Banking Department

Withdrawal.

If, however, the money market restores its balances to the former level, it borrows of the Bank of England or discounts bills at that institution.

We have already seen that gold is the final means for settling international trade, and that it can only be obtained in large quantities from the Bank of England.

When capital is leaving this country in the shape of gold it represents a variety of transactions - such as a scarcity of capital at a foreign centre, or to pay for food imported into this country, or possibly to carry out a large financial operation.

In addition to the currency requirements of this country, it is necessary to keep a certain amount of gold in order to preserve the convertibility of bank notes.

We are informed sometimes that the Bank directors have decided to raise the rate, because possibly a small quantity of gold has left the Bank; whereas the actual cause might be a depletion of the reserve in the banking department, caused by a scarcity of capital, or possibly other considerations known only to the Bank directors. Of the two reserves of which we have spoken, it is certainly the reserve in the banking department which is most important in causing fluctuations in the rate of discount.

Mr. Palgrave says: "Though the total amount of bullion held by the Bank is a very important thing, the rate of discount does not appear to be regulated by it".

This is shown by the following returns: -

We know that at times the market suffers from a scarcity of capital rather than of gold. The figures which we have given show that on several occasions the reserve of gold in the issue department has been low, and yet the rate of interest has also been low; but there is a closer connection between the reserve in the banking department and the rate of discount.

It has been already stated that the demand for capital does affect the amount of bullion in the issue department. Capital is required to pay for the balance of trade against us, and must be liquidated by means of gold drawn from this department. It indicates that capital is leaving this country for the payment of food and other necessaries purchased. The all-important question is, How much gold should be retained in the issue department to meet every contingency?

There is no doubt that the Bank is able to attract bullion from abroad when its reserves of that commodity are low by raising the rate.

On the other hand we must remember that the Bank has not experienced in the last fifty years a run on its resources for gold. So long as notes can be obtained, the holders do not appear to require gold in exchange. In consequence of the banks keeping their reserves at the Bank, they retain in their tills a less amount of gold; although the liabilities of the banks have increased, yet the amount of cash held is smaller.

Cash held. Thus - 1890, 11 banks' liabilities, £161,326,100 10.3 per cent. 1879 „ „ 125,539,000 12.8

Of course, improved communication, the use of telegraphic transfers, and the great use of cheques have economised gold. Yet, on the other hand, a sudden demand for that metal must be met by the Bank of England. We therefore get changes in the rate of discount, due to the movements of comparatively small amounts of gold.

Mr. Giffen estimates that with a capital of 6000 millions the quantity of gold and silver held only amounts to 20 millions, or 3 per cent.

Any increase or decrease in the amount must affect the value of money, and these changes are reflected in the reserve of the Bank of England. All transactions are expressed in gold, and therefore if we get prices rising an additional amount must be added to the nominal capital, and particularly to the capital represented by the loans and deposit of banks. If wages rise in this country more gold is required, and consequently the reserve at the Bank is diminished.

Our monetary system is a delicate one, and what M. de Laveleye stated in 1864 is possibly of more force at the present time. "All countries which carry on gigantic transactions with small reserves of gold and silver, and which have a vast movement of importations and exportation, must be exposed to these economical perturbations. The more a country expels the precious metals from the channels of circulation and replaces them by instruments of credit, bank notes, cheques, warrants, deposits, clearing houses, etc., and the more, at the same time, it develops its relations with foreign countries, the more it will be exposed to the periodical return of financial perturbations, because more easily an unfavourable balance of trade and payments will disturb all the mechanism of exchange, and will require from the managers of credit institutions redoubled circumspection, prudence, and ability."

We have in this country a gigantic system of credit built up on a small gold reserve, and in order to protect the same the Bank of England has very frequently to alter the rate of discount.

By raising the rate capital is attracted from abroad, and the reserve at the Bank is replenished.

London being the financial centre of the world, all foreign countries naturally ascertain the rates of interest prevailing in London, and if higher rates are ruling here capital finds its way to the most profitable market.

The effect of high rates prevailing in London soon makes itself felt on the trade of this country. Prices of commodities would fall, and this would tend to diminish imports; but, on the other hand, exports would be increased, and would have to be paid for by means of gold.

If we study the Bank reports we shall observe that the rate of interest is dependent upon the reserve, principally that of the banking department. With a low reserve the rates of interest are high, and with a high reserve a low rate of interest. This is shown from the following table: -