Bankers' Money

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BANKERS' MONEYA SUPPLEMENT TO

A TREATISE ON MONEY


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y the same Author.Principles

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BANKERS' MONEYA SUPPLEMENT TO

A TREATISE ON MONEY

BYjfsfflELD NICHOLSON, M.A., D.Sc.

PROFESSOR OF POLITICAL ECONOMY IN THE UNIVERSITY OF EDINBURGHSOMETIME EXAMINER IN THE UNIVERSITIES OF CAMBRIDGE, LONDON, AND VICTORIA

LONDONADAM AND CHARLES BLACK1902


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PREFACEThe following chapters are based on a series ofLectures delivered before the Society of Accountantsin Edinburgh, the Institute of Accountants andActuaries in Glasgow, and the Institute of Bankers inScotland. Some corrections have been made, and thematter has been broken up and arranged in sectionsfor the convenience of the reader, but no substantialchanges have been- introduced, and the work bearsthroughout the impress of its origin. The success ofthe book on Money and Monetary ProUems (now inits 6th edition) has led the writer to hope that theseadditional chapters may also prove useful to the sameclass of readers. The treatment, as in the earlier work,is intended to be introductory and suggestive and suchas may help to stimulate those engaged in practicalbusiness to a wider study of the principles andhistory of finance.

J. SHIELD NICHOLSON-.Univbbsity of Edinbttegh,

August 1902.


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CONTENTSCHAPTER I

WHAT IS money ?1. The money of the money market of the United Kingdom

2. Its practical importance 3. General scope of argument 4. Different kiuds of material money 5. Representativemoney 6. On the use of economic methods 7. Necessary toseparate the functions of money 8. Money as a general mediumof exchange 9. Money as a standard measure of values 10.Money as a standard for deferred payments 11. On the meaningof stability of value in the standard 12. Money as a store ofvalues 13. Rdsume of the argument 14. The definition andmeaning of money must vary with its monetary function 15.The standard as determined by positive law 16. The mediumof exchange line as determined bylaw 17. Gold itself strictlynot money but money material 18. In monetary problemsnecessary to state what meaning of money is intended Page 1

CHAPTER IITHE FOKEIGN EXCIfANGBS

1. Introductory 2. International debtsExports and imports 3. Real par of exchange 4. Trade of countries and of individualtraders 5. Other elements in international indebtedness com-pared with exports and imports 6. Exports and imports typicalof all international debts 7. Traders in each country receivepayment in money of that country 8. Meaning and object offoreign exchanges^ 9. The mint par of exchange 10. Limitsof fluctuationsGold points 11. R&um6 and illustrations 12. Favourable and unfavourable exchanges 13. Historicaland present importance of 14. Short and long exchange 15. Influence of rate of interest 16. Of state of credit^ 17. Variable effects of depreciation of currency 18. Firstcase 19. Second case 20. Third case 21. The silver

- 22. Summary of results .... 22


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mi CONTENTS

CHAPTER IIITHE RATE OF INTEREST

i1. Interest on money and on capital distinguished 2. Illustrations 3. Difficulties in definition of capital 4. Interest on capitaldivided into PROFiT-interest and LOAN-interest 5. LoAN-interest 6. Interaction between the two rates 7. Interest is a priceand subject to the laws of pricesCompetition and monopoly

8. Widening of markets with progress 9. The supply of loan-able capitalProduction 10. Efiective desire of accumulation 11. Security 12. Demand for capital, and first for unproductivepurposes 13. Demand for productive purposes 14. Forecast 15. Efiects of war 16. Interest on loanable money 17.Importance of legal tender 18. Supply of legal tender inelastic^ 19. The bank rate and the market rate 20. Interaction ofinterest on capital, and interest on money as such 21. Pro-bable effects of great gold discoveries 22. Practical illustra-tion Page 42

CHAPTER IVCOMMERCIAL CRISES

1. Monetary and commercial crises distinguished 2. In monetarytransactions ultimate solvency not sufficient 3. Deferred con-vertibility and suspended convertibility i. Possible over-issueof bank notes 5. Same principle applicable to other forms ofcredit 6. Banks of deposit and banks of issue 7. Depositbanks subject to little legal control 8. Causes of financial crisesInsufficient reserve 9. The credit superstructure 10. Causesof commercial crisesOver-speculationHistorical Cases 11.Similarity in development 12. The tulip mania 13. Otherspeculative manias 14. Other causesExcess of fixed capital 15. Over-production 16. Raw materials and the seasons 17. The sun-spot theory 18. Theory of credit cycles 19.Importance of reference to history 63


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BANKERS' MONEYA SUPPLEMENT TO A TREATISEON MONEY

CHAPTEE IWHAT IS MONEY ?

1. The money of the money market of theUnited Kingdom.In a very able address on theConstitution and Course of the Money Market,delivered in 1888 by Dr Charles Gairdner, latemanager of the Union Bank of Scotland, the intro-ductory sentences are as follows : The money marketof the United Kingdom is an institution of greatimportance and of some complexity. It has graduallygrown to enormous proportions, and embraces a fundalmost equal in amount to the sum of the NationalDebt. This fund is held by the banks, is practicallyat call, and is repayable in gold; and yet ninety-fiveper cent, of it is engaged in promoting the industriesand material interests of the country and the world,while only five per cent, is actually held in coin. Ifyou consider carefully the meaning of this statement.


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2 BANKERS' MONEYit must strike you that, in spite of your familiaritywith the state of things described, it is a very ex-traordinary statement. The fund of money of themoney market is, on this calculation, over 600,000,000in amount ; 95 per cent, of it is apparently not in themarket at all, that is to say, not in the banks by whichit is said to be held ; and only 5 per cent, is actuallyin coin. It may be added also that the total amountof coin in the United Kingdom is only about one-sixth of the total money of the money market as givenby Dr Gairdner, and it is not in any sense under thecontrol of the banks, but is being circulated fromhand to hand.

2. Its p7'actical importance.Since, then, thegreater part of the money of the money market isnot metallic money, the question is, What is it ?It is no doubt something very real, for, as we all know,the abundance or scarcity of money affects the ratescharged by banks for advances and discounts, and inthat way affects the whole trade of the country. Whenthe scarcity of money becomes extreme, we have indeeda commercial crisis, and for the time being all the tradeof the country is thoroughly disorganised. And weknow also by experience that at times of crisis theamount of metallic money or money material held by thebanks is of the most vital importance. In the wordsof Walter Bagehot, the author of Lombard Street,and a banker and an economist of the first rank, Allour credit system depends on the Bank of England forits security. On the wisdom of the directors of thatone joint-stock company it depends whether Englandshall be solvent or insolvent. And if the precise


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WHAT IS MONEY ? 3method of stating the truth seems rather overstrained,there is no question of the central fact. Once thereal gold reserves available for banking purposes getbelow a certain levelwhich again is variable accord-ing to circumstancesthe whole monetary system ofthe country becomes clogged, and for the time almostunworkable.

3. GeTieral scope of argument.The subject Ipropose to discuss in this and the following chapters isin reality The Constitution and Functions of theMoney Market. In the first chapter I shall examinethe meaning and nature of the term '' money ; in thesecond I shall examine under the title of the ForeignExchanges the interaction of the money of differ-ent countries ; in the third I shall treat of the ratescharged for loans of money under the title of the Eate of Interest ; and in the fourth, I shall givesome account of the disorganisation of the moneymarket under the title of Commercial Crises. Oneach of these topics it would be much more easy towrite a treatise than a chapter, and in each of themalso the familiarity of the terms employed concealsgreat difficulties. Accordingly, at the risk of appearingtoo simple, I shall give most attention to the funda-mental principles ; but at the same time, in order notto appear too theoretical, I shall endeavour to illus-trate the principles by reference to concrete facts ofstriking importance in themselves.

8 4. Different kinds of material money.In dealingwith the question What is money ? we may beginby a rapid survey of the various things that havebeen in the past or are in the present actually called


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4 BANKERS' MONEY money. You will find in the book on Money, bythe late Professor Jevons, an interesting account of agreat variety of primitive kinds of money e.g., cattle,slaves, tobacco, dried fish, straw mats, skins, and manyothers. You will also find in the very remarkable andlearned work of Professor Eidgeway on the Origin ofCurrency and Weight Standards excellent illustrationsof the beginnings of the evolution of money. Inthe course of progress the metals gradually displacedother substances ; in the struggle for monetary exist-ence amongst the metals, silver and gold were thesurvivors ; next, in the duel between gold and silver,for centuries silver held the supremacy ; and it is onlyin the last quarter of a century that gold has obtainedthe position of being practically the world standard formaterial money.

5. Representative money.Long, however, beforethe battle of the standards had become critical, someof the most important money functions had cometo be performed by other things, these otherthings being embraced by Jevons under thecomprehensive term representative money. Thesubstance of all these things, if it can be calledsubstance, is in effect credit ; and although forcertain purposes bank notes seem to have moreof the nature of metallic money than do billsof exchange or cheques, as a matter of fact, in themoney economy of the present day, bills of exchange,and especially cheques, are of far greater importancethan bank notes. You might without much incon-venience abolish bank notes and carry on all internaltrade and all foreign trade by coin, cheques, and bills


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WHAT IS MONEY ? 5of exchange, but without cheques and bills or some-thing of the same kind our present monetary systemwould be impossible. These various instrumentsthese credit documentsperform most importantmonetary functions ; of this fact there can be nodoubt. The latest return of the London Bankers'Clearing-House gives nearly 10,000 millions sterlingas the amount of the cheques, bills, etc. for the year1901.

I have said that bank notes are now of relativelysmall importance, but it was not always so. Thehistory of Scottish bankiag in particular shows ofwhat vital importance were the one-pound notes, andby no one has this importance been better broughtout than by Sir Walter Scott in his famous letterson the Currency to the editor of the EdinburghWeekly Journal, under the pseudonym of MalachiMalagrowther. The publication of these letters, itmay be said, preserved for Scotland its one-poundnote. The one-pound note,this is the sum of SirWalter's argument,converted Scotland from apoor, miserable, and barren country into one where,if nature has done less, art and industry have donemore, than in any country in Europe, England herselfnot excepted.

6. On the use of economic methods.And here,if you will allow me, I will interject a general remarkon the study of economies. It is necessary in thefirst place to get a real grip of economic methods,and especially of the method of abstract analysis. Ifyou start at once with what you are pleased to callfacts, you will make no progress whatever ; you might


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6 BANKERS' MONEYas well hope to understand botany by taking atrandom a barrow-full of weeds and making your ownclassifications and dissections without reference to thescience of the subject. You must in economic sciencein general, and in monetary science in particular, getfirm hold of leading principles, or, if you prefer, ofguiding hypotheses ; you must not be afraid of abstractreasoning. Thorold Eogers, who collected an invalu-able mass of materials in his great work on thehistory of Six Centuries of English Prices, fell intothe most serious errors in his commentaries and deduc-tions, simply because he despised and failed to under-stand the abstract theory of money and prices.* Thecorresponding work for France, also for six centuries,by Vicomte d'Avenel, is in this respect far superior tothat of Rogers, because the author has taken thetrouble to make himself a master of theory. Youmust, then, begin with theoryabstract, hypotheticaltheory.

But it is equally important to observe that youmust end with facts and with history; your theoryis only prehminary. And in dealing with historicalfacts, you must not expect to find them all nicely cutand dried and ready to be ticketed with some par-ticular form of some particular theory. Eeal factsare never isolated in this way ; they are intermingledwith all kinds of other facts, and that is why yourequire your analytic methods to make the separation.And, moreover, facts of one kind being so intertwinedwith facts of other kinds, you must be prepared to

* There is similar weakness in his most interesting work on theFirst Nine Years of the Bank of Englamd.


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WHAT IS MONEY ? 7search in very unlikely places. Most of you will notlook naturally to Sir Walter Scott for the history ofScottish banking, but on the important phase to whichI referred he may rank as an authority; and I maysay incidentally that there is more economic history,that is to say history dealing with the real life of thepeople, in the novels of Sir Walter Scott than in anygeneral history with which I am acquainted. Iapologise for the length of this digression, and turnagain to my abstract theories.

7. Necessary to separate the functions of money.Seeing, then, that in actual usage the term money isso variable, it is hopeless to begin with the so-calledfacts ; we must take our monetary system to pieces todiscover the working ; in other words, we must considerseparately the various functions of money. We shallthen find that the reason why it is so difficult, if notimpossible, to frame a definition of money whichshall include all the things actually called money,the reason is that some of the functions of moneyare best performed by some things and others by otherthings. This is true even of the so-called primaryfunctions, and only when we have examined theseprimary functions shall we be able to determine if asimple definition of money is possible.

S 8. Money as a general medium of exchange.TheUrd great function of money is to provide a generalmedium of exchange. It is usual to begin an accountof this function by reference to the inconveniencesof barter, as in the example of the prima donna on avoyage round the world, who, in exchange for her songsin the Society Islands, was to get a third of the receipts.


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8 BANKERS' MONEYWhen counted, her share consisted of three pigs, twenty-three turkeys, forty-four chickens, four thousand cocoa-nuts, and large quantities of bananas, lemons, andoranges. The only method of saving this -svealth wasto set the live stock to devour the fruit, and althoughthis may be called a primitive form of banking, it ishighly inconvenient.

After some such preliminary statement of the incon-.veniences of barter, and the insinuation that barter isonly proper for savages, it is usual again to drag upbarter from these lowest deeps and to set it on thehighest pinnacle of civilisation. We are told that allexchange is in reality barter, that commodities pay forcommodities, and that money is only an intermediary.That trade is incapable of development when confinedto direct barter, and also that all trade is in the lastresort barter, are both truths of the highest importance.And both propositions being true, the appearance of con-tradiction must be an appearance only. All the difficultywould be avoided if it were stated that all exchange isultimately barter, but that money is in general anecessary intermediary. To describe money as only an intermediary is to suggest, at anyrate, that it mightbe dispensed with. And if by money we meanexclusively metallic money, that is perfectly true ; butif we mean that the monetary function, as performedby some representative of this metallic money, can beeliminated and dispensed with, that is perfectly false.

You can only realise the fundamental importance ofthis primary monetary function by tracing the stages ofindustrial progress. The gradual substitution of ex-change by money for exchange by barter has been one of


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WHAT IS MONEY ? 9the greatest agencies in civilisation. Without money inits simplest form, that is in the shape of cattle or skinsor some material thing generally desired and acceptable,trade would have been strangled in its infancy. Andwithout money in its most highly developed form, thatis in the form which it assumes in banking, modernindustry would be impossible. In any just analysisbanks are as necessary to production as are ships,railways, or factories.

But before leaving this primary function of money,that is, as a medium of exchange, we may go one stepfurther. It is not necessary in modern commerce thatsome credit document, such as would be taken by abanker, should directly represent so much coin at everytransaction. Besides cheques and bills, there are bookcredits, and even book credits are not necessary. Itis sufficient that the commodities to be exchanged shallbe expressed in terms of money, and in this case arelatively small balance (if any) of money need betransferred. In the case of international trade, indeed,we often have cases in which commodities are directlyexchanged for commodities without the intervention ofany form of credit. In this and similar cases, however,the monetary function passes into that of a measure ofvalues. Both sets of commodities are measured in termsof money, and this is very different from simple barter.S 9. Money as a standard measure of values.Itis time to observe then, secondly, that money isrequired not only to furnish a common medium ofexchange, but to provide a standard measure of values,or common measure in which all values can beexpressed.


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lo BANKERS' MONEYThe necessity for a common measure of values

appears very early in history. Thus, in the earlymedieval period, when rents were actually paid in theshape of so much labour or so much produce, itbecame customary to measure the values in termsof money. And in our own times valuations are madefor all kinds of purposes as well as for actual ex-changes. Thus, historically and actually, we mayseparate the function of money as a measure of valuesfrom the function as a medium of exchange. But thetwo are so closely connected, that though there maybe measurement without exchange, there cannot beexchange without measurement, that is, in the ordinarycourse of modern trade.

In spite of this close connection, however, it isimportant to observe that the actual medium may notitself be the standard measure ; it is enough if it isrelated to the standard as multiples or sub-multiples,or in any exactly determinate way. At present, inthe United Kingdom, the sovereign is the standardunit of value ; all values are measured in numbers, orin parts of sovereigns or pounds sterling. But theactual payments may be made by bronze, silver, notes,cheques, or entries in books. And the unit of valuewhich itself constitutes or determines the standardmeasure need not itself be a coin at all. Thus, inmost European countries the standard unit of valuewas originally the pound of silver, but there was nevera coin of that magnitude or ponderosity. In fact, forcenturies in England, though the standard measurewas the pound of sterling, the only coins of anyimportance were silver penniesthe table, twenty


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WHAT IS MONEY ? iipennyweights one ounce, and twelve ounces one pound,shows the original relation of the penny coin to thepound measure : the pennyweight was literally apenny weight.

If all transactions and exchanges were effectedimmediately, anything that is universally acceptedwould serve as a standard measure of values. Thus,for example, inconvertible bank notes, at any'particular moment, will effect exchanges just as wellas convertible notes or coins. If others accept thenotes at the same valuation in any market, that issufficient. But as soon as we consider the productionof things, we pass from a moment of time to a more orless prolonged period of time.

10. Money as a standard for deferred payments.It is this element of time which gives rise to a thirdprimary function of money, namely, to provide astandard for deferred payments. Both theoreticallyand practically this function of money presents thegreatest difficulties. The real meaning of anymonetary contract is liable to be disturbed by fluctua-tions in the value of the monetary standard. Here,again, the best and most easy example is in-convertible paper. Suppose the notes were constantlychanging in value, and that in the course of a weekor a year you had to pay for every new purchase twiceas much in notes, whilst for your old contracts,includiag your income, you only receive the old amountof notes, obviously you would be deprived of half thepurchasing power of your money. That is theessential evil of inconvertible paper; it fluctuates in

vitiates the real meaning of contracts. In


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12 BANKERS' MONEYextreme cases it ceases to fulfil this function of money-altogether, and monetary bargains are made on someother basis in spite of legal prohibitions and penalties.Now what is true of inconvertible paper in amagnified form is true of every standard for deferredpayments in a greater or lesser degree. You makea contract on a gold basisyou will no doubt receiveso much gold, or what represents so much gold, whenthe contract matures ; but what the value of thatgold will be depends entirely on the course of pricesin the meantime. And, as a rule, if you take anyselection of representative commodities, there is somemovement in prices ; that is to say, so much goldpurchases more or less of various things and services.

11. On the meaning of stability of value in thestandard.So long as the conditions of productionand of demand are liable to change, it is impossible toget any standard with absolute stability of value, andthe utmost we can aim at is relative stability ofvalue. To attain this end we may eliminate certaincommon causes of fluctuation. Thus, for example, asregards supply, it is quite clear that if you have a verylarge durable stock, the variation in the annual pro-duction will be of minor importance. The annualsupply of gold, for example, is always small relativelyin the total world's supply, unlike the annual supplyof wheat. Thus, so far, gold is a better standardthan wheat. Again, for some things there is afluctuating demand, and for others relatively a steadydemand ; and here again gold has the advantagecompared with other substances that at different times


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WHAT IS MONEY ? 13At first sight it seems as if the want of stability of

value in the standard itself is a very terrible thingbut in this world there is perhaps nothing practicalwhich attains the perfection of theory, and fortunatelywithin limits this want of perfection is under ordinaryconditions of no practical importance. Your yardmeasure expands and contracts with every change intemperature, but for ordinary purposes this is of noimportance. In the accurate measurement of time,however, such contraction and expansion must beallowed for, and you have great skill displayed inmaking compensations in chronometers ; and similarlyin certain astronomical observations and calculationsan error in the instrument of the smallest degree mayvitiate the result, and incidentally send a big ship tothe bottom of ocean. Fortvinately, as regards value, nosuch precise measurements are required for practicalpurposeseverything is, as a rule, done withinreasonable margins. It is only occasionally, with verygreat change in the conditions of demand or supply,that serious changes occur in the value of the moneymaterial that constitutes the standard. On suchoccasions there may be a very real disturbance of themeaning of monetary contracts and a very real dis-turbance of the distribution of wealth. Even in thiscase, however, the evil ought not to be exaggerated.The loss of one is the gain of another in any monetarydisturbance, and the evil only becomes serious wherethe uncertainty actually dominates the volume oftrade and production.

12. Money as a store of values.To the threeprimary functions of money already considered we may


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14 BANKERS' MONEYadd a derivative function. Money may be used as astore of values. In its elementary form this functionis extremely simpleit consists simply of hoarding somuch actual metal. But in the course of developmentthis function of money has also become much moredifficult of comprehension. To pay money into a bankby means of a cheque is very different from puttingaccording to the French idiom^ little sous into a bigstocking. In the case of the cheque, the only materialdifference consists, as a rule, in the change of a fewfigures in the books of one or two banks. And yet wespeak as if the money were stored in the bank.

13. R4sum6 of the argument.Thus, again, weare led back to the original question propounded asthe problem of this lecture, namely, What is money ?What is this money that I put in the bank when Ipay in a cheque, and What does the bank do with themoney ? We may indeed ask not only What isthe money, but Where is the money ?

The answer to the question What is money ?which serves to cover most of the popular usages, isthe answer given in the late Professor Walker's bookon Morhey Money is that money does or, in otherwords, anything which performs the functions of moneymay be classed as money.

But then all the difficulties of the definition reappearwhen we ask the further question : In order that athing may be classed as money, must it perform all thefunctions or only one or two of these functions ? Take,for example, concrete cases : In this country, forpractical purposes, the gold coinage only fulfils all thefunctions. Gold only is compulsory legal tender under


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WHAT IS MONEY ? 15all conditions for the fulfilment of monetary contractsBank of England notes, for example, are not legaltender by the bank itself, and other bank notes arestill more restricted as regards this function ; even theother coins made of silver and bronze, thoughpopularly classed as money, have only a limitedacceptancethey are, indeed, token money, andlegally on the same footing as bank notes except forsmall payments.

The sovereign, again, is, in this country, the onlystandard measure of values ; it is so, however, simplybecause the law has so determined. When a countryis obliged to resort to inconvertible paper, it veryoften prohibits the use of gold as a standard, and bypenalties tries to make its notes the standard. If werefer back to history we find examples of what iscalled the double standard, or better the alternativestandard of gold or silverthat is to say, at theoption of the debtor a monetary contract might bemet by so much gold or so much silver, the ratebeing in general determined by law. On variousgrounds economists have proposed other standards, as,for example, an amalgam of gold and silver, or notesrepresenting so much gold and silver.

Again, in this country gold is the standard fordeferred payments. Take the National Debt : it isrepayable in gold, though it may not be repaid forcenturies. Similarly as regards many perpetualdebentures, the interest is payable in pounds sterlingthat is to say, gold. But when we take very longperiods, changes in the value of the standard may beof practical importance. In this case we have all


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i6 BANKERS' MONEYthe difficulties connected with appreciation and de-preciation, some of which will be considered inconnection with the Foreign Exchanges. To remedythese difficulties some economists have proposed atabular standard. In effect, this is a compositestandard composed of a number of representativecommodities. It is assumed that the debtor willcovenant to pay not so much gold, but so muchpurchasing power, and thus the amount of gold moneyto be paid would vary with the course of prices.

Finally, when we consider the function of moneyas a store of value, the most important store is, inthis country, the reserve of gold in the Bank ofEngland. Most of the rest of the money that isdeposited or stored in our banks is only represen-tative money ; it is only supposed to be repayable ingold. As a matter of fact, if all the so-called moneywhich is supposed to be repayable at call weredemanded at the same time, only a very smallpercentage could be paid. But although all this bank money could not be changed into gold atany particular time, and although it only representsgold in the highly conventional sense that it is re-payable in gold, if demanded, it is not to be con-sidered as in any sense unreal or intangible. Thefunds of the banks which are not represented by goldare represented by other forms of property, as, forexample, by the produce and manufactures againstwhich bills are drawn and are taken to the banks fordiscount, and also by the Government and othersecurities which are really mortgages over the propertyof the nation or of companies or of individuals.


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WHAT IS MONEY ? 17It was said by Sir James Steuart, a great writer

who preceded Adam Smith, that any form of propertycould be melted down into bank money. But theaggregate amount of this bank money mustalways depend partly on the amount of the realreserve available, and partly on the nature of thedemands likely to be made on this reserve. Theprogress of bankiug in one important respect is shownby the diminution in the proportion of gold reserveto liabilities which it is necessary to keep, and thisagain depends partly on the demands for gold for cir-culating purposesincluding transmission abroadandpartly on the credit of the banking system as a whole.

14. The definition and meaning of money mustvary with its monetary function.It would obviouslybe absurd to say that only the gold of the moneymarket is money, and still more absurd to go to theother extreme and say that the other forms of propertypledged directly or indirectly to the banks are money.If, then, for the last time we put the questionWhat is money ?As the result of our inquiryinto the monetary functions, the only satisfactoryanswer appears to be that we must recognise thatthere are various kinds of money, and that thedefinition must vary according to the monetaryfunction that we are considering. In reality, insteadof trying merely to frame a verbal definition, we oughtalways to make clear the different monetary functions.And a good practical rule is, as in other similar casesin economics, to use quahfying adjectives indicatingthe kind of money or the kind of monetary functionto be considered.


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i8 BANKERS' MONEY 15. The standard as determined hy positive

law.The standard of value in any country is exactlydetermined by the law of that country, and thisdefinition governs the interpretation of all monetarycontracts. How far the use of such a standard iscompulsory is also a matter of law, and how far thelaw can be carried out depends partly on publicopinion. As a matter of fact, at the present timemost commercial contracts in this country are expressedin terms of money,'' that is to say, in terms of thepound sterling ; but if people so desire, there is nothingto prevent them making bargains to make paymentaccording to a tabular standard or any other standard.But, as a matter of history, in the course of time thegovernments of all countries beyond a certain stagehave adopted as their standard some definite amountof gold or silver (and in some cases an alternative ata certain rate). At the beginning of last centuryEngland formally adopted the gold standard, and inthe last thirty years the gold standard has been adoptedto such an extent that it may now claim to be thecommercial standard of the world. The gold moneysof the different countries are in this way related accord-ing to the amount of fine gold they contain. Incertain countries, however, silver is still the standard,and in others there are various legal standards whichare only indirectly or partially on a gold basis, as, forexample, the rupee in India. These other standards,however, for the purposes of international trade, maybe reduced to terms of gold at any particular time.*

16. The medium of exchange line as determined* Compare the chapter on The Foreign Exchanges.


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WHAT IS MONEY ? 19ly law.The medium of exchange in any countrywhich people Wjust accept in satisfaction of a debtwhen offered by the debtor is also a matter of law,and how far its compulsion can be extended to futurecontracts is a matter of Government and public opinion.How far, as a matter of fact, people may and do acceptother means of settlement in place of legal tenders isa matter of habit and convenience, and how far suchacceptance is final or irrevocable is a matter of law.These various things, which locally and temporarilyso far fulfil the function of money as a medium ofexchange, may be said to represent, or to be basedupon, standard moneythat is, in most countries,gold, directly or indirectly. Thus, gold in gold-standard countries may also be said to be the fvmda-mental medium of exchange, though in some cases thefoundation may be in bulk and value relativelysmall compared with the ^superstructure. The actualuse of gold may be economised to a marvellous extentby the use of representative

money ; but it cannotbe dispensed with altogether, any more than the founda-tion of a building.

17. Gold itself strictly not money hut moneymaterial.Gold, then, under present conditionscertainly fulfils all the monetary functions to a degreethat is not true of anything else. But, to raise onelast difficulty for purposes of illustration, gold itself isnot money but only money material, and therefore sofar only representative of money. At the time ofthe great Australian gold discoveries in the early'Fifties, gold in South Australia is said to have fallento 45s. an ounce, and in Victoria to 60s., as compared


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20 BANKERS' MONEYwith the mint price of 3, 17s. 10|


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WHAT IS MONEY ? 21attached to the term money in the course of theargumenta precaution of special importance indealing with the quantity theory of money. Other-wise, if we do not take this precaution, it is hardlypossible to escape confusion. And this habit ofconstantly looking into the meaning of money has itspractical advantages. The whole business of bankingconsists in estimating the demand for money ofdifferent kinds for different purposes : in some cases ademand for money may mean no more than a changeof figures in bankers' books ; but in other cases it maymean that the Bank of England is obliged to borrow,as on certain historical occasions, actual gold from theBank of France.

\Note.For a full development and illustration ofthe argument, see the writer's Principles of PoliticalEconomy, vol. ii. chaps, xi.-xviii.]


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CHAPTER IITHE FOREIGN EXCHANGES

I 1. Introductory.In attempting to give in asingle chapter an account of the theory of the foreignexchanges, it is obvious that the attention must hemainly devoted to general principles. Those whorequire practical details may be referred to Tate'sCambist, or to the A B C of the Foreign Exchangesby Mr George Clare. That the general theoryrequires careful statement, and is not so obvious as issometimes assumed, is evident from Viscount Goschen'sstandard work, which is still of the highest value onaccount of its principles, although most of theexamples are altogether out of date.

I shall first of all explain the meaning of the termsand the extent and limits of the fluctuations, and thenI shall notice, so far as space permits, some of theimportant indirect effects on banking and trade ofcertain kinds of fluctuations in the exchanges.

I 2. International debtsExports and imports.The term foreign exchanges refers to the settlement ofinternational debts. Accordingly, in the logical treat-


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THE FOREIGN EXCHANGES] 23ment of the subject, we ought to begin with theanalysis of international indebtedness. The firstelement to be considered is the amount of the exportsand imports. It is a commonplace of economictheory that imports are paid for by exports. And ifthere were no other elements in international indebted-ness, imports could be paid for in no other way.Either the value of the exports must equal that of theimports, or else the trade must cease. A country thatdoes not itself produce gold could not go on paying forimports with money; it must replenish its moneysupplies, and it could only do so by selling exportsabroad. Suppose that a country had an excess ofimports which it could only pay for by sending moneyor money material. As the country was denuded ofits money, prices would fall ; it would become a goodcountry to buy from and a bad country to sell to ; andthus exports would be stimulated and imports wouldbe checked until the adverse balance was reversed.In practice, in modern societies, long before thecountry was denuded of its money there would be,through the drain on the reserves of the banks, such acheck to credit that prices must fall. But theprinciple is still the same : Provided exports and im-ports are the only elements in international indebted-ness, prices must be so adjusted that exports and im-ports balance, or else the trade must diminish or cease.

8 3. Beal par of exchange.The operation of thisprinciple is hidden by various conflicting circumstances.As Adam Smith pointed out long ago, it is practicallyimpossible at any time to say what is the balance oftrade between any two countries. What is some-


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24 BANKERS' MONEYtimes called the real par of exchange, in the senseof an equality of indebtedness, is much better calledan ideal or hypothetical para useful assumptionin certain kinds of reasoning. It is altogether differentfrom the mint par, or nominal par, which expressesa definite concrete fact, as is explained later on.

4. Trade of countries and of individual traders.Again, for simplicity of reasoning, we say that onecoimtryEnglandtrades with another countryFrance, just as if the two countries were run by agigantic trust on each side, and as if the state ofaccount were reckoned up and published every day.Nothing, of course, could be further from the truth.It was well said by Eicardo, who spent most of hisdays in making money on the stock exchange and hisnights in making fame in economic theory, that everytransaction in commerce is an independent transaction.The trade between France and England is not run bytwo trusts, but by a multitude of independentmerchants.

The reconciliation between the two positions isfound in the course of prices. The merchants haveto make their bargains in terms of prices, andprices are influenced not only by particular relativecauses but by general causes. And amongst suchgeneral causes are the terms on which biUs can bediscounted or advances from banks obtained. And, aswill be shown presently, the rate of discount depends,inter alia, on the course of the foreign exchanges,which again depends, inter alia, on the balance ofexports and imports, or rather on the payments thathave to be made on account of trade transactions.


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THE FOREIGN EXCHANGES 25 5. Other elements in international indebtedness

compared ivith exports and imports.There are, how-ever, other elements in international indebtedness aswell as exports and imports, on account of which pay-ments have to be made. These elements I shall onlyenumerate, as I must in some way economise mylimited time. You will find them very clearly statedin Lord Goschen's second chapter- and in the pagethat forms the frontispiece to Mr Clare's little bookyou will see a debtor and creditor statement for Londonof international transactions.

Besides exports and imports we have to takeaccount of payments in connection with freights, thepurchase or sale of stock-exchange securities, theadvance of loans, the interest on loans, the expenses ofgovernments abroad, the expenses of foreign residents,the obligations incurred by banks, the profits of com-missions of various kinds, and other minor elements.You will find it useful, I think, to translate all thesevarious elements into the language of exports and im-ports ; that is to say, to consider what would be theeffect on the state of indebtedness if these various obliga-tions were equivalent to or expressed by a correspond-ing increase of exports or imports as the case might be.This, indeed, is not only a good practical rule, but is anecessary procedure when we seek to explain the courseof international trade ; why, for example, year afteryear, the imports into the United Kingdom exceed theexports by many millions. This undoubted fact doesnot show that the imports are not paid for by the ex-ports, but only that some of the exports are not in theform of material commodities. Thus, for example, a


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26 BANKERS' MONEYfreight has been well called an invisible export ; theadvance of a loan i.e., the capital sumis, so to speak,an import of securities from the foreigner, and we mustpay for the securities by exporting more commoditiesthe interest on the loans, on the other hand, acts fromthis point of view like another invisible exportnowwe export, so to speak, the coupons and receive paymentin the shape of so much additional imports ; theexpenses of government or of absentees abroad may beregarded as if we actually were obliged to pay for ad-ditional imports to that extentthe imports beingconsumed on the way ; and finally, foreigners have topay us, by sending us something of valuethat is tosay, really by adding to our importson account ofour commissions in settling international transactionsof various kinds.

6. Exports and imports typical of all internationaldebts.It appears, then, that not only are exportsand imports the principal elements to be consideredin international indebtedness, but that other elementsmay also be likened to them and expressed m bermsof exports and imports, and, indeed, they have aprecisely similar effect on the balance of indebtedness.We are justified, then, in dealing with internationalindebtedness, in taking exports and imports as typicalor representative, and in that way simplifying thecentral problem.

I 7. Traders in each country receive payment inmoney of that country.If, however, it may be takenas axiomatic that the exports are paid for by imports,in the extended use of those terms, it is equallycertain, as a matter of common observation, that the


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THE FOREIGN EXCHANGES 27producers of these exports are paid for them inthe money of their own country, and the producers ofthe corresponding imports are also paid for them inthe money of their country. It is all very well tosay that the coal exported by England is paid for bythe wine imported from France, but it is prettycertain that the English colliers do not drink theFrench wine, and the French wine-growers do notbum the English coal. The English colliers even-tually receive English money, and the French wine-growers French money, for their respective productions.Accordingly, if we carry out the same reasoning asregards all the other exports and imports, we seethat the settlement of this international indebtednessinvolves the conversion at some point or other ofFrench money into English money, and conversely.The French consumers of English coal in some wayor other have to pay for it in English money, and insome way or other to pay this money in England.

8 8. Meaning and olject of foreign exchanges.Theway in which this is done is explained by the theoryof the foreign exchanges. The foreign exchanges,to quote the old standard work,* are transfers fromthe money of one country to that of another effectedby the operation of Bills of Exchange.

It may, of course, happen that different foreigncountries have identical currencies, but the terms ofthe definition do not exclude this case ; the essence isthe transfer of money power from one country toanother. The French consumer, through suitableagents or intermediaries, is obliged, not only to change

* Tate's Oaml-ist.


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28 BANKERS' MONEYhis francs into sovereigns, but the sovereigns mustbe paid in England. If, however, every independenttransaction of commerce were settled independently,we should have a multitude of parcels of coin orbullion constantly flowing in about equal streamsfrom and to every country. England would bereceiving money for exports and sending away moneyfor imports. But the resources of very early civiUsa-tions were equal to avoiding this source of waste,and the foreign bill of exchange may be traced back,at any rate, to the middle ages.

For simplicity, it is convenient to assume that inthis method of the settlement of the indebtedness onecountry is altogether active and the other altogetherpassive i.e., that one always draws and the otheraccepts. Suppose, for example, that Americanmerchants export corn, cotton, etc. to England, anddraw for the value on the corresponding Englishimporters or purchasers. The bills being drawn onLondon entitle the drawers to receive money therefrom the acceptors. But so far they would be nobetter off, for they would have to fetch the correspond-ing gold from London. But suppose, further, thatother American merchants buy from London piecegoods of the same value as this exported corn. Theycan, of course, settle their debts by sending gold, butthey can settle them equally well by buying thesebills from the exporters and sending them toLondon, where they wUl be paid by the acceptors.By the intervention of these bills the remittance,to and fro, of bullion is avoided, and the Americanexporters of produce receive American money, and


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THE FOREIGN EXCHANGES 29the English sellers of piece goods receive Enghshmoney.

9. The mint par of exchange.It is clear, how-ever, that the bills being payable in pounds sterling,and being sold for dollars, the first element in deter-mining the price of the bill is the relative value of thepound sterling and the dollar. This again dependson the amount of fine gold each contains, and what iscalled the mint par of exchange tells us how much ofthe other country's currency contains, according to itslaw, the same amount of pure metal as is contained inour standard coin, according to our law. The mintpar is deduced from the legal definitions of the respec-tive standard coins. If we take the pound sterling asfixed, or as the basis, the mint par with U.S.A. is 4'866dollars, with France 25-2215 francs, with Germany20-43 marks.

If the foreign coins were being exchanged at thesame spot in order to be melted down, this mint parwould also give the actual rates of exchange. Butthe term foreign exchanges refers primarily to a trans-action in which a bill (say) for pounds payable inLondon is sold for dollars received in America, and itis this difference of place which accounts for thefluctuations in the rates of exchanges, or, as it is called,the rise and fall in the exchanges.

I proceed, then, next to notice the principal causesof these fluctuations and the limits to their riseand fall. It is better now to pass from the simplecase of one kind of export and one kind of import,and to include all the elements in international in-


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30 BANKERS' MONEYand, if I may coin a similar phrase, the intangible obligations.

10. Limits offluctuationsGold points.Suppose,then, at any particular time a number of people inNew York have to make remittances to London, andthat a number of other people in New York are anxiousto sell various credit documents, bills, drafts, etc., whichentitle the holders to receive money in London. Ifthe demand exceeds the supply, the price of these bills(or other documents) will rise. But the limit of therise will be given by the point at which it will be justas cheap for the American debtor to send actual goldto London. This is the out-going gold point from NewYork, and it may be taken as 1 = 4'89|- ; conversely,if the supply of bills exceeds the demand the pricefalls, and it may fall to such a point that it would bejust as profitable for the owner of the billthe Ameri-can creditorto send for the gold. This is theincoming gold point to New York, and may be takenas 1 = 4-83i

11. B4sum6 and illustrations. To resume : Themint par is just 4'866 = 1. If the rate rises to4'89|-, it generally pays to send us gold ; if it fallsto 4'83|-, it generally pays to take gold from us.*These gold points, or specie points as they used to becalled, for export and import cannot, of course, be fixedwith absolute precision, as they depend on the cost oftransmitting the gold, but the average or normal is

* If the dollar is taken as fixed and the pence given as variable, themint par is l= 492^jd., and the gold points are l = 49d. for us, and|1= 49|d. against us. If the dollar in New York would only buy 49d.in London, it would pay to send gold ; if it would buy 49|d., it would


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THE FOREIGN EXCHANGES 31approximately certain, and it is only under excep-tional conditions that these limits are exceeded.

If you refer to Mr Clare's book * you will see adiagram showing the course of the exchange at NewYork per cable transfer on London for the year 1891.In January, to begin with, the rate is low4'85^,and it rises to the maximum (the out-going gold pointfrom New York) in Marchviz., |4'89|-. It remainshigh till the end of June, when there is a fall to theminimum of 4-83|the incoming gold point for NewYork. The general course of the fluctuations in thiscase is determined mainly by trade influences. TheStates, as a rule, ship to us large quantities of corn,cotton, etc. in the autumn, and from August to Decemberthe exchanges are therefore generally favourable to theStates and, conversely, unfavourable to us. Duringthe rest of the year the balance is in our favour andagainst America. In this particular year, however, italso happened that London was selling in Americalarge quantities of American securities in the spring, sothat there was an extra demand for remittances fromNew York to London.

The difficulty of giving actual concrete cases for thepurpose of illustrating the theory is that we cannot inthis way take the theory in parts and in order ofsimplicity; the concrete cases generally require fortheir explanation the whole of the theory and somepractical qualifications besides. And in this example,which I chose to illustrate the effect of exports andimports on the exchanges between New York andLondon, I have introduced two terms not yet explained

* Note, p. 137.


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32 BANKERS' MONEYnamely, the term favourable, and the term cabletransfer.

S 12. Favourable and unfavourable exchanges.What, then, is the meaning of the expression that theexchanges are favourable or unfavourable, or for oragainst a country ? The use of the terms may be ex-plained in two waysone partly historical, and theother very real at the present time. If we take ourformer illustration and consider the case of the Ameri-can importer, if the exchange is below par he is ableto buy his remittance for so much lesshe givesfewer dollars for a hundred pounds payable in London.Thus it looks as if American currency fetched more ofEnglish currency. In former times there was alwaysmuch anxiety about the actual exchange of currencies,and this is one historical meaning of the term favour-able i.e., to obtain more foreign currency than usualfor the native money. There is, however, a deepermeaningalso historical. When the exchange isfavourable to a country it shows, so farthat is,omitting other elements of indebtednessthat theexports have exceeded the imports. Under the oldideas of the mercantile system this was considered afavourable state of trade. Sell much and buy little was considered the chief rule of the national tradeeconomy. It is not necessary, again, on the one sideto expose the fallacy, or on the other to indicate theelement of truth, contained in this maxim.

13. Historical and present importance of.It isplain that, so far as any advantage was obtained fromthe state of the exchanges by way of trade, if theexchange was favourable to the importer or the buyer


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THE FOREIGN EXCHANGES 33of the bill, it was so far unfavourable to the exporter orthe drawer of the bill. Probably the idea was thatthe exporter would transfer any loss to his foreigndebtor. This usage, however, of the terms favour-able and unfavourable namely, as supposed toindicate the balance of tradeis now, or at any rateought to be, only of historical interest.

But, I hasten to say, there is a sense in which theterms, favourable and unfavourable exchanges, maystill be used with a very real meaning. Gold is acommodity which, for many purposes, is very differentfrom any other commodity. The gold held by theBank of England is of far greater importance to theUnited Kingdom than is indicated by its monetaryvalue. If, owing to any cause, we exported suddenlytwenty or thirty millions more of commodities thanwas usual at that period of the yearif, for example,owing to the outbreak of war between China andJapan we exported a mass of materials suitable forthe mutual destruction of these friendly states, theremight be some political protests and some interestinglawsuits, but, on the whole, the trade of this countrywould be stimulated, and possibly leap and bound.But if, on the other hand, these wily orientals wereable suddenly and unexpectedly to withdraw from theBank of England twenty or thirty millions of gold,which also is very useful in time of war, our trade,instead of leaping and bounding, might very possiblysuffer from the depressing influence of a commercialcrisis.

It is the passage of gold from one country to anotherthat gives the principal general interest to the foreign


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34 BANKERS' MONEYexchanges. To the great mass of the people of thiscountry who are engaged in business of various kinds,the course of the foreign exchanges is in general of nointerest whatever, except in one particularnamely,if there is a rise or fall, in consequence, in the rate ofdiscount. That they see and feel. For one businessman who considers the course of the foreign exchanges,a thousand consider the movements of the bank rate.There are also, it is true, other indirect influenceswhich occasionally have far-reaching consequences andcall for careful examination. In general, however,especially in this country, the principal interest of theforeign exchanges is iu connection with the rate ofdiscount.

14. Short and long exchange.And this leads meto notice the other term which arose in my New Yorkillustrationnamely, cable transfer. In itself thisterm requires no explanation, but it leads up to apoint of importancenamely, the difference betweenthe short exchange or exchange at sight, and the longexchange or after so many days' notice. This distinc-tion also, it will be found, is closely connected withthe rate of discount.

The typical instrument for settling internationalindebtedness is, as already pointed out, the bill ofexchange, which arises from an actual trade transaction.If, then, this bill of exchange is not payable at sight,but, say for simplicity, after three months, its presentvalue is subject to three months' discount. Accord-ingly, if in New York a cable transfer on Londoncould be bought, say at par i.e., if for one poundpayable at once in London 4 866 dollars would be


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THE FOREIGN EXCHANGES 35given, then for a pound payable after sixty days thediscount must be subtracted. Thus, referring to theforeign rates of exchange in London quoted in theEconomist at the date of writing, the New Yorkcable transfer on London is l = 4-87|-, wliile thelong exchange at sixty days is 4-84f.

15. Inflxience of rate of interest.It may be worthwhile to consider this case with an example in which aremittance is sent from London (say) to Paris. If theLondon debtor can purchase for a pound a cheque forso many francs payable on demand, he will require forhis pound so many more francs in a bill which mustbe discounted, and how many more francs will dependon the rate of discount in Paris. Thus, in the samenumber of the Economist, I find in the London courseof exchange Paris cheques are quoted at 2512^, whichhappens to be very nearly the gold point against us,and bills at three months are quoted at 25-32|-. Theprincipal cause of the difference is the rate of discountin Paris.

In certain cases, moreover, the rate of interest, orrather the relative rate, in the country which drawsthe bills may be of importance in influencing the courseof exchanges. Suppose, for example, that the rate ofdiscount in Paris is much lower than in London, orsuppose that the Bank of England raises its rateand that the conditions of the London money marketare such that the market rate in London rises to thesame extent, or it may be even more. What would bethe effect on the exchange between Paris and London ?One natural and obvious result would be that Paris

would wish to send for investment in


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36 BANKERS' MONEYLondon at the more profitable rate, and thus theexchange would turnso farin our favour. Thisnatural and obvious effect would be intensified by aless obvious cause. Bills drawn on London by Parishaving their present value calculated at the Londonrate, would be a good investment for Paris bankers.Thus they would compete for these billsnot forremittance but for investment. This extra demand,however, must so far turn the exchanges in ourfavour still more, or at least make the movement morespeedy. It is, of course, the difference in the rates inthe two places which must be considered in thisconnection.

As I indicated before, as regards this country, themovement in the exchanges is generally only ofinterest in connection with the bank rate. If theexchanges turn against this country so that gold isexported, or even if a drain is anticipated, the bankrate is raised, and directly or indirectly this rise mayoperate on mercantile advances generally.*

I 16. Of state of credit.The foreign exchanges mayalso be affected by the state of credit in both thecountries considered. This is obvious from the fact thatthe documents used for remittance are credit docu-ments, and our typical bill of exchange depends ulti-mately on the credit both of the drawer and the accep-tor. The intervention of banks also has become of lateyears of more and more importance, and all bankingrests on credit. The rate of exchange between anytwo centres, say London and Paris, will also beaffected by the rates subsisting between these centres

* Compare the chapter on The Rate of Interest.


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THE FOREIGN EXCHANGES 37and other centres with which they have transactions.The principles applied, however, are the same, andindeed for purposes of theory we may regard the restof the world as one great foreign country.

Similarly the operations of banks in adding stabilityto the exchanges by creating paper for remittances topay for imports, which are really paid for by exportsat a later date,those operations present no theoreticaldifficulty.

17. Variable effects of depreciation of currency.It seems to be otherwise, however, when we come tothe case of the depreciation of currency and its effectson foreign trade. The problem is simple enough sofar as the actual premium on gold is concerned. If asovereign will buy so many francs at the rate of themint par, and if the francs are depreciated, thesovereign must obtain so many more to the extent ofthe depreciation. If the depreciation is considerable,it may be said that the apparent course of theexchanges depends mainly on the extent of thedepreciation. The other causes of fluctuation are stillthere, but they are altogether hidden by the premiumon gold. There are also in this case no limits to thenominal or apparent rise in the exchangethat is,taking the sovereign as fixed and the depreciatedcurrency as variable.

So far the matter is simple enough. There is,however, a point involved which is by no meanssimple in theory, and is yet of very great practicalimportance. The question is this: Suppose thecurrency of a country, which was formerly on a goldbasis, becomes depreciated owing to excessive issues


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38 BANKERS' MONEYof inconvertible notes, will this depreciation of itselftend to encourage exports or diminish exports (and,conversely, of imports), or will it have no real effect ?I believe that the correct answer to this problem is,that the effect will depend altogether on the way inwhich the depreciation takes place, and that theanswer must be different in the different eases.

18. First case.First, take the case in which thenotes become discredited almost as soon as they areissuedthat is to say, suppose that long before thereare such abundant issues as to cause an inflation ofprices through the increase in the quantity of currencya premium on gold arises. What will happen asregards exports and imports ? People exporting tothe country in question, and selling for the inconvert-ible paper which is, we may suppose, practically theonly currency, will only receive about the same priceas before, but, owing to the premium on gold, theywill not obtain the same amount of gold to take backor send back to their own country.

Therefore, exports to the country with the depreci-ated notes will be checked. Conversely, exportersfrom that country will sell for the old prices reckonedin gold in other countries, and with this gold they canpurchase more currency at home, and thus there willbe a stimulus, so far, to exports from the country inquestion.

I 19. Second ease.But take now another case.It might happen that prices in the country consideredrose more than was indicated by the premium on gold.The Government might make its issues with greatprudence, and float a mass of this paper and gradually


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THE FOREIGN EXCHANGES 39inflate prices before any danger of inconvertibility wassuspected, and thus without any premium on goldarising, and later, for a time at any rate, the inflationof prices might exceed the premium on gold.

In this case exports to this country would be stimu-lated, and exports from it would be checked ; and thefinal resultwould be that the adverse balance must be metin gold; then, as gold left the country the premium wouldrise, and ultimately it is quite possible that the effect ofthe depreciation might come to be exactly the opposite.

20. Third case.Take now a third case. If allthe parties concerned were practically to ignore thedepreciation, and conduct all their exchanges on a goldbasis, there would be no stimulating influence eitherway. But it is very doubtful if this theoretical resultis ever attained in practice. The people who reallypay for the imports are the consumers in the countrywith the depreciated paper, and the people who musteventually receive the money for the exports from thiscountry are the producers there, and both consumersand producers in the country concerned are in generalobliged to use this depreciated paper.

The foreign trader may insure himself against riskby making his bargains on a sterling basis of exchange,but he cannot prevent the depreciation affecting the con-ditions of demand and supply in the internal marketsof this country, and these markets are influenced bythe extent and by the mode of the depreciation, andthus indirectly the foreigner also must be affected.

S 21. The silver exchanges.The use of inconvertiblepaper is of very frequent occurrence, and has importantindirect consequences, In recent years also the


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40 BANKERS' MONEYfluctuation in the rates of exchange between gold andsilver have been of even greater interest and importance.The same principles must be applied, mutatis mutandis,as in the case of inconvertible paper. It would,however, be hopeless at the end of a lecture of thiskiad to tire your attention by trying to show the wayin which the principles must be applied, or to discoverto which of the three cases of depreciated paper thedepreciation of silver may be likened. To those whowish to work at a good monetary problem I canheartily recommend the subject of the effect (if any)of the depreciation of silver on the prices of com-modities in gold-using countries.

22. Summary of results.As the subject treatedin this chapter is necessarily both technical and com-plex, it may be useful if, m conclusion, I restate brieflythe principal positions.

The term foreign exchanges refers to thesettlement of international debts. These debts areexpressed in the moneys of the respective countries.Accordingly, the first thing is to find out the relativevalues of these moneys accordiag to the fine gold theycontain. This gives the mint par.

Next, we note that the comsumer in one countrymust in some way pay the producer in the otherthatis, he must remit money or something that wiU commandmoneyin the typical case, a bill of exchange. Theprice of these bills varies with the demand and supply,and the limits of the fluctuations are given by thecost of sending gold or of sending for gold. Thisgives the gold points or specie points.

In most cases these fluctuations in the exchanges


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THE FOREIGN EXCHANGES 41are only of interest to mercliauts directly engaged inforeign trade, and, being within narrow limits, are oflittle importance. But whenever the course of theexchanges is such that a drain of gold sets in, or isfeared, there is a riseand it may be a sharp anda great risein the hank rate. Such a movementmay affect trade generally, and in extreme cases leadto a commercial crisis.

Another case is also of general importance. If thecurrency of one country becomes depreciated, thepremium on gold will rise to the extent of thedepreciation, and there are practically no limits tothis rise. The British dealer with the foreign countrywhich has the depreciated currency may make himselfsafe by making his bargains on a sterling basis, but hecannot avoid the indirect effects of this depreciation.Under various conditions the depreciation of thecurrency of a country may stimulate or may diminishits exports. It reaUy depends on the way in whichthe depreciation arises.A similar argument may be applied when onecountry has a silver standard and the other gold.The effect of the depreciation of silver upon the tradeof silver-using countries depends on the causes andmethods of the depreciation. The assertion that thedepreciation of a currency acts as a bounty on exportsmay be true in some cases; in others, however, itwould act like a tax on exports, and in any case theseeffects tend to disappear in time.

The great evil of depreciation is that with everychange in the degree of the depreciation a new setof disturbances may arise.


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CHAPTER IIITHE KATE OF INTEREST

1. Interest on money and on capital dis-tinguished.It was shown in the first chapter ofthis bjjok that the term money is used with avariety of meanings. If, then, we take the term interest in what seems the most simple and obvioussensenamely, as the price paid for the use of aloan of money for a timein order to get at the realor underlying meaning we must decide what is tobe understood by money in this connection. Wefind on the first inspection that very often in thoseloans the money is merely an intermediary, andthat what is really lent and borrowedwhen thewhole transaction is completeis so much capital.Take, for example, the common case of the conversionof some private manufacturing concern into a limitedcompany. The company, in effect, borrows so muchmoney from the investors and pays in return so muchinterest of various kinds and under various conditions.But this interest is only earned by converting the


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THE RATE OF INTEREST 43money into various forms of productive capital.The money in this case is only, to begin with, a mediumof exchange, and the essence of the loan is capital.

In other cases, however, the primary object of theloan is not to obtain capital for extending production,but to obtain money in the sense of legal tender,or at least in some form that will be accepted assuchthe object being to meet some prior monetaryobligation. In times of financial crisis, for example,many houses may be perfectly solvent if only timeis allowed for realisation, but they fail simply becausethey cannot meet in money their monetary obligations.Accordingly, most recent writers on the principles ofeconomics have drawn a sharp distinction betweeninterest on loanable capital and interest on loanable money, although, unfortunately, writers on moneyarticles constantly use the terms money and capital as interchangeable.

2. Illustrations.In an examination of causesand principles the distinction is fundamental, and itis so also as a rule in practical business. If we takethe Bank of England rate as typical or representativeof the rate charged for loanable money as such, andthe rate on first-class securities or debentures astypical or representative of the interest on loanablecapital, we find that there is often a considerabledifference between the two rates. Whilst interest oncapital is relatively very steadythe yield toconsols not varying perhaps one per cent, in fiftyyearsthe bank rate may sometimes be above andsometimes below, and the changes are often very


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44 BANKERS' MONEYsame period between 2 and 10 per cent. Thesedifferences are not to be explained by any differencein security or in risk. In both cases the securityfor all practical purposes may be considered perfect.I propose, then, to deal separately with these twokinds of interest, and to notice later on the interactionthere may be between the two rates.

3. Difficulties in definition of capital.I haveused the expression interest on capital, but a veryslight application of economic analysis shows thatcapital itself is even more difficult of definition thanmoney. It would be hopeless, by way of introductionto a subject sufBiciently complex already, to enterinto all those difficulties, but by way of illustrationI may mention the two most popular meanings.Some peopleand they may quote the authority ofAdam Smithlook on capital as wealth that yieldsa revenue ; othersand they may quote J. S. Millregard capital as wealth used in production. In somecases those differences of definition are of no practicalimportance, because the capital yields revenueby being used in production ; but in other cases theremight be great differences between capital and non-capital according to the definition. The recent warloan, for example, yields a revenue to the lenders, and,for all we know, may yield a revenue for centuriesbut the corresponding capital has been used for themost part in the destruction of life and property, andit would be too severe a strain on language, even witha plentiful use of those convenient terms indirectly and fructifying, to include destruction by war underthe term economic production, and cases might be


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THE RATE OF INTEREST 45multiplied indefinitely. Take, again, the borrowingsof various local authorities on the security of therates. The loans will yield a revenue and so farrank as capital to the creditors so long as the citiesand towns yield sufficient rates; but it is quitepossible that, considered from the point of view ofproduction, the capital will very soon melt awayaltogether. Those examples show that the terms loanable capital, and consequently interest onloanable capital, are by no means so simple as theyappear at first sight. And the deeper we carry theanalysis, whether ia theory or in practice, so muchgreater do the difficulties become. Eecently thehighest legal talent of the country has been exercisedin determining what is the nature of capital and howcapital is related to dividends.

In whatever way we regard it, the answer to thequestion What is capital ? presents difficulties intheory, in business, and ia law. These difficultiesmay be partly surmounted and the nature andmeaning of capital and interest on capital madeclear by taking different cases. Capital, like money,has different functions.

S 4. Interest on capital divided into v&OJlT-interestand LOAN-interestOf vnOFlT-interest.The intereston capital as such, in which the money is onlyused as an intermediary, may be divided first ofall into two great classes which we may call profit-interest and Zoa?i-interest.

Pro/i-interest arises in this way. The owner ofany form of capital who employs it in production willexpect to gain certain gross profits. He will expect


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46 BANKERS' MONEYsomething in the form of reward for his labour andenterprise, which economists call wages of managementor superintendence ; he will also expect on the averageof a mass of transactions or over a period of time tocover all sorts of depreciation of his capitalhis grossprofit must provide for insurance against risk; andbesides these two elements he will expect somethingby way of interest. The three elements are bestdistinguished in the case of a joint-stock company.In this case the wages of superintendence appear in theshape of directors' fees and salaries ; the insuranceagainst risk is represented by the reserve fund, or itmay be by actual insurances under that name; andthe balance which goes in dividends to the shareholdersrepresents the interest on their capital. This interestagain differs according to the security e.g., debentures,various preferences, ordinary shares, etc. ; but after allallowances there remains an element which may becalled pure interestthat is, interest on capital inwhich there is practically no risk and no trouble ofmanagement, although the interest is, so to speak,produced in the business. If any industry gets intoa depressed condition, it is quite possible that thegross profits may not yield any interest after allowingfor management and depreciation, and, of course, thecapital may disappear altogether; but over a periodof years it may be said that the productive capitalof the country yields, on the whole, a certain rate ofpure interest besides the other elements in gross profit.

5. JjOKS-interest. Zoa.-interest on capital isconsidered from a point of view in which directproduction is of a secondary or, it may be, of no


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THE RATE OF INTEREST 47importance. People may be unable or unwilling toemploy their capital themselves, and they lend it toothers, receiving so much interest for its use. Inthis case it is indifferent to the lender what use ismade of his capital ; it may be wasted by anextravagant landlord or by an improvident governmentbut so long as the interest is obtainable from otherfunds at the disposal of the debtor this makes nodifference. The interest on large amounts of capitalis paid out of the produce of rates and taxes, andcannot be considered as earned by the productiveemployment of the capital concerned ; and in othercases the interest is really paid out of other capitalbelonging to the debtor.

If, however, we leave out of account for the presentthe case of foreign investments and consider onecountry in isolation, it is plain that all this interestobtained on loans must itself in some way be produced inthe country. The Zoaw-interest may in some cases bea simple transfer of jjr'o/i^-interest, as in the case ofvarious companies or of private firms, so far as theywork with borrowed capital. This case is simplebut the tew-interest may also come, as alreadyindicated, from other sourcesfrom the general incomeof the tax-payers or from the gradual dissipation ofother forms of capital. Zoaw-interest of this kindwhatever form it may assume, that is to say if it isnot obtained from the productive employment of thecorresponding capitalis of the nature of a tax uponproductive capital and industry ; and if all the capitalof a country were advanced in unproductive loans ofthis kind the country would speedily be ruined.


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48 BANKERS' MONEYIf the capital is sent for investment in foreign

countries, the case is in some ways similar to loansfor unproductive purposes at home. In this caseonly the interest is received by the lending countryand thus from the national standpoint there is so fara reduction of income as regards the profits andwages which arise from the employment of capital inhome industries.Consider now the causes that determine thedirection of the employment of loanable capital. Itis clear that after allowing for security, facility forinvestment, and other conditions, the rate of intereston all kinds of capital must tend to equality.

6. Interaction between the two rates.Accord-ingly there must be a constant interaction betweenloans for productive and for unproductive purposes.If trade is flourishing, and gross profits, includingprofit-interest, are advancing, capital is directed to-wards industrial concerns ; and conversely, with adepression of trade and profit-interest declining,capital is turned to non-industrial loans or to advancesto foreign states on which the yield is a little better.

7. Interest is a price and subject to the laws ofpricesCompetition and monopoly.Interest for manypurposes is best regarded as the price paid for the useof capital. And if .interest is once looked on as aprice, it comes under the general principles determin-ing prices. In the course of progress the tendency ofprices is to come under the influence of competition.And if we take a rapid glance over the actual historyof industrial progress, we find that one of the moststriking results is the substitution of the principle of


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THE RATE OF INTEREST 49competition for the principle of monopoly in thedetermination of interest. In old societies interestwas usually regarded as immoral and sinful, becausein most cases it represented what was extractedby the usurer from the absolute necessities of theborrower. Under modern conditions the rate variesprincipally with the security that is offered, and notaccording to the particular necessities of the borrower.The borrower might be willing for his purposes to pay10 per cent, a-month ; but if the security is satis-factory he may have to pay less than 5 per cent, a-year.

8. Widening of markets with progress.Anotherprinciple that becomes prominent in the course ofindustrial progress is that prices are determined moreand more by wider and wider markets. In oldersocieties there were numbers of local markets, andprices were mainly determined by the local conditionsaffecting demand and supply. Under present con-ditions, for many commodities using the term inan extended sensethere is a world-wide market.The prices of wheat, of cotton, of silverto take butthree instancesare determined by the conditions ofdemand and supply all the world over. A strikingexample was afforded by wheat in the year 1879.This year was the coldest of which there is any instru-mental record in these islands, and there was a greatfailure of the harvest. So easily, however, was thedeficit met, that the price of wheat only rose to 53s. 6d.,as compared with 51s. as the average of 1871-1880.Even at the beginning of the nineteenth centurysuch a deficiency in the harvest might have doubledor trebled the price.


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50 BANKERS' MONEYThe point of the illustration is this, that the price

of loanable capitalthat is, interestin the course ofindustrial progress has also come to be subject toconditions of demand and supply all the world over,and no longer depends on local or even nationalmarkets. The rate of interest on loanable capital inthis country depends, to say the least, very largelyupon the rates that may be obtained in othercountries ; and with every development of the means ofcommunication, including the diffusion of knowledge orthe extension of publicity in the world's great marketswith every increase in the security afforded by theadvance of international law, and of the recognition byindividuals and by governments of the saoredness or thecompelling force of contracts,loanable capital willcome more and more under these great world-influences.

I proceed, now, to notice very briefly some of theprincipal causes affecting, first the supply, and nextthe demand, for loanable capital as distinguished from money.

9. The supply of loanable capitalProduction.As regards the supply of capital, the causes may bedivided into two groups. First, there are all thecauses which tend to increase production or todiminish cost. A given amount of labour and also agiven amount of coal will, with appropriate machinery,produce more than ever before, and, in all probability,this increase in the powers of production will continue.Again, the great improvements in transport, in security,and, I may add, in knowledge, have opened up abundantnew sources for supplies of various forms of raw


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THE RATE OF INTEREST 51material, including the raw material of food. Thisprocess seems also likely to continue, and man's powerover nature to be further extended to a great degree.There is also to be considered the continuous utili-sation of waste products, and the adoption andextension of multitudes of economies. And perhapsthe greatest cause of allif we are to considerthe world's supply of capitalis the advance of allthe other nations on the roads made by the pioneersof civilisation. China may follow Japan, as Japan hasfollowed the West.

10. Effective desire of accumulation.But whetherthis enormous increase of wealth will be turned into capital, or will be consumed directly and unproduc-tively, depends on a second group of causes. These causesare mainly moral and intellectual, but they are equallyreal and important. Such, for example, are the causeswhich are summarised under the phrase the effectivedesire of accumulation. There can be no doubt that,taking a wide survey, these causes tend to increasein force. The people in civilised states look furtherinto the future and they make more provision for thefuture. This is shown not only by the growth of allforms of insurance, but by the growth of educationand of morality, and by the desire to rise in the socialscale. The better members of the lower social classesstrive more and more to rise into the higher, andone potent means is by saving a certain amount ofcapital.

But it is not so much on the moral as on theintellectual side that the creation of capital is affectedby modern progress. People are willing to wait


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52 BANKERS' MONEYlonger and to take more roundabout methods to securetheir ends, and in the last resort that means they putmore and more wealth into the form of capital.

11. Security.^The great cause affecting theaccumulation of capital that always appears in everypart of the inquiry is security. Security to enjoy orto dispose of the fruits of saving is a necessary con-dition to the creation of capital. Under presentconditions the increase of security as affecting theaccumulation of capital may be specially observed intwo ways. First, in the countries that are in the vanof progress more and more undertakings are conductedon a sound basis. We are apt to lay too much stress onstriking failures or gigantic frauds, but there is noquestion that relatively the losses of business are lessthan ever before, or the losses that occur are moreeasily repaired. The ordinary increase of capital inthis country has been estimated at 200 million poundsper annum.*

But, secondly, the influence of the increase ofsecurity is still more noticeable in backward and newcountries. More and more countries are offeringsecurity for the creation of capital, and with thegrowth of security there is at once an increase inproductive power. Thus, from whatever point it isregarded, there is no question that, as far as supplyis concerned, the tendency is for a continuous andconsiderable increase of capital.

12. Demand for capital, and first for unpro-ductive purposes.Let us now consider demand, and,

* Such estimates are necessarily very rough, tut they suffice forcomparative purposes. See Giffen's Orowth of Capital.


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THE RATE OF INTEREST 53in the first place, the demand on the part of unpro-ductive consumers. Amongst these the most importantare the governments of the world, hoth national andmunicipal. The national debts of the world are saidto have a par value of about 6000 millions sterling,and have mainly been incurred for unproductive pur-poses, especially for war or for armaments, andaccordingly the interest is not derived from theproductive employment of the original capital. Localdebts to a greater extent represent productive capital,but still in this case also a large part is unproductivethat is to say, the loans do not produce their owninterest. On the other hand, however, a large partof this expenditure, though classed as unproductive, inreality adds greatly to the efficiency o

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