1 Commons, 5121.
It is alleged that the Act still farther reduced the rate of interest, and promoted speculative undertakings, by placing the Bank of England in a position in which the directors were led to adopt a new system of management.
In September, 1844, soon after the Act was passed, the directors, whose rate of interest had never previously been lower than 4 per cent., reduced it to 2 1/2 per cent. The object of this reduction was to invest a larger portion of their funds in the discount of bills. It is stated that, to effect this object, the directors not only reduced their rate of discount, but also canvassed for business, and thus gave a stimulus to new transactions. They had been told that the banking department of the Bank of England was to be managed "like any other banking concern using Bank of England notes." And it is not an unusual thing for bankers, when they cannot employ their funds at so high % rate of interest as they wish to obtain, to employ them at a lower rate. Nor is it unusual for a banker to offer his surplus cash to bill-brokers and others, who are known to be in the habit of supplying bankers with bills. But however consistent the conduct of the directors may have been with banking principles, the reduction of the bank rate of discount immediately caused a reduction in the market rate, and in the rates charged by bankers throughout the country. For it must be observed, that when the bank lowers its rate of interest upon money in seasons of abundance, it has the necessary effect of reducing the market rate of interest still lower than the bank rate. Suppose, for instance, the bank discounts at 5 per cent. and the market rate of discount is 4 per cent., of course no bills are offered for discount to the bank. Then the bank, to get discounts, lowers its rate of interest to 4 per cent. A portion of bills that were previously discounted by private bankers and bill-brokers will then be taken to the bank; but the notes thus drawn from the bank make money still more plentiful, and the market rate falls to 3 1/2 or 3 per cent. Now, should the bank reduce its rate to 3 per cent. the same effects would again follow. For the additional notes thus drawn out would make money so abundant as to reduce the market rate of interest to 2 1/2 or 2 per cent., and so on.
But in seasons of scarcity, precisely the opposite effect follows. For when the bank raises the rate of discount, it has the effect of raising the market rate still higher. Thus, if the bank should be discounting at 5 per cent. and the market rate should be 5 1/2 per cent., let the bank raise her rate to 6 per cent. and the market rate will immediately become 7 or perhaps 8 per cent., or even higher upon inferior bills. For the bank rate of discount will be the market rate for only the first class of bills - such bills as could be discounted at the bank; and all bills of the second class will have to pay an advanced rate, and those of a still more inferior character will not be discountable at all.
In 1844 the rate of discount was lower than in any previous season of abundance of money. This low rate of interest was produced, in the first place, by the principle of the Act of 1844, which caused the issue of a large amount of notes against gold and silver bullion; and, secondly, by that provision of the Act which separated the two departments, and thus brought the banking department of the Bank of England into competition with other bankers and money dealers, as discounters of bills.1 The directors of the bank seem to think that the spirit of the Act of 1844 required that the bank should employ its reserve.
"If we keep the notes in the reserve, instead of giving them out to the public, the effect that ought to be produced by gold coming into the country is counteracted; it,induces a larger amount of capital to come into the country, because you do not allow that portion which has come in to be employed. If you do not put out the gold, or the representative of gold, you entirely prevent its having any effect upon the circulation. The exchange will be kept up, and gold will continue to come in." 2
Thus it appears that, although there is no positive enactment in the Act respecting the management of the banking department, the directors so understand its spirit as to believe that when gold is going out of the country they ought to take measures to prevent its exit; and when gold is coming into the country, they ought to endeavour to drive it back again. The first object is attained by raising the rate of interest very high; the second, by reducing it very low. It must, however, be acknowledged that, apart from any efforts of the banking department, a large importation of gold will under the Act necessarily cause a low rate of interest.
Secondly. The next charge against the Act of 1844 is, that it does not admit of those occasional expansions of the amount of notes in circulation which are often required by the domestic transactions of the country.
1 Commons, 2275, 5189, 5347 - 5350. 2 Commons, 3009.
It is alleged that one imperfection of the Act was strikingly manifested in the beginning of the year 1846. The Parliament required that all railway companies that intended to apply for an Act, should lodge 10 per cent. on their capital within fifteen days after the meeting of Parliament. It was impossible to say beforehand what amount of notes would be required to make these payments. It was variously estimated at from £12,000,000 to £25,000,000, while all the notes in the hands of the public amounted to only about £20,000,000. Ultimately the railway companies of Ireland and Scotland were allowed to make their payments in Dublin and Edinburgh, respectively; and the payments in London did not amount to more than £14,000,000.1 This large sum was paid by means of the banking department of the Bank of England lending out the money as fast as it was received. Had the Act of 1844 not been in existence, the Bank of England (as in the case of the West India loan, and of previous loans) might have lent out the money before the time of payment arrived, and no apprehensions would have been entertained. The notes in circulation would have been largely increased for a few days, and then again have subsided to the former amount. As it was, the payment was not made through any virtue in the Act. And had it been required under different circumstances, or when the banking department had a smaller reserve, it could not have been made at all.2