We will now consider the causes of fluctuations in the bank rate. They are of a varied character, in fact each year brings to light some new force which affects the value of money.

The first great cause would be the state of English commerce. The trade of this country is, as we have seen, transacted by means of borrowed capital obtained from the banks, which are the great storehouses of capital.

When trade is active more capital is required, and therefore we should expect the rate of interest to rise. 'On the other hand, when trade is depressed less capital is necessary for the requirements of the country.

Our imports and exports are a good index as to the state of trade. Every month we see reference made in the money articles of the daily papers, as to the increase or decrease of our commerce. The reports from our consuls abroad, also inform us whether capital is required in various parts of the world.

When trade is active we should expect prices to rise because of an increased demand. When this occurs we get merchants anxious to take advantage of the improvement in commerce, and therefore increase their business by means of borrowed capital.

Again, when prices are rising, the merchant is able to borrow more capital from the banker, because of the increased value of his goods. We should also expect to notice the imports increasing with a rise of prices, because other nations are anxious to send goods to this country in order to obtain higher values for their commodities.

On the other hand, exports would be diminished because the rise of prices would cause a less number of purchases to be made in this country for export, in consequence of the margin of profit becoming less on each transaction. Whenever there is a great difference between the values of imports and exports, the balance finally must be paid in gold, the only commodity which can be utilised for settling international indebtedness. Of course, one notices a 'great discrepancy between the values of our imports and exports, and therefore one would imagine that large sums of gold have continually to be sent from this country. This, however, is not the case, because England has lent enormous sums to foreign countries, which have to remit money as interest.

Again, this country derives a large income from her carrying trade. When, however, there is no equilibrium the balance must be paid in gold, and that metal can only be obtained in large quantities from the Bank of England. This is one of the reasons why the reserve of gold at the Bank is so important. As gold represents capital, its movements to and from this country show to some extent the supply and demand for capital.

Another important cause is that the reserve of gold in the vaults of the Bank represents the final resources of this country for meeting cash payments. We have seen that the banks keep their reserves at the Bank of England, and consequently there is no other stock of gold in existence. All sudden demands must be met by that institution.

Our credit system is so vast that one naturally looks to the stability of the banks which hold the surplus capital of the country. If the banks were called upon to repay all their depositors at a given time, they would be unable to do so. The state of credit is therefore an important item in studying changes in the rate of interest.

All sudden demands for capital soon affect the reserve at the Bank of England. As we recognise in this country the importance of keeping a reserve for emergencies, it is important that something should be done to protect such reserve. Fortunately the Bank of England has a good instrument to protect its resources, viz., the rate of discount. Capital soon finds its way to the centre where the highest rate of interest prevails. The reserve at the Bank is therefore of great importance, and consequently it is necessary to understand how it influences the value of money. There are in reality three aspects of the reserve.

In the first place, the currency requirements of the country are obtained from the Bank. We shall have a good illustration of this, when we consider the autumnal demand for gold.

Secondly, a greater part of the bullion which is required for international purposes is obtained from the amount deposited.

Finally, there is the reserve of gold and notes in the banking department, which is of the greatest importance in influencing the rate of discount.

The daily papers continually make reference to the reserve in commenting upon the value of money. To an outsider not conversant with the familiar terms used daily in Lombard Street, the remarks sometimes made are misleading. We find reference made to the reserve of gold and notes in the banking department, and then, possibly in the same paragraph, reference to the bullion in the issue department. We are then informed that although a fair reserve exists in the banking department yet we must expect to see capital very dear, because a million or two has been drawn from the issue department.

By the Act of 1844 the Bank is allowed to issue fifteen millions of notes against securities, and for any sum issued in excess gold must be held in reserve.

It is clear that any one holding notes can obtain gold from the Bank, because that institution is compelled to pay in coin all notes presented for that purpose. How then does the withdrawal of gold from the issue department affect the value of money?

Mr. Clare, in his excellent book entitled A Money Market Primer, shows the effect of a withdrawal of gold on the reserve at the Bank of England.

Thus, when a depositor withdraws £500,000, notes to that amount are taken from the reserve and returned to the issue department. These notes are cancelled, and sovereigns which are held against them are given in exchange. The effect on the balance sheet is as follows:

Withdrawal.