume of exports of goods can be sent out of the country.”

The Home Minister paused for a moment.

“ I do hope I am making myself clear,” he went on.  “ The mere fact that gold leaves a country matters nothing to anybody since nobody eats the metal.  But it matters tremendously to a man who is lending promises to pay ten times the quantity of gold which he possesses.  The real anxiety about an export of gold is not the fact of export but the fact that the gold has been asked for.  Not one of the International Bankers can stand such a demand for any length of time because not one of them holds more than a tenth part of the money he has promised to pay.

“ In other words the whole trouble resides in the private creation of IOU’s to serve as money.  The banker is trying to convince the world that a lie-namely, that he can fulfil his promises to pay ten times as much money as he possesses, is true.  The only way in which he can make the lie look like truth is to prevent the holders of his IOU’s from asking for their money.  Our present banking system is therefore designed primarily to prevent demands being made for real money whether inside of the country or outside of it, whether in the form of notes of the national bank or of gold.  Bankers keep urging their clients to use more cheques, that is IOU’s, and by implication less money.  No bank can stand a 'run’ which means that no bank can make good more than a very small proportion of its promises.

“ At the same time every banker wants to get as much for these false promises of his as the world will give him.  He wants therefore to be able to change his IOU’s from one kind of money into another kind of money at a moment’s notice.  If, for example, I have lent IOU’s for £1,000 in England and find that there is a borrower in France who will pay me a higher rate of interest than my English borrower, I want to be able to call up my loan and change it, instantly, into IOU’s for, say, 100,000 francs.  But I don’t want to be asked to honour my IOU’s in the process by giving gold for them.  I want the movement of goods to follow my loans in such a way that, no matter what I may do exports everywhere will pay for imports and no demands will therefore be made upon me for gold.”

“ Please explain to me,” the Bishop interrupted, “ how these demands for gold arise.  If I make a loan to France don’t I pay that loan in pounds ?  ”

“ No.  If the worst comes to the worst you buy francs with pounds.  You part with your pounds for gold and use the gold to buy francs.”

“ The worst comes to the worst ? ”

“ I mean if the French don’t use their loan to buy goods in England.”

“ What happens if they do buy goods in England ? ”

“ Then you pay the makers of the goods.  You pay them by means of cheques drawn on yourself; by means, in other words, of promises-to-pay, of IOU’s.  That, of course, costs you nothing.”

“What!”

“My dear Bishop, the whole object of international usury is to compel governments and peoples to compete with one another for the IOU’s of the financiers.  People will not compete for loans unless they need them.  How can people be made to need loans ?  In what circumstances does a man or a company usually borrow ?  Surely when that man or that company lacks money either to carry on or to develop his business.  Men with ample capital of their own do not borrow.  Very well then, it is the aim of the financial system to prevent good borrowers from accumulating money of their own.  That may be said to be the financial system’s first and most important aim.  Ask yourself in what circumstances men tend to accumulate capital.  ` Is it not when prices are rising or when, having risen, prices are remaining more or less stable ? ’ This is the position of affairs during an ordinary period of prosperity in trade.  Obviously the financial system cannot allow such a state of affairs to continue indefinitely.  What would happen if such a state of affairs did continue would be that many credit-worthy borrowers would become too rich to want to borrow at all and that, in consequence, loans would have to be made to less and less desirable recipients.

“ The financial system protects those who live by it against this danger.  As prices rise, more and more actual money is needed in shops and markets.  Bankers are compelled, to a greater and greater extent, to honour their promises-to-pay.  Their customers present cheques and ask for cash.  Their stores of real money become depleted and they begin, in consequence, to stop lending and to call in loans so that they may not be caught out by a 'run.  When they stop lending prices of course fall and the men with money soon lose it and become good borrowers once more.

“ High prices at home, therefore, threaten the Home Bankers by forcing them to part with real money.  And that threat is soon passed on to the International Bankers because high-priced goods cannot be sold abroad.  Exports fall and no longer pay for imports and International Bankers, in their turn, are asked to make good their promises in money -in gold.  Both Home and International Bankers therefore must, on pain of catastrophe, bring any rise of prices to an end or (it amounts to the same thing) compel a fall of prices if somebody else in the world is producing more cheaply.

“ In a sense the system works automatically.  If prices are too high in any country, that country will not be able to export.  Goods will therefore pile up at home and prices will break.  But we must be careful not to be led away by this aspect of the matter for it is obvious that, if the foreign exchange was free to move, high prices at home would not constitute an obstacle to the export trade.  Our money would lose value the moment our exports did not pay for our imports.  This fall in the value of our money would enable us to sell still in foreign markets because what cost £1 at home would be selling for, say, 15s. abroad.  (Owing to the fact that our £1 was worth now, in other countries, only 15s.)”

The Bishop shook his head.

“ Surely that would suit the bankers better than the present system ? ” he said.  “ If the exchanges were allowed to fluctuate, they could not be asked to pay gold for their IOU’s.”

“ No.  But then their control of the price-level would be gone.  The moment it was discovered that a fluctuating exchange unpegged in any way, is harmless to trade, price-levels would be maintained by public agitation against anything which money lenders might say.  Would business men, who knew that they had nothing to fear, even as exporters, from a home market which was possessed of a high degree of buying power, allow their home market to be emptied of that buying-power ?  Of course not.  On the contrary it would soon be insisted that, as more goods were produced, more money should be issued to ensure their distribution.  Money, remember, costs nothing.  If the bankers tried to resist, they would be sidetracked by the government which would issue money on its own account.  And even if it escaped that danger the financial system would perish from want of good borrowers.  For producers would soon be in possession of enough capital to finance their own developments.”

“ I see.”

“ Therefore the financial system will never part with fixed exchanges or with gold, which is the most convenient and most satisfactory `peg’ for these exchanges that has so far been devised.  This golden ` peg’ of the foreign exchanges is the lever whereby the price-level in every country can be raised or lowered and whereby, therefore, the supply of good borrowers can be maintained.”

The Home Minister rose and began to walk about the room.

“ In theory, as you know,” he went on, “ the exchanges reflect the movements of goods and services.  Exports pay for imports.  If one exports more goods than one imports, one receives gold to make up the difference; if one imports more than one exports one pays gold out.  And so on.  Actually, however, as we have seen, it is possible by means of loans to foreigners to tip the balance one way or the other.  The International Bankers, in other words, can create ` invisible imports ’ or ` invisible exports ’ by means of finance bills and other devices and so compel rapid and drastic changes in the price-levels and thus, also, in wage-levels.  Think what the power means when one is dealing with a reluctant government.  If the government in question refuses to grant the terms asked for, the International Bankers can put the exchanges against it, draw off its gold and compel it to cut wages and reduce public expenditure.  Thus, the negotiating Government may find itself with a political crisis on its hands accompanied perhaps by strikes and riots.”

The Home Minister approached the Bishop’s desk and stood in front of it.

“ So here is the process as it is now in operation.  The International Banker lends promises to pay to those countries whose production is cheapest and where, therefore, the highest rates of interest are available.  He lends these IOU’s on the security of National incomes (bonds) of land (mortgages), of debentures and of cargoes of readily saleable commodities.  By lending, he causes rises of bank-rates in the countries from which the IOU’s have been taken, each Home Banker being anxious to protect himself against a possible 'run’ upon him if gold should begin to leave the country and if, in consequence, a sharp break in prices should occur.  The rises in bank-rates cause a falling off of borrowing and hence a gradual decline in buying-power.  Prices sag.  Wages fall.  Firms fail to pay the interest due on debentures and mortgages and governments find themselves, owing to difficulty in collecting taxes, with unbalanced budgets.  The market values of mortgages, debentures and government bonds fall sharply.  Bankers begin to sell the securities, the land and factories and workshops and even the government bonds against which they lend their IOU’s.  These securities naturally fetch very little and large amounts of them pass into the hands of the bankers themselves at ` rubbish ’ prices.

“The time has now come when the ` deflated’ country is ripe for a new expansion of credit ; for prices are low, wages are low and stocks are depleted.  Back come the IOU’s.  Up go the prices.  Soon the bankers are able to sell off the bonds, and land and factories and workshops and cargoes to new owners (or even to the old owners by means of loans from the bankers themselves) at a substantial profit.  The sheep have been sheared.  It is time to think about a new crop of wool.”

“ Terrible, terrible ! ”

The Bishop’s voice was charged with a lively distress.

“And this,” he said, “is the system of which I made myself the defender.  You are quite right.  The root of the evil is the lie that a man who has promised to pay ten times what he possesses can possibly fulfil his promises.  The system, as you have shown me, marches from lie to lie-the lie that a loss of gold is disastrous, the lie that foreign exchanges must be kept fixed, the lie that a country lives by its export trade, the lie that purchasing power in the home market is an evil if it interferes with exports, the lie that high wages are a danger, the lie that a country which does not export more than it imports is living above its means, the lie that the remedy for over-production is economy in consumption.  What a hideous pyramid of falsehood ! And what a spectacle ; a world glutted with goods on the one side and with hungry paupers on the other ! ”

The Bishop remained silent for a moment.  Then he rose and stood facing his visitor.

“ This system of IOU’s,” he asked, “ was established, was it not, about the time that the power of the Christian Church in Europe began to weaken ?  ”

“ Yes.  In the eighteenth century.  The Christian Church absolutely forbade usury.” The old man nodded.

“ I begin to see a war,” he said, “of principalities and powers rather than of bankers and their victims.”

He held out his hand to the Home Minister.

“ I was an army chaplain,” he said.  “ I saw so many men lay down their lives for what they believed to be righteousness.  And so I lift up my heart.  If the Christian civilization of Europe has not perished that is only because the spirit of its Founder dwells still in millions of hearts.  Go out and tell the people.  When that task has been accomplished fully, the fields will be white towards the harvest.”

CONCLUSION

A STRUGGLE is proceeding to-day between International Bankers, frantically concerned to maintain fixed exchanges throughout the world, and the rest of mankind concerned only to produce and consume.  Farmers and manufacturers, scourged by falling prices, are reaching out blindly towards such means of protecting their price-levels as tariffs, quotas and restrictions on foreign exchange ; workpeople are clinging desperately to their “ doles ” in order to defeat the attempts of the bankers to reduce their wages.  Thus, foreign exchanges made as rigid as possible by equalization funds and other devices, are opposed to price-levels and wage-levels the rigidity of which is equally great.

The Bankers are reluctant to lend unless and until they are assured that their former power to change the price-level will be restored to them (on the principle that an empty house is better than a bad tenant) ; but this assurance cannot be given unless tariffs, restrictions on foreign exchange and “ doles ” are all materially reduced.  A rise of prices, in these circumstances, can come only when existing stocks are exhausted.  These existing stocks are so large, thanks to science and machinery as applied to the bounty of Nature, that the time of exhaustion has been long deferred.  Meanwhile the fall in prices has made money much more valuable in terms of goods and so has doubled the weight of all debts.

The dictatorships which are being set up in so many countries are, primarily, attempts by International Finance to compel farmers, manufacturers and wage-earners to accept a fluctuating price-level and a fluctuating wage-level.  In each case, however, the dictator, soon after his coming to power, has veered away from the bankers towards the mass of the people and has concerned himself to raise prices and wages and to devise means of keeping them stable once they shall have risen.  Dictatorships in consequence are now exceedingly unpopular with International Finance.  International Finance is not less unpopular with the dictators.

President Roosevelt’s efforts to raise prices and wages preparatory to stabilizing both the price-level and the wage-level is, naturally, peculiarly hateful to International Finance since, if it succeeds, stabilization of the foreign exchanges cannot be effected.  The American banks have hesitated therefore to lend their IOU’s to the National Recovery Campaign.  Thus the position foreseen by the “ international banker ” of these pages has come to pass.  A powerful government possessed of half the world’s stock of gold is asking itself why it should not create its own money and so distribute the goods which, at present, cannot be disposed of.  The American Government no longer believes that overproduction is inherent in the nature of things and hence rejects the view that a fall in prices is part of an economic law which decrees freely movable levels of prices and wages.

Can International Finance defeat the American Government ?  Only if it can compel President Roosevelt to abandon his present policy, peg the dollar exchange (and not, as at present, the price level) with gold, remove exchange restrictions and reduce some, at any rate, of his tariffs.  Another question : If President Roosevelt’s campaign succeeds, whether by the creation of new money or the compulsion of the banks to expand their loans, can International Finance survive ?  If the credit-worthy borrowers of America get out of debt and acquire their own capital will the credit-worthy borrowers elsewhere be willing to submit, any longer, to the banker’s dictation ?

CURRENCY means legal-tender money whether notes or gold.  This money is issued under the authority of Government.  It amounts in England to about £350,000,000.

CREDIT consists of the promises of bankers to pay currency.  These promises-to-pay amount to about ten times the total of the currency, say £3,000,000,000.  Credit is not legal-tender money but, since it is used daily to buy goods and services and to pay debts, it performs all the functions of money and is, in fact, indistinguishable from it.

Thus of a total of some £3,000,000,000 in this country :

£350.000,000 is money issued by Government and £2,650,000,000 consists of promises-to-pay issued by private individuals.

These promises-to-pay are issued only as loans repayable with interest.  They can be withdrawn.  So that the bankers actually have it in their power to remove nine-tenths of the buying-power of the country whenever they choose to do so.  Actually, of course, they content themselves with much smaller fluctuations of their credit because quite small fluctuations are enough to cause those changes in the level of prices, upwards or downwards, by which they live.

BANKERS are lenders not of money but of promises to pay money.  They lend promises-to-pay ten times the quantity of legal-tender money which they possess.  Consequently they live in permanent fear of “ runs ” upon them-that is to say of demands by the holders of their promises-to-pay for actual payment in legal-tender money.  The financial system is so designed as to reduce the danger of “ runs ” to the smallest possible dimensions.

A BANKER’S Balance Sheet shows how much legal-tender money he possesses under the heading of “ Cash and Deposits at the Central Bank.”

The next item is always given as “ Deposits ” and these deposits are divided into “ Advances ” and “ Securities ”.  This means :

CASH.  Legal-tender money in the till and in the strong-room.

DEPOSITS AT THE CENTRAL BANK are loans from the Central Bank given to private banks and secured by “ collateral ”—that is to say by government bonds, and other forms of high-class securities.

Deposits at the Central Bank count as cash in the sense that they can be changed immediately into legal-tender money.  The Central Bank, in other words, as the issuer, for the Government, of legal-tender money will always pay legal-tender money on demand to those who have claims upon it.  Private bankers therefore lend their clients promises-to-pay ten times the quantity of the deposits they, the private Bankers, possess at the Central Bank just as they lend promises-to-pay ten times the quantity of cash they possess.  Cash and Deposits at the Central Bank are really one and the same thing.

Nevertheless a difference between them does exist.  Cash is cash.  It is legal-tender money.  But, as has been said, deposits at the Central Bank are loans from the Central Bank.  The Central Bank, like all banks, in other words, issues promises to pay legal-tender money.  It can, nevertheless, call up its loans and shorten sail like all other banks.  It does this in several ways.  The effect is to reduce every private bank’s “ deposits at the Central Bank ” and so every private bank’s holding of legal-tender money.  When a private bank loses legal-tender money it, too, has to shorten sail and call in its loans so that it may not, at any time, be lending promises-to-pay to a greater amount than ten times its holding of legal-tender money.  For example :

A private bank has
Cash .. .. .. .. £100
Deposits at the Central Bank . . £100
Total .. .. .. £200

It will lend promises-to-pay to the amount of £2,000.

But the Central Bank now calls up £50 of its loan and so the private bank has :

Cash .. .. .. .. £100
Deposits at the Central Bank . . £50
Total .. .. .. £150

The private bank will now lend promises-to-pay to the amount only of £1,500.

Thus the system by which private banks borrow from the Central Bank enables the Central Bark to control them by increasing or decreasing the amounts of their legal-tender money.

But the Central Bank itself is controlled by the movements of gold because, when the gold standard is working, it is compelled to withdraw notes to the full value of any gold which it may be exporting from the country.  An export of gold, therefore, causes the Central Bank to “ retire ” notes and this may force it to reduce its loans (“ deposits at the Central Bank ”) to the private banks.

Movements of gold are determined by the relationship existing between exports and imports.  If exports do not pay for imports gold will leave the country to settle the bill.  If exports exceed imports gold will come into the country to settle the bill.  But it is possible for international bankers to “ tip ” this balance of exports and imports by making loans across the exchanges in such a way that gold may be demanded by the borrowers of the money.  The International Bankers, therefore, really control the movements of gold.

And so we have :

Employment and profits depend on the price-level.
The price-level depends on the quantity of money.  The quantity of money depends on private bankers’ loans.

Private bankers’ loans depend on Deposits at the Central Bank.

Deposits at the Central Bank depend on Central Bank loans.

Central Bank loans depend on Movements of Gold.

Movements of Gold depend on the Foreign Exchanges.

The Foreign Exchanges can be made to depend on the operations of International Finance.

Consequently the old nursery rhyme can be applied with accuracy thus :

“ The International Banker began to lend his promises-to-pay across the Exchanges.  His promises-to-pay began to lead to an export of gold.  The export of gold began to make the Central Bank call in its loans.  The calling in of the Central Bank’s loans began to make the private bankers call in their loans.  The calling in of the private bankers’ loans began to cause prices to fall.  The fall in prices began to cause a fall in profits.  The fall in profits began to cause a fall in wages and unemployment.  And then the country produced more cheaply and the International Banker didn’t have to honour his promises-to-pay by giving money for them after all.  And so he got 8 per cent. in a far country without having to part with a penny piece.  “ Which was as well, seeing that lie possessed no money.”

DEPOSITS.  It is important to distinguish between “Deposits at the Central Bank” and “Deposits”.  The former are loans to the private banker, the latter are loans made by him.

Deposits, in fact, mean loans of promises to pay legal-tender.  Deposits therefore amount as a rule to ten times the private bankers’ holdings of “ Cash and Deposits at the Central Bank ”.

ADVANCES.  Private bankers divide their deposits into “ Advances ” and “ Securities ”.  Advances are loans of promises-to-pay to industrialists, farmers, manufacturers and so on.  They are, therefore, money in the market.  When a private banker is taking in sail it is his advances which will shrink.

SECURITIES.  When private bankers do not wish to lend their promises-to-pay to producers they buy securities, for example War loan, with them.  Thus in times of boom “ advances ” are increased ; in times of slump an increase in “ securities ” takes place.  This merely means that, when trade is bad, bankers like to have the government itself for their borrower.  Hence the cry that Governments must balance their budgets.

LOANS TO THE MONEY MARKET.  Private bankers always lend some of their promises to the Money Market, that is to say, to the International Bankers.

These are short term loans and hence readily available in case of need.  Thus a private banker might have :

Cash and Deposits at the Central Bank. .£10
Deposits
Loans to Money Market .. . . £50
Advances . . . . £50
Securities (Government and other) .. £30
Total Deposits . . . . £100

PRICE-LEVEL.  If the price-level falls all debts become more burdensome because it takes more goods to pay them off.  If a farmer can pay his rent with two sheep he is obviously better off than when it requires four sheep to pay the same rent.

A rise in the price-level reduces the burden of debt by reducing the quantity of goods needed to pay off debts.

FOREIGN EXCHANGE MARKET.  The market where promises to pay e.g. pounds are sold for promises to pay e.g. dollars, francs and so on.  The value of every such promise-to-pay is determined by the demand for it.  If there is a big demand for promises to pay pounds by holders of promises to pay dollars, the dollar will fall in relation to the pound.  In other words more dollars will be needed to buy a pound than formerly.  This is what happens when exchanges are “ unpegged ”.

Pegging a currency means that it is prevented from falling by an export of gold.  If owners of promises to pay dollars, for example, are able to change their promises into gold, they will do so if dollars look like losing their value ; for gold, having a fixed price everywhere, cannot lose its value.  If, for example, the owner of a promise to pay five dollars can no longer get a pound for his promises-to-pay he will change his promises into gold by demanding their fulfilment.  The gold he obtains from the banker making the promises will buy rather more than a pound.  Gold as a result of this transaction will leave America to come to England.  When it leaves America a corresponding quantity of dollar notes will be withdrawn from circulation and American prices, therefore, will be made to fall.  When the gold reaches England a corresponding quantity of pound notes will be put into circulation and English prices, therefore, will be made to rise.  Thus America will be better able to export goods than England and so the demand for dollars (to pay for the exported goods) will increase and the demand for pounds will fall.  Dollar and pound will now once more be level with one another and the bankers issuing promises to pay dollars will no longer be asked to redeem these promises.

DISCOUNT MARKET.  Market where promises-to-pay of various bankers are borrowed on short terms by Government (on security of Treasury bills), by international bankers (on security of finance bills) and by traders and merchants (on security of commercial bills).

The Discount Market and the Foreign Exchange Market are necessarily closely related.  Thus bill brokers, bullion brokers, discount houses, acceptance houses, private banks and the Central Bank itself have a common meeting ground in what is generally called The Money Market.

Examples of Central Banks are the Bank of England, the Banque de France, the Reichsbank, and the Federal Reserve System.  These are often called “ bankers’ banks.” Practice varies from country to country but the bed-rock principles do not vary.