The most striking fact connected with this rate is its variation from the ordinary rate of interest and its tendency to fluctuate. Reasoning from the principle of political economy that the income from capital invested in all forms tends to conform to the same rate, due allowance being made for differences of risk, length of the period of investment, etc., we should expect that the rate of discount would approximate very closely the general rate of interest. As a matter of fact, however, the two rates fluctuate quite independently of each other.

Between 1848 and 1878 the rate of discount of the Bank of England ranged from two to two and one-half per cent about one-quarter of the time, was three per cent or below about one-half of the time, and four and one-half per cent or above about one-third of the time. During this period it is believed that the general rate of interest steadily declined and was probably between two and three per cent, as indicated by the income derived from English consols. The rate of discount of the Bank of France during the same period was four per cent most frequently, but fluctuated from two per cent to nine per cent, while the general rate of interest was probably slightly above that of England, and, like it, tended constantly to decline. The rate of the Bank of Prussia and of its successor, the Imperial Bank of Germany, ranged between three and nine per cent during the period, and, like that of the French bank, stood at four per cent more frequently than at any other rate. In these cases, as well as in those of the other great banks of which we have statistical records, the greatest fluctuations in the rate of discount have occurred in recent times, and, while the average rate is a little lower than formerly, it does not exhibit that marked tendency to fall that is observed in the general rate of interest.

There can be no doubt that the income derived from one kind of investment exerts an influence upon every other, and that the economic law above mentioned is valid, but the rate of discount is subject to special and peculiar influences which make it necessary to put it in a class by itself and to distinguish it from all others. In the long run it is regulated by the supply of bills of exchange and the funds available in the hands of bankers and bill-brokers for investment in this form. When the number of bills is so great that it becomes difficult to sell them, the rate rises, and when the bankers find it difficult to invest their funds it falls. Whether or not an exact equilibrium of demand and supply brings this rate into harmony with the general rate of interest it is impossible to determine with certainty, but there seems to be some reason why this need not necessarily be the case. This will appear from a comparison of the influences affecting the demand and supply of bills and those which determine the general rate of interest.

The supply of bills depends upon the extent of trade and the degree of development of the credit system. If all exchanges were accomplished by means of coin, banknotes, and checks, there would be no bills. It is only when credit is granted that this particular form of document makes its appearance. The habit of granting credit regularly on certain classes of transactions being established, the number of bills will, of course, depend upon the magnitude of these transactions. If it be true, as is claimed by some, that a relatively increasing proportion of exchanges is being each year settled by cash in some form, the supply of bills must be relatively decreasing, although it may be and probably is increasing absolutely. The funds available for investment in this form come, as we have previously shown, from three main sources, namely, from the cash deposits of business men, a portion of which can be lent, from capital temporarily lodged with the bank because its owners have no immediate use for it or prefer the small rate of interest paid by the banks on deposits to any other use at the time open to them, and from the bank's own credit. The general rate of interest depends upon the total supply of capital within a country or a market and the demand for it for all sorts of purposes for which it can be employed. The question before us concerns the exact relation between the total demand and supply of capital within a country on the one hand, and the loan fund of banks and the supply of bills on the other. Undoubtedly the general demand for capital throughout a country is greater when trade is active and bills accordingly abundant than when trade is sluggish and bills scarce, and it is also probably true that when capital is abundant the amounts entrusted to banks for temporary keeping and the current accounts of business men are apt to be relatively large, and under the opposite circumstances relatively small. It is doubtful, however, if this general relation between the market for capital and that for bills is so intimate and close that an equilibrium between the demand and the supply of bills would always bring the rate of discount into harmony with the general rate of interest. There is no fixed proportion between the total amount of capital in a country and bank deposits on the one hand, and between the magnitude of commerce and that of industry in general on the other. These proportions are probably changing all the time, certainly they change frequently, and it is, therefore, quite possible that the equilibrium rate in the case of bills at a given time may be quite different from that of the total fund of capital of the country.

A very close connection exists between the rate of discount and the cash reserves, the former being generally high when the reserve is low and low when it is high. The explanation for this is to be found in the fact that bank credit is an element of the fund available for investment in bills. When the reserve runs low it is necessary to contract this element, and when it is high the bank is anxious to expand it. The ratio between the demand and the supply of bills is thus changed, and with it the rate of discount. In other words, when a bank finds that its cash is running low it either stops discounting or diminishes the amount of its discounts by refusing everything except paper of the highest class. In either case the rate will probably rise. On the other hand, when it has more money than is required to meet the daily needs of its customers and to provide for unexpected demands, it seeks investment for the surplus by lowering its rate and by showing its willingness to accept all the well-secured bills that are presented. By way of illustration the table on p. 278, showing the relation between the rate of discount and the reserve of the Bank of England for a series of years, may be studied with profit.