That the power of the Bank to lend need not be crippled by regard for the amount of its reserve was strikingly illustrated by the events of the terrible year, 1866. On May 9 the Bank had a reserve of 13 1/2 millions in round numbers, and had lent 20 3/4 millions. After the black Friday of May 16, it had lent 31 millions, whilst its reserve stood at 12 millions - more than 1 million less than it had when it lent only 20 3/4 millions. On May 30 the loans reached the unexampled sum of 33 1/2 millions, yet the reserve had sunk to 11 3/4 millions. The reserve goes down. In the teeth of this fact the lendings of the Bank rise to a gigantic height. What becomes of the doctrine that it must lend less as the reserve goes down? Did a single man call the Bank unsafe when this disregard for the reserve, and this hardihood in lending, went on? Not one. What then becomes of this miserable doctrine, the great practical rule, that when the Bank loses a few hundreds of thousands, it must contract its operations and make loans difficult and dear? The real indisputable fact revealed by the Bank's weekly reports is that all sorts of reserves accompany all sorts of lendings. Large reserves are found with small discounting, and great advances with small reserves. The man who merely looks at the size of the Bank's reserve will be utterly unable to guess how numerous are its securities, how much it has lent.
But, reply the City theorists, gold rules the rate of interest. When the reserve is full of gold, borrowing is cheap; when gold flows away the rate rises and traders suffer. But is this so? Let us put the question to the same great year of agony 1866,, and compare its answer with those of 1856. In the first week of 1856, with 10 1/2 millions of gold we have a rate of discount of 6 and 7 per cent. In 1866 the gold has mounted up to 13 millions - 2 1/2 millions more. At what rate stands discount. At a lower figure, in obedience to the alleged law? Just the reverse. It too has gone up to 8 per cent. On March 21, 1856, the bullion and the rate of discount remain unchanged. In the same week of 1866, the bullion has reached 14 1/2 millions - 4 additional millions. Have they told on the bank rate? By no means. They have done nothing at all. It continues at the same figures. On May 9, 1856, the bullion stood at 9 3/4 millions with a rate of 6 and 7 per cen.; in 1866 there were 3 more millions of gold, and then, as if to mock the City and its doctrine, the rate runs up to 9- per cent. Then comes the return of June 12. There are 18 millions of gold with a rate of 5 per cent, in 1856; in 1866 14 1/2 millions stand side by side with 10 per cent, double the charge imposed on the discount market, in the teeth of 2 1/2 millions more of gold. The statements of the whole year tell the same tale. They demonstrate that the doctrine which makes the rate of discount depend on the quantity of reserve is an absolute untruth - the fallacy of City articles and the practical man. These facts cause no surprise to one who has learnt the nature of currency. He knows that gold and notes are required for ready-money payments only, and that if there is an excess of them it cannot be employed, it cannot be lent, and if it is not a fund available for lending, it cannot exercise any influence on the charge for lending. When the supply for ready-money payments is provided, all the rest of the business of the country is carried out by paper documents, by cheques and bills. But the City may still contend that the Bank can, and, when it chooses, does fix the rate with reference to the movements of the gold. That is true, I believe, it does so occasionally; but the Bank returns here cited prove two things, that they are not obliged to do so, for the Bank gets on perfectly well when it violates this fancy rule, and further that as a fact it does act upon the rule very rarely.
It is no unusual sight to find writers of oracular authority, whether in or out of the Press, in times such as the present, when trade is exceptionally slack and profits are weak, and capital shows little eagerness to embark on new undertakings, and the rate of banking interest is unwontedly low, endeavouring to rally the spirits of desponding traders by announcing that gold is likely to flow in from foreign parts, and will be sure to animate industry, and to improve business, and to swell both wages and profits, and, most of all, restore the gains of the banking world and the money-market. What can be the idea which such persons have of currency? Have they ever said to themselves, in plain words, what currency can and does do? The stock of gold all the world over remains the same, whether the nation is uplifted with swelling prosperity, or whether trade is groaning under biting losses and the money-market convulsed with agony. The only possible thing that can have happened to the gold is to be found in a different place; and will any man venture to assert that gold put in one place in the stead of another - gold which can only have been procured by buying it with an equal quantity of other wealth - makes precisely the difference between the production and the destruction of wealth, between a trade that accumulates riches and one that plunges into ruin? If there be an iota of truth in such a view, let us be told how the gold acts, how it accomplishes these wonders. The mode of operation is essential to the understanding of such effects. Gold, we know, can place goods in one person's hands in the stead of another's; but what increase of wealth, what gain to profits and wages, is there in that, when there is already gold enough for carrying out ready-money payments? There are no believers in magical and mysterious powers comparable to the oracles of the money-market.
But what then is the power which governs the rate of interest? The answer to this question must be sought from the character of a banker, as a broker between two principals. The power to determine the rate of interest at his own caprice does not lie with him, but he is the interpreter for the moment of the forces at work, and he makes a trial of the rate which those forces prescribe. If he errs, events will compel him to alter the rate; in other words, the banker, as the fixer of price in the loan market, is subject, as all dealers in all markets, to the universal law of supply and demand. He deals in purchasing power lodged in his hands by one principal and borrowed by another. When farmers, manufacturers, and merchants are thriving and making profits, they tend to buy less than they receive; hence the banker's means of lending expand. Bad harvests, losing trade, slackening buyers, diminish profits and weaken the banker; there is less to lend. On the other side, opportunities may offer for employing capital with increased advantage, in a colony, in a new industry at home, and the like; the demand for loans increases. Or particular trades may languish, and require less borrowed capital than formerly; loans are in weaker demand, and the rate of interest tends to falling. Or again, borrowers may have lost what was lent them, and their bills are dishonoured, and losses deal blows all round; then swiftly rises the rate. In one word, the events which are happening, to his two principals rule the banker's charge for lending.