Effect Of A Rise In The Bank-Rate On Foreign Exchanges

It has been pointed out that when our merchants have imported more than they have exported (in connection with any country), bills of a less aggregate value are available upon foreign houses and competition ensues for the purchase of the insufficient stock for the settlement of our foreign indebtedness. The standard equality (or par) being the exchange of £1 for 25.2215 francs, the illustration was furnished of one sovereign purchasing only 25.17 francs. Similarly, in Paris in these circumstances, with close approximation, 25.17 francs instead of 25.22 will buy a bill for £1; that is to say, the exchange is low, or unfavourable to England. In other words, the purchase-price of bills in England upon Paris (for payment of commercial debts owing in that city - the city which we have employed in the illustration) may become so high, that is, may procure so inferior an amount in francs, that it may ultimately prove to be cheaper, notwithstanding the charges for carriage and insurance, to defray the indebtedness by the transport of gold - with consequent depletion of the Bank of England Reserve. But, when in this condition of the exchanges the bank-rate in England is superior to that in France, banks and merchants in that centre invest (on account of the more advantageous terms for loans to be realised in London) in bills drawn upon

England; and this increased competition enhances the price of English bills. Hence, for example, regarding our illustration, 25.27 francs, or more, in France may gradually become the price of £1 (since the value of bills on England has advanced by the foreign operations above mentioned); the exchange will then be favourably turned in connection with England, and the possibility of an export of gold from England be reduced on this account - an exchange of 25.32 francs to £1 bringing gold from Paris. (The eagerness in Paris to secure bills drawn upon English firms, when our bank-rate is increased, would probably be mainly directed to bills which were payable on demand or "at sight," so that the proceeds might be received immediately for investment at the prevailing rate. For if a bill maturing in three months' time were bought it could only at once be utilised for investment by discounting, and the high rate of discount would tend to neutralise the pecuniary benefit from the investment of the proceeds. And, in addition, the bank-rate might possibly soon be reduced.) Corresponding remarks apply to the exchanges with foreign countries generally.

When Is The Rate Of Exchange Favourable To England?

An exchange is thus termed favourable to England when (citing France again as example) the cost of placing £1 in England (that is, the price in francs of a bill of exchange per each £1 which it expresses) approaches the level at which it would practically be as cheap to dispatch gold from France; the favourable aspect consisting of the inflow of gold in augmentation of our Reserve, and thus rendering possible the borrowing of money for purposes of trade at a cheaper rate, in consequence of the Bank, through its re-established Reserve, being soon placed in a position to reduce its official terms for discounts.

The proper proportion between the Cash Reserve and the country's liabilities.

It is obvious that the precisely adequate proportion of the Cash Reserve to the country's liabilities cannot be mathematically fixed. The average over a term of years appears to be about 43 per cent. Men of business are properly not troubled on large problems with decimal exactitude, and there exists a universal tendency to employ "round" figures. The general teachings of experience afford the only valid guide; and we may apparently regard 50 per cent as a standard which produces full confidence and a sound sense of commercial security.

Normal Fluctuations Of Public Deposits In Bank Of England

For completeness of statement it may be noted that the amount of public deposits in the Bank of England diminishes at the beginning of each year in consequence of the payment of the interest upon Consols. Then up to the end of March it gradually increases by the receipt of a large portion of the income tax payments and other taxes. This concentration of funds in the Bank of England, arising from this collection of the national revenue in taxes, reduces obviously the amount of loanable capital which the banks in general possess for advances, and borrowers consequently are required to pay a higher rate of interest for its use. Speculation in Stock Exchange investments thus suffers discouragement, with a resulting tendency to a fall in the values of securities. The "other deposits" regularly increase about the close of June and December, as banks then pay in considerable amounts to the credit of their several accounts with the Bank for the purpose of exhibiting in their balance sheets an adequate proportion of cash in order to strengthen public confidence. And in periods of financial disturbance and alarm, and increasingly so as the area and intensity of that disturbance extend, the amount of "other deposits" receives a substantial accession by reason of the joint stock banks augmenting their credits with the Bank as a provision for possible contingencies.

What would happen if in a time of great strain the Bank's stock of gold were in danger of exhaustion 1

The reader who ponders and not simply stores will submit a pertinent question. The convertibility of the Bank of England notes, he will observe, is guaranteed only partially by gold coin and bullion: a considerable portion of their security exists in the shape of a debt and investments. If, then, a crisis occurred of an exceptionally stringent and extensive nature, and the increase of the bank-rate failed sufficiently to arrest the drain of gold, the entire stock of gold might vanish, and yet a considerable liability under notes would remain and require to be discharged. The Government debt would, at such a period, form an idle entry for all practical uses; and the investments of the Bank would be unrealisable in cash, since the assumed condition of affairs would prevent their purchase in the market. The Bank then must become insolvent.