1 In the books of all well-regulated banks consols are written down to much below the market price, so that in seasons of pressure when sales are necessary the loss sustained does not come out of profit and loss, and does not affect the dividend, nor, consequently, the credit of the bank.
2 At the meeting of the London and Westminster Bank, July, 1855, the Chairman, J. L. Ricardo, Esq., M.P., made a comparison between the interest obtained on money invested in the funds and that employed with bill-brokers. Upon an average of twelve years the following is the result: On the 2nd January, 1843, the price of consols was 94 1/2, which yields an interest per annum of £3 3s. 6d. per cent. The interest allowed upon money at call by Messrs. Overend & Co. for twelve years, from January, 1843, to December, 1854, would average £2 10s. l0d. per cent. Upon bills, the rate allowed is usually half per cent. more, that is, £3 0s. l0d. per cent. £1,000,000 invested at £3 3s. 6d. would produce annually the sum of £31,750. At £3 0s. l0d. per cent. it would produce only £30,416 13s. 4d. This shows, that upon an average of years the funds are more productive than brokers' bills.
[It should be remembered that in 1888 the interest on Consols was reduced from 3 to 2 3/4 per cent., and in 1903 to 2 1/2. The comparison which Gilbart makes is rendered difficult of confirmation by the recent fluctuations in the price of Consols, which has varied from 84 3/4 to 114 in the last ten years.] though in a state of perfect solvency, be compelled to stop payment from being unable to realize its investments.
Another advantage of a large investment in Government securities is, that the bank, by the publication of its balance-sheet, has always the means of showing to its depositors that a large portion of its deposits is at all times amply secured. The Bank of England state the amount of their "Government securities" distinct from the "other securities." It may so be that the "other securities" are as good as the Government securities, and perhaps more profitable, but the public do not know that to be the case; and were all the investments in "other securities," they might not feel the same degree of confidence as to the prompt repayment of their deposits. The same principle applies to other banks. And it may reasonably be supposed that between two banks in similar circumstances as to other respects, depositors would rather lodge their money in a bank which had a large amount of Government securities than in one which had none.
As we have referred in this section to some of the operations of the Stock Exchange, this may be a proper place to discuss the nature of these transactions, so far, at least, as concerns bankers.
The reader is of course aware that the " Stocks," or the "Funds," or by whatever other name they may be called, are debts due from the nation to those persons whose names are entered on the Bank books. The man who holds £100 consols is a creditor of the nation for £100, for which he receives £3 per annum; and the price of consols is the amount of the money for which he is willing to transfer this debt from himself to another person. Now, if this man knows another who is willing to give him, say £90 for this £100 consols, they can go to the Bank, and the seller being properly identified, will transfer this £100 consols into the name of the person to whom he has sold it. His account is then closed in the Bank books, and a new account is opened in the name of the buyer; for every holder of stock has an account in the Bank ledger, in the same way as bankers and merchants open ledger accounts for their customers. The seller of the stock will also give a receipt to the buyer for the money on a printed form issued by the Bank of England.
But parties do not usually treat with each other in this way. A broker is employed either to buy or to sell, as the case may be. The members of the Stock Exchange are an association consisting of about 5,000 persons, who meet together in a building in Throgmorton Street, close to the Bank. Each member, before admission, must find three securities for £500 each, which sum is applied to meet any claims the other members of the "House" may have upon him during the first four years. The suretyship then ceases. The subscription paid by each member is forty guineas per annum, and the entrance fee is five hundred guineas. The House is governed by a Committee for General Purposes, consisting of thirty persons chosen from the members.
Although all the "members of the House" are called stock-brokers by the public, yet within the House they are divided into two classes, brokers and jobbers. A broker, as the name implies, is an agent who buys or sells for his customers out of the House, and he charges them a commission upon the amount of the stock. A stock-jobber is a stock dealer; but he does not deal with the public: he deals only with the brokers; and he is at all times ready either to buy or to sell. The price at which he sells usually is 1/8 more than the price at which he buys. If one broker has an order from his customer to buy £100 consols, and another broker has an order to sell £100 consols, these two brokers do not deal together, but both go to a jobber, who will "make him a price." One will sell his consols to the jobber, say at 90, and the other will buy his consols from the jobber at 90 1/8. Hence the difference between the buying and the selling price of consols is usually 1/8, and thus in the newspapers the price is quoted in this way, 90 to 90 1/8.
A banker is, of course, one of the public, and when he wants to buy or to sell stock, he gives instructions to his broker, and the process is as we have now described.
Were there no jobbers, a broker would not easily find at all times another broker who had occasion to sell the same amount of stock which he wished to buy, and he would have a difficulty in buying or selling small amounts. But there is no difficulty with the jobbers. The jobbers will not only buy and sell stock on the same day, but they will buy stock on one day, and agree to sell it at a future day, or vice versa. These future days are called the settling days, being the days on which the members of the House settle their accounts. They are fixed by the Committee of the Stock Exchange, and they now occur regularly once a month. Now, if a banker wants a sum of money for a short time, either to pay off a deposit, or to make an advance to a customer, he will direct his stock-broker to sell, say £50,000 consols "for money," and buy them "for time;" that is, against the. next "settling day," or, as it is sometimes called, the next "account day." On the other hand, if a banker has money he wishes to employ for a short time, he will reverse the operation, and desire his broker to buy consols for money and sell them for time. He thus gets interest for his money, according to the difference of price between consols for time and consols for money.
Generally, the price for time is higher than the price for money; and the difference between these two prices is called the "Continuation." Supposing that the next settling day is a month distant, and the continuation is one-eighth per cent., that amounts to twelve-eighths, or one and a half per cent. per annum. The continuation will vary according to the near approach of the settling-day - according to the abundance of money, and the market rate of interest - and according to the abundance or scarcity of stock. The last cause is not so readily understood by the public, and we will therefore explain it. The stock-jobbers, as we have said, are stock dealers. Of course they are large holders of stock; it is their capital, on which they trade. But however large may be the sum they hold, they often agree to sell on the next settling day a much larger sum, expecting that in the mean time they shall buy a large sum, and thus be able to set off one against the other. But sometimes, as the settling day approaches, they find this is not the case, and they are consequently under an engagement to "deliver" - that is, sell - more stock than they hold. What can they do now? They will try to get stock from those who have it, by agreeing to buy it of them now, and selling it at the ensuing account day, a month hence, at the same price; thus abolishing "the continuation." When that is the case, a banker's broker will go to the banker and say, "If you like to lend your consols, you can get money for nothing till the next account day." The banker replies, "Well, I don't know that I can make much interest of the money just now; but as I can lose nothing, you may lend them." Thus the jobbers get their stock, and complete their engagements. But sometimes the jobbers are obliged to go farther, and even to offer a premium to parties who will lend their consols. This premium is called "Backwardation; " it is just the reverse of "Continuation," and implies that the time price of stock is less than the money price.
We have thus described the legitimate operations of the Stock Exchange, so far as it may be necessary to explain the transactions of bankers in the employment of their surplus funds.