CHAPTER XIV

EXHAUSTIBILITY

If what is called the loanable fund were perfectly elastic and “promptly adjusted itself to the demands upon it,” how is it that the value of money, called the rate of interest, is not more uniform? It certainly should be more uniform if it were a fund that automatically responded to the demands upon it, increasing as the output of wealth increased, decreasing when the output of wealth fell off. In a perfect system this would certainly happen; but sound as banking may be within its limitations, we must admit that it is far from being a system of perfection. The fact that the rate of interest is not uniform, that it rises and falls in a capricious and not uniform way, is further proof that the fund is not, as it should be in a perfect or improved system, elastic.

Experience shows us clearly that as demand grows the potential supply diminishes; therefore it cannot be a perennial, inexhaustible fund. If bankers find that the demand is growing, they advance their rates of interest. In other words, they demand a larger share of the profits of the community. They have two objects to serve in this. They desire to increase their own profits and they desire to check the demands upon them. From their point of view, it is better to lend a little at a high rate of interest than much at a low rate. In their annual or semi-annual speeches bank chairmen are pleased if they can show their shareholders that during a certain period the rate of interest has been high; for it is evidence to them that circumstances have been in their favour; that they have done good, profitable business. They lament times when interest has ruled low. And interest rules low when the fund is said to be overflowing, when the banks cannot lend as much as they would like. There are, however, as I have already pointed out, exceptions to this. It is no invariable rule, or law, or sequence, whatever we may please to call it, that interest is low when the fund is overflowing and high when the fund has fallen. Interest is governed by many causes extraneous to the power of banks to lend, and these causes often arise in an unforeseen, capricious way.

We may say, however, while recognizing the effects of irregular, uncertain causes, that the value of what is called bank money is affected by the well-known law of supply and demand, the law that affects the prices of commodities and of labour. In a general sense, when the supply of money is greater than the demand the rate of interest falls; when the demand is in excess of the supply the rate of interest rises.

Demand increases when borrowers multiply. Borrowers go in growing numbers to the banks. As the loans thereby increase, so the deposits increase. If, therefore, the deposits compose the loanable fund, the loanable fund increases. At last, however, the loanable grows so large that the banks say they can lend no more. Lend no more, when the loanable fund is greater than ever? But the banker shakes his head. He knows that though the loanable fund is greater than ever in appearance, it is smaller than ever in fact. He knows that the greater the demands made upon him the more his power of lending decreases, until the moment arrives when he has to say “Stop!” He sees that as the fund rises the proportion of the gold reserve falls. So he stops lending, lets his loans run off, whether secured on bills of discount or securities, and waits until that so-called loan-fund falls. And when it has fallen, when the loan-fund is less, then he can lend again, although to the uninitiated he has apparently less to lend.

How, then, does this fund promptly respond to the demands upon it if the supply of gold flowing into the banks does not keep pace with those demands? If the supply of gold, not loan-deposits, kept pace with the demands then, and then only, could the fund “promptly adjust itself to the demands upon it.”

It is elementary knowledge in Lombard Street that when the Bank of England is able, week after week and month after month, to buy up all the South African and other gold coming into the bullion market, that it will tend to increase “credit” and depress loan-rates. We know that the gold will increase the supply of market money more surely than the growth in the country’s wealth. This is because we know the gold will eventually find its way to the banks, increase their gold reserves, and enable them to lend more.

It proves, then, that the working of the fund, elastically or otherwise, is dependent upon the flow of gold into the Bank of England. This is because the law has decreed that gold shall be legal tender. Therefore, the supply of money for the help of commerce, for the fettered working of the banking system, is dependent in the ultimate resort upon the law of the land. It is not dependent in the ultimate resort upon the law of supply and demand, because a more powerful law controls the economic law. If the law, then, controls the supply of money, then the law must control the supply of wealth, and the law must control ultimately the prices of labour and of commodities.

When liquid capital is provided by the banks a charge is made for it. This rate of interest not only affects the amount of capital that shall be furnished, but it must affect the prices of the product that comes into existence from the use of that capital. If the merchant has to pay a high price for that capital, he must ask a higher price for his product, for he will not use that capital unremuneratively. The greater the abundance of capital employed in the country the greater is the quantity of wealth produced, and the cheaper the capital the lower are the prices of its products. That is to say, the greater are the chances of the community partaking of a larger share of that wealth. If they partake of this larger share it simultaneously increases the collective, or aggregate, powers of consumption.

It is indisputable that in times of trade activity the demands for capital grow. Times of depression are coincident with a decline in the demand.

In this chapter I am but repeating much of what I have urged in former chapters, but I am naturally anxious to make my argument as strong as possible by the help of wider and, I trust, clearer illustrations as I proceed. When we travel over a wide tract of country our vision is too weak to take in all its topographical features. We can see general features, but not the minute features which the botanist and the geologist would examine. The poet would see what the geologist would not see, and the botanist would see what would escape the naturalist.

So when we take a survey of the economic and financial world we see a mechanism which is not the same when examined minutely as when looked at from a distance. When we look at it from afar we cannot see those defects which on close examination we are able to find.

If rates of interest arbitrarily rise and fall, and the supply of capital is controlled in an arbitrary way, the general well-being of the community must be affected. We suffer when the monopolist takes advantage of the helplessness of the community to raise prices. We suffer when shipowners take advantage of accidental circumstances to raise freights and the price of food. We suffer when the colliery proprietors in the depth of winter raise the price of coal. We suffer also when the banks raise the rate of interest, thereby raising prices and affecting employment.

When prices rise, as they have almost uniformly risen in recent years, many theories are advanced as to the causes of this. Some attribute it to the increased output of gold. They mean by this that the output of gold has increased so greatly that more money, or more purchasing power, is placed in the hands of the community. Producers, observing this, raise the prices of their commodities. If this were so, the advance in prices would be general, and we should be no worse or better off than when prices are low. Wages would inevitably advance if prices were affected by this universal, not local cause. But it is asserted that wages have not advanced uniformly, while tradesmen on their part declare that their profits have fallen. Workmen and tradesmen alike say that they are poorer than they were ten and twenty years ago, and the housewife declares that a sovereign now will only go as far as fifteen or ten shillings went years back.

It is impossible to prove that such a rise is a consequence of an accelerated production of gold. It is an hypothesis, and an hypothesis it will remain, for it ignores a multitude of causes more important in their aggregate effect than gold.

It does not follow, then, that because at given moments capital may be dearer than at other moments, a general rise or a general fall in prices will immediately follow. Neither can we lay it down as an indisputable axiom that a 5 per cent. interest, say, is detrimental to trade, and a 2 per cent. interest is beneficial to trade. But we can say, I think, that a very high rate of interest is harmful to trade, particularly if it be prolonged, and that a constantly fluctuating rate of interest is more unfavourable for trade than a uniform rate, or a rate that varies but slightly.

A high rate of interest means dearth of capital, and dearth of capital must affect production and consumption and the output of wealth, just as a dearth of seed must affect the coming harvest. The community, therefore, must necessarily suffer from a dearth of capital, and as the community is largely dependent upon the banks for the supply of capital, then it follows that it is best for the community that the supply should be constant, that it should adjust itself to the demands upon it. If it could do this, then the rate of interest would tend to greater uniformity. At any rate, it would not rise and fall so capriciously as it does do. If it varied it would vary within narrower compass.

If this could be accomplished, if the supply of capital were less dependent than it has been and still is, upon extraneous circumstances, we may see steadier prices, and perhaps one happy effect would be less labour difficulties and less strikes. Strikes are, in many instances, the effect of constantly fluctuating prices. But the supply and price of capital would not alone put an end to fluctuating prices. I merely hint that it might help to correct those frequent and extreme fluctuations that cause so much discontentment, and so much envy, and so much misery.

It would be interesting to speculate what would happen if the Germans conquered us and took away our colonies and our goldfields. If Germany restricted or cut off the supply of gold to this country, what would happen to our loanable fund? How would it affect what we call the creation of credit? How would it affect the supply of capital? If the law remained as it is, and the banks could get no more gold reserves, then there would be no loanable fund and no supply of capital. But the law being what it is, the supply of capital is dependent upon the supply of gold.

Mr. Cole admits 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, where it is simply a question of the rate of interest whether the money is forthcoming. After admitting, then, that the machinery can break down and that then there can be but one source of supply, that supply can only be obtained at a higher price. If it is to be obtained at a higher price, then it is to be obtained at the general expense of the community. If capitalists will not pay that higher price, then this is tantamount to a lessened supply of money. As the Bank of England, too, will not lend on the same class of wealth that the other banks will lend on, a vast mass of wealth is excluded. Therefore a vast mass of wealth cannot be transformed into liquid capital. If no one will liquefy this wealth, then the production of liquid capital must be limited, and that capital must remain in its fixed form till the other banks restart their transforming machinery. If this be so, then the supply even from the Bank of England is not, as Mr. Cole would have us believe, unrestricted and illimitable. It is, after all, a restricted supply, regardless of the entire claims or needs of the community, for narrower discrimination is practised. The Bank of England may always be willing to discount or lend upon good bills. But there are other bills of a lower grade than this class of bill, and there is a vast quantity of wealth that is rejected by the Bank. If the lending is limited to good bills, and if the quantity of good bills is limited, then the supply of money from the Bank must be limited. To say that the supply is inexhaustible is, therefore, misleading.

We know, too, from experience that when the Bank has been lending for a time on good bills it has had at times to check these loans. And in order to check them it has raised the Bank rate. Why has it raised the rate? To replenish the supply that is said to be inexhaustible. Mr. Cole says it could get that supply from abroad, and therefore the fund would be replenished inexhaustibly. If, however, the supply from abroad were checked, as we can imagine it could be, would the fund be inexhaustible then? It would be interesting to know if, should the Bank Act be suspended in certain circumstances, this would fall in with Mr. Cole’s idea, or conception, of inexhaustibility. Also if the creation of the Treasury notes falls in with that idea.

We know, of course, that since the war the Bank has lent enormous sums of money by discounting pre-moratorium bills of exchange. This may seem to furnish proof of the inexhaustibility of the fund. But while it has been lending it has been simultaneously receiving gold. There has been no competition for the gold from South Africa and elsewhere, and therefore the Bank has been able to procure it in the usual way. Then New York has been obliged to liquidate its indebtedness to us in large amounts of gold. But with all this, the proportion of the reserve has kept well below the normal. What would have happened had the rebellion spread in South Africa, and had the mines there been closed down indefinitely?

Even as it was, the Bank rate had to be maintained at an artificially high level compared with loan and discount rates in the outside market.