Such a reserve as we have seen is kept to meet sudden and unexpected demands. If the bankers of a country are asked for much more than is commonly wanted, then this reserve must be resorted to. What then are these extra demands? and how is this extra reserve to be used? Speaking broadly, these extra demands are of two kinds—one from abroad to meet foreign payments requisite to pay large and unusual foreign debts, and the other from at home to meet sudden apprehension or panic arising in any manner, rational or irrational.

No country has ever been so exposed as England to a foreign demand on its banking reserve, not only because at present England is a large borrower from foreign nations, but also (and much more) because no nation has ever had a foreign trade of such magnitude, in such varied objects, or so ramified through the world. The ordinary foreign trade of a country requires no cash; the exports on one side balance the imports on the other. But a sudden trade of import like the import of foreign corn after a bad harvestor (what is much less common, though there are cases of it) the cessation of any great export, causes a balance to become due, which must be paid in cash.

Now, the only source from which large sums of cash can be withdrawn in countries where banking is at all developed, is a 'bank reserve.' In England especially, except a few sums of no very considerable amount held by bullion dealers in the course of their business, there are no sums worth mentioning in cash out of the banks; an ordinary person could hardly pay a serious sum without going to some bank, even if he spent a month in trying. All persons who wish to pay a large sum in cash trench of necessity on the banking reserve. But then what is 'cash?' Within a country the action of a Government can settle the quantity, and therefore the value, of its currency; but outside its own country, no Government can do so. Bullion is the cash' of international trade; paper currencies are of no use there, and coins pass only as they contain more or less bullion.

When then the legal tender of a country is purely metallic, all that is necessary is that banks should keep a sufficient store of that 'legal tender.' But when the 'legal tender' is partly metal and partly paper, it is necessary that the paper 'legal tender'—the bank note—should be convertible into bullion. And here I should pass my limits, and enter on the theory of Peel's Act if I began to discuss the conditions of convertibility. I deal only with the primary pre-requisite of effectual foreign payments—a sufficient supply of the local legal tender; with the afterstep—the change of the local legal tender into the universally acceptable commodity cannot deal.

What I have to deal with is, for the present, ample enough. The Bank of England must keep a reserve of 'legal tender' to be used for foreign payments if itself fit, and to be used in obtaining bullion if itself unfit. And foreign payments are sometimes very large, and often very sudden. The 'cotton drain,' as it is called—the drain to the East to pay for Indian cotton during the American Civil War took many millions from this country for a series of years. A bad harvest must take millions in a single year. In order to find such great sums, the Bank of England requires the steady use of an effectual instrument.

That instrument is the elevation of the rate of interest. If the interest of money be raised, it is proved by experience that money does come to Lombard Street, and theory shows that it ought to come. To fully explain the matter I must go deep into the theory of the exchanges, but the general notion is plain enough. Loanable capital, like every other commodity, comes where there is most to be made of it. Continental bankers and others instantly send great sums here, as soon as the rate of interest shows that it can be done profitably. While English credit is good, a rise of the value of money in Lombard Street immediately by a banking operation brings money to Lombard Street. And there is also a slower mercantile operation. The rise in the rate of discount acts immediately on the trade of this country. Prices fall here; in consequence imports are diminished, exports are increased, and, therefore, there is more likelihood of a balance in bullion coming to this country after the rise in the rate than there was before.

Whatever persons—one bank or many banks—in any country hold the banking reserve of that country, ought at the very beginning of an unfavourable foreign exchange at once to raise the rate of interest, so as to prevent their reserve from being diminished farther, and so as to replenish it by imports of bullion.

This duty, up to about the year 1860, the Bank of England did not perform at all, as I shall show farther on. A more miserable history can hardly be found than that of the attempts of the Bank—if indeed they can be called attempts—to keep a reserve and to manage a foreign drain between the year 1819 (when cash payments were resumed by the Bank, and when our modern Money Market may be said to begin) and the year 1857. The panic of that year for the first time taught the Bank directors wisdom, and converted them to sound principles. The present policy of the Bank is an infinite improvement on the policy before 1857: the two must not be for an instant confounded; but nevertheless, as I shall hereafter show, the present policy is now still most defective, and much discussion and much effort, will be wanted before that policy becomes what it ought to be.

A domestic drain is very different. Such a drain arises from a disturbance of credit within the country, and the difficulty of dealing with it is the greater, because it is often caused, or at least often enhanced, by a foreign drain. Times without number the public have been alarmed mainly because they saw that the Banking reserve was already low, and that it was daily getting lower. The two maladies—an external drain and an internal—often attack the money market at once. What then ought to be done?

In opposition to what might be at first sight supposed, the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely. The first instinct of everyone is the contrary. There being a large demand on a fund which you want to preserve, the most obvious way to preserve it is to hoard it—to get in as much as you can, and to let nothing go out which you can help. But every banker knows that this is not the way to diminish discredit. This discredit means, 'an opinion that you have not got any money,' and to dissipate that opinion, you must, if possible, show that you have money: you must employ it for the public benefit in order that the public may know that you have it. The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.

Ordinarily discredit does not at first settle on any particular bank, still less does it at first concentrate itself on the bank or banks holding the principal cash reserve. These banks are almost sure to be those in best credit, or they would not be in that position, and, having the reserve, they are likely to look stronger and seem stronger than any others. At first, incipient panic amounts to a kind of vague conversation: Is A. B. as good as he used to be? Has not C. D. lost money? and a thousand such questions. A hundred people are talked about, and a thousand think,—'Am I talked about, or am I not?' 'Is my credit as good as it used to be, or is it less?' And every day, as a panic grows, this floating suspicion becomes both more intense and more diffused; it attacks more persons; and attacks them all more virulently than at first. All men of experience, therefore, try to strengthen themselves,' as it is called, in the early stage of a panic; they borrow money while they can; they come to their banker and offer bills for discount, which commonly they would not have offered for days or weeks to come. And if the merchant be a regular customer, a banker does not like to refuse, because if he does he will be said, or may be said, to be in want of money, and so may attract the panic to himself. Not only merchants but all persons under pecuniary liabilities—present or imminent—feel this wish to 'strengthen themselves,' and in proportion to those liabilities. Especially is this the case with what may be called the auxiliary dealers in credit. Under any system of banking there will always group themselves about the main bank or banks (in which is kept the reserve) a crowd of smaller money dealers, who watch the minutae of bills, look into special securities which busy bankers have not time for, and so gain a livelihood. As business grows, the number of such subsidiary persons augments. The various modes in which money may be lent have each their peculiarities, and persons who devote themselves to one only lend in that way more safely, and therefore more cheaply. In time of panic, these subordinate dealers in money will always come to the principal dealers. In ordinary times, the intercourse between the two is probably close enough. The little dealer is probably in the habit of pledging his 'securities' to the larger dealer at a rate less than he has himself charged, and of running into the market to lend again. His time and brains are his principal capital, and he wants to be always using them. But in times of incipient panic, the minor money dealer always becomes alarmed. His credit is never very established or very wide; he always fears that he may be the person on whom current suspicion will fasten, and often he is so. Accordingly he asks the larger dealer for advances. A number of such persons ask all the large dealers—those who have the money—the holders of the reserve. And then the plain problem before the great dealers comes to be 'How shall we best protect ourselves? No doubt the immediate advance to these second-class dealers is annoying, but may not the refusal of it even be dangerous? A panic grows by what it feeds on; if it devours these second-class men, shall we, the first class, be safe?'

A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to 'this man and that man,' whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. 'We lent it,' said Mr. Harman, on behalf of the Bank of England, 'by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.' After a day or two of this treatment, the entire panic subsided, and the 'City' was quite calm.

The problem of managing a panic must not be thought of as mainly a 'banking' problem. It is primarily a mercantile one. All merchants are under liabilities; they have bills to meet soon, and they can only pay those bills by discounting bills on other merchants. In other words, all merchants are dependent on borrowing money, and large merchants are dependent on borrowing much money. At the slightest symptom of panic many merchants want to borrow more than usual; they think they will supply themselves with the means of meeting their bills while those means are still forthcoming. If the bankers gratify the merchants, they must lend largely just when they like it least; if they do not gratify them, there is a panic.

On the surface there seems a great inconsistency in all this. First, you establish in some bank or banks a certain reserve; you make of it or them a kind of ultimate treasury, where the last shilling of the country is deposited and kept. And then you go on to say that this final treasury is also to be the last lending-house; that out of it unbounded, or at any rate immense, advances are to be made when no once else lends. This seems like saying—first, that the reserve should be kept, and then that it should not be kept. But there is no puzzle in the matter. The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country. It is not unreasonable that our ultimate treasure in particular cases should be lent; on the contrary, we keep that treasure for the very reason that in particular cases it should be lent.

When reduced to abstract principle, the subject comes to this. An 'alarm' is an opinion that the money of certain persons will not pay their creditors when those creditors want to be paid. If possible, that alarm is best met by enabling those persons to pay their creditors to the very moment. For this purpose only a little money is wanted. If that alarm is not so met, it aggravates into a panic, which is an opinion that most people, or very many people, will not pay their creditors; and this too can only be met by enabling all those persons to pay what they owe, which takes a great deal of money. No one has enough money, or anything like enough, but the holders of the bank reserve.

Not that the help so given by the banks holding that reserve necessarily diminishes it. Very commonly the panic extends as far, or almost as far, as the bank or banks which hold the reserve, but does not touch it or them at all. In this case it is enough if the dominant bank or banks, so to speak, pledge their credit for those who want it. Under our present system it is often quite enough that a merchant or a banker gets the advance made to him put to his credit in the books of the Bank of England; he may never draw a cheque on it, or, if he does, that cheque may come in again to the credit of some other customer, who lets it remain on his account. An increase of loans at such times is often an increase of the liabilities of the bank, not a diminution of its reserve. Just so before 1844, an issue of notes, as in to quell a panic entirely internal did not diminish the bullion reserve. The notes went out, but they did not return. They were issued as loans to the public, but the public wanted no more; they never presented them for payment; they never asked that sovereigns should be given for them. But the acceptance of a great liability during an augmenting alarm, though not as bad as an equal advance of cash, is the thing next worst. At any moment the cash may be demanded. Supposing the panic to grow, it will be demanded, and the reserve will be lessened accordingly.

No doubt all precautions may, in the end, be unavailing. 'On extraordinary occasions,' says Ricardo, 'a general panic may seize the country, when every one becomes desirous of possessing himself of the precious metals as the most convenient mode of realising or concealing his property, against such panic banks have no security on any system.' The bank or banks which hold the reserve may last a little longer than the others; but if apprehension pass a certain bound, they must perish too. The use of credit is, that it enables debtors to use a certain part of the money their creditors have lent them. If all those creditors demand all that money at once, they cannot have it, for that which their debtors have used, is for the time employed, and not to be obtained. With the advantages of credit we must take the disadvantages too; but to lessen them as much as we can, we must keep a great store of ready money always available, and advance out of it very freely in periods of panic, and in times of incipient alarm.

The management of the Money Market is the more difficult, because, as has been said, periods of internal panic and external demand for bullion commonly occur together. The foreign drain empties the Bank till, and that emptiness, and the resulting rise in the rate of discount, tend to frighten the market. The holders of the reserve have, therefore, to treat two opposite maladies at once—one requiring stringent remedies, and especially a rapid rise in the rate of interest; and the other, an alleviative treatment with large and ready loans.

Before we had much specific experience, it was not easy to prescribe for this compound disease; but now we know how to deal with it. We must look first to the foreign drain, and raise the rate of interest as high as may be necessary. Unless you can stop the foreign export, you cannot allay the domestic alarm. The Bank will get poorer and poorer, and its poverty will protract or renew the apprehension. And at the rate of interest so raised, the holders—one or more-of the final Bank reserve must lend freely. Very large loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain. Any notion that money is not to be had, or that it may not be had at any price, only raises alarm to panic and enhances panic to madness. But though the rule is clear, the greatest delicacy, the finest and best skilled judgment, are needed to deal at once with such great and contrary evils.

And great as is the delicacy of such a problem in all countries, it is far greater in England now than it was or is elsewhere. The strain thrown by a panic on the final bank reserve is proportional to the magnitude of a country's commerce, and to the number and size of the dependent banks—banks, that is, holding no cash reserve—that are grouped around the central bank or banks. And in both respects our system causes a stupendous strain. The magnitude of our commerce, and the number and magnitude of the banks which depend on the Bank of England, are undeniable. There are very many more persons under great liabilities than there are, or ever were, anywhere else. At the commencement of every panic, all persons under such liabilities try to supply themselves with the means of meeting those liabilities while they can. This causes a great demand for new loans. And so far from being able to meet it, the bankers who do not keep an extra reserve at that time borrow largely, or do not renew large loans—very likely do both.

London bankers, other than the Bank of England, effect this in several ways. First, they have probably discounted bills to a large amount for the bill brokers, and if these bills are paid, they decline discounting any others to replace them. The directors of the London and Westminster Bank had, in the panic of 1857, discounted millions of such bills, and they justly said that if those bills were paid they would have an amount of cash far more than sufficient for any demand. But how were those bills to be paid? Some one else must lend the money to pay them. The mercantile community could not on a sudden bear to lose so large a sum of borrowed money; they have been used to rely on it, and they could not carry on their business without it. Least of all could they bear it at the beginning of a panic, when everybody wants more money than usual. Speaking broadly, those bills can only be paid by the discount of other bills. When the bills (suppose) of a Manchester warehouseman which he gave to the manufacturer become due, he cannot, as a rule, pay for them at once in cash; he has bought on credit, and he has sold on credit. He is but a middleman. To pay his own bill to the maker of the goods, he must discount the bills he has received from the shopkeepers to whom he has sold the goods; but if there is a sudden cessation in the means of discount, he will not be able to discount them. All our mercantile community must obtain new loans to pay old debts. If some one else did not pour into the market the money which the banks like the London and Westminster Bank take out of it, the bills held by the London and Westminster Bank could not be paid.

Who then is to pour in the new money? Certainly not the bill brokers. They have been used to re-discount with such banks as the London and Westminster millions of bills, and if they see that they are not likely to be able to re-discount those bills, they instantly protect themselves and do not discount them. Their business does not allow them to keep much cash unemployed. They give interest for all the money deposited with them—an interest often nearly approaching the interest they can charge; as they can only keep a small reserve a panic tells on them more quickly than on anyone else. They stop their discounts, or much diminish their discounts, immediately. There is no new money to be had from them, and the only place at which they can have it is the Bank of England.

There is even a simpler case: the banker who is uncertain of his credit, and wants to increase his cash, may have money on deposit at the bill brokers. If he wants to replenish his reserve, he may ask for it, suppose, just when the alarm is beginning. But if a great number of persons do this very suddenly, the bill brokers will not at once be able to pay without borrowing. They have excellent bills in their case, but these will not be due for some days; and the demand from the more or less alarmed bankers is for payment at once and to-day. Accordingly the bill broker takes refuge at the Bank of England the only place where at such a moment new money is to be had.

The case is just the same if the banker wants to sell Consols, or to call in money lent on Consols. These he reckons as part of his reserve. And in ordinary times nothing can be better. According to the saying, you 'can sell Consols on a Sunday.' In a time of no alarm, or in any alarm affecting that particular banker only, he can rely on such reserve without misgiving. But not so in a general panic. Then, if he wants to sell 500,000 L. worth of Consols, he will not find 500,000 L. of fresh money ready to come into the market. All ordinary bankers are wanting to sell, or thinking they may have to sell. The only resource is the Bank of England. In a great panic, Consols cannot be sold unless the Bank of England will advance to the buyer, and no buyer can obtain advances on Consols at such a time unless the Bank of England will lend to him.

The case is worse if the alarm is not confined to the great towns, but is diffused through the country. As a rule, country bankers only keep so much barren cash as is necessary for their common business. All the rest they leave at the bill brokers, or at the interest-giving banks, or invest in Consols and such securities. But in a panic they come to London and want this money. And it is only from the Bank of England that they can get it, for all the rest of London want their money for themselves.

If we remember that the liabilities of Lombard Street payable on demand are far larger than those of any like market, and that the liabilities of the country are greater still, we can conceive the magnitude of the pressure on the Bank of England when both Lombard Street and the country suddenly and at once come upon it for aid. No other bank was ever exposed to a demand so formidable, for none ever before kept the banking reserve for such a nation as the English. The mode in which the Bank of England meets this great responsibility is very curious. It unquestionably does make enormous advances in every panic

In 1847 the loans on 'private securities'

increased from 18,963,000 L to 20,409,000 L

1857 ditto ditto 20,404,000 L to 31,350,000 L

1866 ditto ditto 18,507,000 L to 33,447,000 L

But, on the other hand, as we have seen, though the Bank, more or less, does its duty, it does not distinctly acknowledge that it is its duty. We are apt to be solemnly told that the Banking Department of the Bank of England is only a bank like other banks—that it has no peculiar duty in times of panic—that it then is to look to itself alone, as other banks look. And there is this excuse for the Bank. Hitherto questions of banking have been so little discussed in comparison with questions of currency, that the duty of the Bank in time of panic has been put on a wrong ground.

It is imagined that because bank notes are a legal tender, the Bank has some peculiar duty to help other people. But bank notes are only a legal tender at the Issue Department, not at the Banking Department, and the accidental combination of the two departments in the same building gives the Banking Department no aid in meeting a panic. If the Issue Department were at Somerset House, and if it issued Government notes there, the position of the Banking Department under the present law would be exactly what it is now. No doubt, formerly the Bank of England could issue what it pleased, but that historical reminiscence makes it no stronger now that it can no longer so issue. We must deal with what is, not with what was.

And a still worse argument is also used. It is said that because the Bank of England keeps the 'State account' and is the Government banker, it is a sort of 'public institution' and ought to help everybody. But the custody of the taxes which have been collected and which wait to be expended is a duty quite apart from panics. The Government money may chance to be much or little when the panic comes. There is no relation or connection between the two. And the State, in getting the Bank to keep what money it may chance to have, or in borrowing of it what money it may chance to want, does not hire it to stop a panic or much help it if it tries.

The real reason has not been distinctly seen. As has been already said—but on account of its importance and perhaps its novelty it is worth saying again—whatever bank or banks keep the ultimate banking reserve of the country must lend that reserve most freely in time of apprehension, for that is one of the characteristic uses of the bank reserve, and the mode in which it attains one of the main ends for which it is kept. Whether rightly or wrongly, at present and in fact the Bank of England keeps our ultimate bank reserve, and therefore it must use it in this manner.

And though the Bank of England certainly do make great advances in time of panic, yet as they do not do so on any distinct principle, they naturally do it hesitatingly, reluctantly, and with misgiving. In 1847, even in 1866—the latest panic, and the one in which on the whole the Bank acted the best—there was nevertheless an instant when it was believed the Bank would not advance on Consols, or at least hesitated to advance on them. The moment this was reported in the City and telegraphed to the country, it made the panic indefinitely worse. In fact, to make large advances in this faltering way is to incur the evil of making them without obtaining the advantage. What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.

In truth, the Bank do not lend from the motives which should make a bank lend. The holders of the Bank reserve ought to lend at once and most freely in an incipient panic, because they fear destruction in the panic. They ought not to do it to serve others; they ought to do it to serve themselves. They ought to know that this bold policy is the only safe one, and for that reason they ought to choose it. But the Bank directors are not afraid. Even at the last moment they say that 'whatever happens to the community, they can preserve themselves.' Both in 1847 and 1857 (I believe also in 1866, though there is no printed evidence of it) the Bank directors contended that the Banking Department was quite safe though its reserve was nearly all gone, and that it could strengthen itself by selling securities and by refusing to discount. But this is a complete dream. The Bank of England could not sell 'securities,' for in an extreme panic there is no one else to buy securities. The Bank cannot stay still and wait till its bills are paid, and so fill its coffers, for unless it discounts equivalent bills, the bills which it has already discounted will not be paid. 'When the reserve in the ultimate bank or banks—those keeping the reserve—runs low, it cannot be augmented by the same means that other and dependent banks commonly adopt to maintain their reserve, for the dependent banks trust that at such moments the ultimate banks will be discounting more than usual and lending more than usual. But ultimate banks have no similar rear-guard to rely upon.

I shall have failed in my purpose if I have not proved that the system of entrusting all our reserve to a single board, like that of the Bank directors, is very anomalous; that it is very dangerous; that its bad consequences, though much felt, have not been fully seen; that they have been obscured by traditional arguments and hidden in the dust of ancient controversies.

But it will be said—What would be better? What other system could there be? We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system—that which would have sprung up if Government had let banking alone—is that of many banks of equal or not altogether unequal size. In all other trades competition brings the traders to a rough approximate equality. In cotton spinning, no single firm far and permanently outstrips the others. There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either. In Manchester, in Liverpool, and all through England, we have a great number of banks, each with a business more or less good, but we have no single bank with any sort of predominance; nor is there any such bank in Scotland. In the new world of Joint Stock Banks outside the Bank of England, we see much the same phenomenon. One or more get for a time a better business than the others, but no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping. A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without.