Having briefly considered the cause of changes in the rate of discount, we will now study some of the effects. Of these the most important would be in relation to the commerce of this country, because, as we have seen, the greater part of our trade is carried on by means of borrowed capital.

Every change in the price of money must of necessity react upon the value of commodities. Merchants purchase goods on the presumption of being able to borrow capital at all times. If borrowing becomes difficult or disorganised, the whole trade of the country suffers. Of course, profits made on the purchase or sale of goods are considerably affected by the fluctuations in the rate. If a merchant has to pay a higher rate for the loan of capital than he has estimated in a contract, his profit might be reduced to nothing.

Trade would become restricted if they were abnormally high, because merchants would find it difficult to obtain a correspondingly higher value for their commodities.

If, however, we get low rates of interest, production would be stimulated, and, as a consequence, trade would be active, but a high rate of interest does not materially affect commerce, although great fluctuations may be detrimental.

A high rate would stop speculation, and this at times is beneficial to the country. It would be the means of preventing a certain amount of circulating capital being converted into fixed, that is, expended in the construction of railways, mines, docks, and other similar undertakings. In such cases capital would not be reproduced for a long term of years.

We find reference made in financial journals as to the price of capital in relation to trade. They inform us that at times the rate of discount should be reduced in order to afford relief to the mercantile community. This demonstrates how closely the trade of this country is associated with the value of money.

Mr. Bagehot has stated that "Lombard Street is by far the greatest combination of economical power and economical delicacy that the world has ever seen ". It is the centre or the money market of the whole world. All demands for capital are supplied from this centre.

If a foreign Government wishes to borrow capital, the rate of interest prevailing in Lombard Street would first be ascertained. If the rate was high, the Government would wait for a more favourable opportunity. Every nation wishes to borrow cheaply, and therefore avoids a market where money is dear.

The English market has been invariably a cheap one for borrowers, and therefore foreign States have found it advantageous to borrow here, rather than in Paris, Berlin, or New York.

This is seen from the average rates since 1845: -

The rate of interest allowed by the banks for money on deposit is determined by the bank rate. The London banks generally allow 1 1/2 per cent. below bank rate unless the rate is very low, when there is only a difference of 1 per cent. We have explained elsewhere the reason of this difference. The London banks and discount houses announce in the daily papers their deposit rates the day after the bank rate is fixed.

If a high rate of interest is allowed, we should expect to see the deposits in banks increase, but if low the deposits would tend to decrease, because the depositors would naturally find other investments for their capital. . It may, however, happen in consequence of the difficulty of finding employment for capital, and also in consequence of a want of confidence, the deposits in banks may increase, although the rate allowed is only 1/2 per cent.

The value of money in the London market soon affects the rates prevailing in other great commercial centres, such as Paris, Berlin, Vienna, Amsterdam, and New York. The changes in the bank rate are soon reflected in the foreign exchanges. Thus, with a high rate prevailing in the London market, we should observe that the exchanges would gradually tend in favour of this country. This is in consequence of capital being sent here for investment.

We might say that London is the great clearing house of the world. More bills of exchange are drawn upon London than any other commercial centre, and such bills are a favourite investment on the Continent. The holders of such bills profit by the variation in the rates of exchange.

Mr. Goschen refers to this subject in his book on the foreign exchanges, thus: "We now come to the fact which it is very important clearly to appreciate, that at any moment there is in the hands of bankers and exchange dealers a large amount of bills on foreign countries, held partly for the purpose of speculating on a rise or fall in the price of bills, but to a very large extent solely for the sake of the interest which is to be made on them. Bills on England, owing to the high rate of interest which they often bear as compared with continental rates, are a favourite investment abroad. In Paris, Berlin, Frankfort, Hamburg, and other continental cities, the bills on England held by bankers and joint-stock companies often amount to many millions sterling, and a very large sum remains in their hands for several months, in fact from the time when the bills are drawn to the time when they fall due."

The changes in the rate of discount have a considerable effect on the Stock Exchange, where vast amounts of capital are lent fortnightly, and consequently such changes soon affect the value of securities. If rates are low, speculation increases and more purchases are effected. Various stocks are bought because the rates of interest on such stocks are higher than the rate which the borrowers pay to the banks.

Supposing £10,000 Colonial Stock is purchased and the stock bears 4 per cent. interest, and 2 1/2 per cent. is paid for the loan of capital advanced on it, then the purchaser gets 1 1/2 per cent. by the transaction if he is able to borrow from one settlement to another.

Again, a low rate encourages speculation, because, the brokers being able to borrow cheaply, there is a tendency for all securities to rise.

The rates charged for "carrying over" stock on the Exchange fluctuate with the bank rate of discount, and if such rates are high, speculation is checked and the price of securities falls. There is therefore a close connection between the rates for money and the price of securities.

We will briefly consider the effect upon some of the securities dealt in on the Stock Exchange. At the head of such securities would be British Government Funds, which are particularly sensitive to changes in the rate of interest. They form a floating security in the money market. The large financial houses are able to borrow capital from the banks against Consols, and, if the average rate of interest in the market is higher than the rate on Consols, there would be a tendency for the price to fall. The holders would prefer selling their stock and lending capital in the open market.

If, again, the banks offer a high rate of interest for deposits, the holders of Government Stock might prefer selling to get the higher rate. With a high market rate prevailing the banks would be inclined to sell Government Stock in order to lend the proceeds to bill brokers, and thus secure a more remunerative return for their capital.

Again, the price of Treasury and Exchequer Bills is largely affected by the market rates for money. These securities like Consols are utilised by discount houses as cover for advances made by banks to such institutions. We therefore find the price of these securities fluctuating with the market value for capital.

Mr. Giffen refers to this as follows: "There is a close connection between the short loan and the speculation in securities. The funds of the short loan market are employed partly in holding securities, and where these funds are diminished or increased from any cause, however temporary, there is an immediate effect on the price of some securities. But the great mass of securities will only be affected by more permanent changes in the rates obtainable for money in other markets."

In recent years the connection between the Stock Exchange and the banks has been of a more intimate character. It has been stated by the Economist that an additional £9,000,000 of capital was lent by the banks on the Stock Exchange for the year 1889.

Large amounts of stock are deposited with the banks by stockbrokers against money lent for the fortnightly account, a certain margin being provided to cover contingencies. When the settlement arrives, a fresh loan is made and the stock is carried over for another fortnightly period. It is easy to understand how the rates for money must affect the price of securities which have not been bought by the public, and therefore do not represent actual purchases or sales.

Credit is also an important force in connection with the Stock Exchange. If at any time a rumour gets abroad that the banks intend to refuse loans on certain securities, the price of such securities falls considerably. The withdrawal of loans by the banks from the Stock Exchange would have a most disastrous effect. It was stated quite recently that certain banks intended curtailing their loans on the Stock Exchange, and even that rumour almost created a panic.

Any increase in the value of money would tend to increase savings, and as a large portion of such savings would-be invested on the Stock Exchange, prices would therefore rise. On the other hand, a low rate of interest would act as a check on savings, and this effect is reflected in the price of securities.

The value of money in the market does therefore exercise a great influence upon all interest-bearing securities.