CHAPTER XIII

ELASTICITY OR INELASTICITY?

One of the great subjects of controversy, on which it seems impossible to arrive at a common agreement, is whether the so-called loanable fund is elastic or inelastic. It is admitted, I think, in a general sense that in order best to help the trade of the country, it should be elastic, that is, should be able to meet all the needs upon it. This certainly should be the province of banking, and, what is more, it should be the province of Governments to provide sufficient money to meet the expansion of trade. It would be a foolish policy to shackle and bind trade, to arrest its growth, by restricting facilities for its growth. It would be like a foolish parent binding the limbs of his child to stay their natural growth and to keep him a dwarf and a freak, unable to do the work of a mature man.

As the banking system practically performs the duties which in its non-existence would have to be performed by a Government, then it devolves upon this system to feed and succour commerce and to give it every facility and every means for expansion. When I said in Chapter XI that the transforming machinery should work with a pace equalling the creation of wealth, it was tantamount to the view expressed by others that the loanable fund of Lombard Street should be elastic.

Instead of calling it a loanable fund, a vast pool of money into which borrowers dip, a pool always filled by a perennial spring, I prefer to call it machinery for transforming fixed wealth into mobile capital, or currency. When I take my wealth to a bank I take it there because I cannot use it fruitfully as capital in its fixed form. As I wish to use it fruitfully the bank temporarily changes it into money for me, and in this new shape I can make full use of it.

Now, all who have practical experience of the banking system know there are times when the banks refuse to perform this office for wealth possessors. The machinery comes to a temporary stop. When we inquire why it has stopped, we learn that it is because the proportion of the reserve to the liabilities has fallen to too low a point. Others would say, it is because the pool had been drained too far, was being dried up, and that time must be given for money to flow in again. If we liken it to a pool we find that instead of it having been drained, it is really over-filled, and that what the banks desire to do is to stop the overflow and to let the water sink. The banks say they have lent too much, and must now lend no more for awhile; so they not only stop lending, but call in loans, which again shows that the fund is overflowing; it must be allowed to subside.

We also see at times, when the fund is overflowing, that banks are so eager to lend, that money is said to be a glut on the market and exceedingly cheap. It is offered at nominal rates of interest. Why, then, are there times when banks are eager to lend when the fund is supposed to be overflowing, and times when, with an overflowing fund, they refuse to lend? Why is it that at times when the fund is low they are willing to lend, and why at other times when the fund is low they are unwilling to lend?

These phenomena prove, I think, that it is not a fund of money in the real sense of the word. We can never tell merely by looking at the aggregate deposits of the banks whether they are able to lend at any given moment or not. We can easily delude ourselves by looking at the bulk of that fund. What governs what we may call the transforming capacity of banks is the quantity of gold they individually possess and general financial and international conditions. In times of uncertainty and apprehension, no matter from what circumstances or events these arise, banks may refuse to lend, no matter what the condition of the so-called loan fund may be. So far from lending when their deposits appear to be very high, they are anxious to diminish these deposits and gather in gold.

It follows that the more gold they hoard the less becomes the loanable fund. Therefore the more legal tender they accumulate at these times, the less money they lend. Which seems anomalous and paradoxical. The more money banks have at certain times the less they have. When the hour of nervousness passes they begin to lend again. The money in the shape of gold diminishes in proportionate quantity, therefore the loanable fund of Lombard Street apparently increases as gold apparently diminishes.

This fund is, at times, like a spring in a desert. The thirsty traveller sees it shimmering in the distance and hurries towards it in profound gratitude, thankful that his thirst is to be slaked and his sufferings are to be relieved at last. But just as he is about to put his lips to the tempting waters, a voice of warning stops him. He is not to drink, for the waters are too precious and must be preserved. Not a drop can be spared. So he does not slake his thirst, and perhaps afterwards succumbs to the torture he is suffering.

The spring is there, but he is forbidden to drink!

In the banks the source of money is there, but the gold must be preserved, and the community must depart unsatisfied, no matter what the consequences may be. The banks will not lend because they must keep and increase, not their deposits, their so-called loanable fund, but their gold.

These deposits, then, are not strictly a loanable fund, otherwise the more they grew the greater would be the fund. In fact, the fund would be inexhaustible, increased and not diminished by the demands made upon it. We know they are increased by loans. Therefore the best means of increasing the fund would be by increasing the loans, and we could then witness money actually piling up mountain-high in our midst. This could put all fables of money-making by magic into the shade.

Instead, however, of increasing the fund by lending as fast as physical resources will permit, the banks adopt the contrary policy. They stop making loans and simultaneously diminish the loans they have already made.

Whatever views the public may hold, bankers labour under no delusions as to the real nature of the loan-fund. They know well enough they do not lend out of that fund at all, for if they lent out of it they would inordinately increase it by lending and so make more profit. It helps to shed more light on the nature of the deposits. Why are banks anxious to diminish the deposits in times of anxiety and apprehension? That is to say, the loan deposits, and not the pure deposits? Why are they anxious to diminish the aggregate of the so-called money fund?

They wish to take away from their borrowers their power to withdraw, even temporarily, gold. If they take this power from them the banks know they will be in a far stronger position, even should the deposits diminish by fifty per cent. In their own language bankers say: “We must strengthen our cash position.” This means, then, that the cash fund and the deposit fund are not one and the same thing. The cash fund is strengthened by weakening the deposit fund. Cash grows as the loanable fund falls.

If the loan deposits are thereby greatly diminished until the deposits are mainly what I have called pure deposits, it shows how the banks safeguard themselves when they think danger is coming. Their assets change. Gold takes the place of other wealth, and the banks are able the better to meet a run on the part of their depositors. They have automatically met the danger from the presence of the loan-deposits, and now they have only to face the danger from the pure deposits. They have fortified themselves for this by differentiating between the characters of their deposits, which in their aggregate are misleadingly called the loan fund of Lombard Street. The gold is the real lending fund.

This is done, too, often at a time most unfortunate for the general community. It is done at a time when the community should receive more and not less help from the banks. Banks ought to lend more freely in times of crisis than at other times, for it is that freer lending that will help the country to meet and get through the crisis. To stay help, to withdraw help already given, is to increase the difficulties of the general community, to feed alarm and apprehension, to aggravate the crisis. The banks do, therefore, what seems wise, perhaps, for them, but unwise for the community.

They are not to be blamed so severely as some imagine. They have to look to the law in the same way as the individual has to look at it, and they cannot be blamed for acting in accordance with law. It is, perhaps, the law that is unwise and not the banks. Communities must abide by the laws they make, and by the limited freedom laws allow. Laws are not the last word in human wisdom. Laws can be modified and improved upon.

Banks have to work within restrictions imposed upon them by the law, and if these restrictions become harsh in times of difficulty and crisis, then it is the law that is at fault and not the banks.

Banks must pay out legal tender to their depositors on demand. The Government restricts the supply of legal tender by enacting that gold alone shall be legal tender. Therefore the Government is not irresponsible for the manner in which the machinery works in all sorts of conditions.

If the supply of legal tender is restricted, no banking system, or any system like it, would be possible if the reserves in legal tender had to be equal, or nearly equal, to the deposits. If the banking system is to be worked in the highest interests of the community, then the gold reserves must necessarily be greatly less than the deposits. If the people of this country took to hoarding gold, then the banking system would eventually come to a stop, which shows again what the nature of the loan fund is. There can be no loan fund without gold, and in that case there could be no currency such as the cheque system of this country.

Ought we, then, to reform and modify the law? I can imagine the time coming when legal tender will not be confined to gold. But this is far distant. I think reform can come in the manner in which we have experienced it since the war. The Government could ensure free working in times of apprehension and crisis in the manner in which it ensured it in August, 1914, by the creation of emergency currency. What can be done successfully and beneficially once can be done again.

If there are times and occasions when banks stop lending and when they call in their loans, then it follows, reverting to market parlance, that the loan-fund is inelastic. If it cannot always and invariably respond to needs, then it cannot conform itself to varying conditions and circumstances. This fact, therefore, supports the contentions of those who say that the fund is inelastic. In my way I say the machinery is far from perfect. It always works with difficulty at the very time when it should work with ease. It will come to a dead stop at the moment when it should be working at high pressure.

To make the position clearer I will recall what Mr. A. C. Cole said in his controversy with Mr. Tritton.

“I entirely disagree,” he said, “as to the inelasticity of this fund. My view is that the inelasticity is apparent, but not real. By this I mean that it is inelastic at any given moment because, in these days of competition, bankers lend all their available surpluses; but to say that the short loan fund is permanently elastic is quite beside the mark. What does inelasticity of the market mean? It means the want of power of the market to adjust itself to pressure or tension. Now, take the discount market. The supply of money always adjusts itself to the demand. Except in times of panic, good bills are always discountable in London. This Mr. Tritton practically admits in his paper. As regards the large amounts of Treasury bills, Exchequer bonds, etc., of which there has been a marked increase in recent years, owing to the [Boer] war, Mr. Tritton says it is not very clear from what source the funds so invested have arisen. This gives away his case, for it is an admission that the money has been forthcoming. In other words, the supply in the short-loan market has been increased because the demands upon it have been larger, and this will always prove to be the case. The short-loan market is really augmented quicker than any other fund. It is quite immaterial whether the funds belong to owners in this country or to capitalists abroad. The fact remains that the money is available when wanted, or, in other words, the short-loan fund is so elastic that it promptly adjusts itself to the demands upon it, though temporary recourse to the Bank of England may be necessary, while the adjustments take place. The apparent inelasticity of the fund is evidence of what I may call the efficiency of the short-loan market. By efficiency I mean that the total available funds in the market are in constant use. This is not a bad thing for the community, but it implies that on the least strain or dislocation of the machinery of the market, recourse has to be made to what is then the only available source of supply--the central institution. But as the Bank of England is always willing to discount or lend upon good bills, the supply of money in the market is never exhausted. It is simply a question (except in times of panic, which we are not here considering) of the rate of interest whether the money is forthcoming.”

I cannot agree with Mr. Cole. If he admits that there is an exception, and the exception works in a time of panic, at the very moment when it is vital to the community that the exception should be removed, then he gives away his case. He admits that the supply is not inexhaustible, for it suddenly dries up when the need is greatest. To say that it is “inelastic at any given moment,” that it is not permanently inelastic, and that there are times when borrowers are driven to the Bank of England, is inconsistent and illogical. If there are moments when it is inelastic, then it cannot be permanently elastic.

When soon after the present war complaints were made that banks were not lending freely, and when a warning to them came from the Chancellor of the Exchequer, it furnished further proof of inelasticity in times of difficulty and pressure.

Let us now examine further the machinery of the Bank of England and the rate of interest.