CHAPTER II

WHAT IS MARKET MONEY?

What is the money that is bought and sold in the money market? Who are the merchants there? Who are the middlemen? Who are the sellers and buyers? What sort of a place is this money market? We can visualize a cattle market, where farmers bring their cattle to sell, and we can visualize Covent Garden, where fruit, vegetables, and flowers are sold: but can we visualize a money market? Is it in some vast building in the City? Is Lombard Street a mighty emporium where many merchants congregate at their stalls and offer, in the same fashion as vendors of apples and sweets do, pounds, shillings, and pence for sale?

It is not located in any spacious building, like the London Stock Exchange. Buyers do not go there and offer golden sovereigns for golden sovereigns and silver shillings for silver shillings. To the ordinary man, who is perplexed by the mysteries of the money market, it sounds strange, indeed, that money can be bought with money. This is because he associates money with pounds, shillings, and pence, and cannot understand a sovereign being bought with a sovereign. Yet he understands the business of a money-lender and he understands borrowing. He knows that when he borrows from a money-lender he borrows money and pays something for the loan, something that he calls interest. Well, the vendors of money in Lombard Street are purely and simply money-lenders on a great scale.

Banks are wholesale business houses where money is made, and where money is sold. The selling is not, however, on all fours with apple selling. When we sell apples we part with the apples for good. We do not lend them for a definite period to the buyer, and the buyer does not return them at the end of that period. In buying and selling apples an absolute exchange is made, money and fruit being definitely parted with.

In the money market the merchandise of the merchants is not exchanged in this absolute fashion, so that, in the literal connotation of the word, Lombard Street is not a market.

Lombard Street is an organism, essential to the vitality, health, and welfare of the body politic, as the heart and the lungs are necessary to the complete life-preservation of the human body. The nation could, of course, live without Lombard Street. But without it, it would be a corpse-like, moribund life in comparison with the vitality and energy imparted to it by this economic organism.

In Lombard Street money is made. What kind of money? Some strongly insist that no money is made, but only what is called credit. This, too, is a highly controversial subject, on which divergent views are held and are likely to be held.

Instead of hoarding our money, placing our golden sovereigns in bags and old tea-pots, and burying them in our cellars, we have reached that stage in our economic development when we place them in the keeping of banks. We have several purposes in view in doing this. We place money in the keeping of the banks for absolute safety; we place it there for convenience; and we place it there to earn what we call interest on it. Hoarding, we are intelligent enough to know, would be unsafe, inconvenient, and unprofitable.

Yet we really obey the instinct of hoarding when we place our savings and surplus money in the keeping of banks. But we have a secondary motive in this action which we will call greed or avarice. We desire our hoards to be fruitful. It is like placing seed in the ground from which to gather future harvests.

But the banks do not hoard our money. If we think they do we labour under a delusion. They employ it in various ways. They lend it to a variety of borrowers at interest, they invest it in all kinds of securities and property, and earn interest on it by this varied employment. Out of this interest they maintain their vast and expensive establishments, pay the salaries to their servants, and pay the interest on the money we, as individuals, place in their keeping.

The position might be illustrated in a simple way. I have saved up two hundred pounds. These two hundred sovereigns I place on deposit at the bank, and am allowed, say, 2½ per cent. interest. I prefer the small interest because I believe the principal will be safe always, safer than if invested in any security or property. Moreover, I know that I can draw this money out whenever I please, but were it locked up in some security or mortgage, I should not feel sure of getting possession of it again in a moment of need. But the bank, lawfully, must return me intact the two hundred sovereigns when I ask for it.

Now the bank re-lends this £200 at, say, 4 per cent. interest, making a profit of 1½ per cent. interest. Out of this interest it must pay salaries, rent, and all working expenses. How can it do it?

It doesn’t do it, and it couldn’t do it. No such miracle could be done. This £200 is multiplied greatly. The bank can make that £200 into £1000 or £2000, and actually lend £2000. If I went one day to ask for the £200, the bank might tell me it could let me have only £10 or £20, and if I insisted on having the £200, it might have to close its doors and go into the bankruptcy court.

How is this £200 made into a fund of £2000? Do the sovereigns actually multiply in the bank’s coffers? Is there a bank fairy that can make sovereigns out of nothing? No. There is no bank fairy, and no sovereigns are multiplied. Yet the bank says it has £2000 to lend, and lends £2000.

That which it lends over and above the original sum of £200 is said to be the bank’s credit. The bank is said, in the terminology of the money market, to create credit to this extent. It keeps, say, ten or twenty sovereigns in its till to provide for the emergencies of a sudden demand, and lends the rest of the gold and something beyond it. This something else is called credit. Some people say it is to all intents and purposes actually money; others declare it is not. And in discussions on this subject a lot of anger has been wasted and more vanity wounded.

Anyway, whether we call it money or whether we call it credit, the fact is indisputable that this is the tangible or intangible something with which banks benefit the trade and commerce of the nation, and help us all to become wealthier. This is the so-called money of Lombard Street.

They risk, however, grave dangers, and the community risks grave dangers in setting up this machinery to facilitate and smooth national and international commercial dealings. These dangers will be unfolded gradually in subsequent chapters.

Already it has been hinted where one danger lies.

If of that £200 I place £100 on deposit and £100 on current account at the bank, the bank has still a total of 200 sovereigns, and can multiply this sum into £1000 or £2000. But it pays interest then only on half the sum--the sum on deposit. On the other half it pays no interest, but it can lend the whole. If I desire to withdraw the £200, I can by law draw half on demand. The bank, however, can insist on some days’ notice before allowing me to withdraw the amount on deposit. But if I insisted on having £100 and the bank had only £20 and could not get the other £80 quickly, it might have to close its doors. This would be a run on the bank that might bring it to ruin.

The bank hopes, of course, that I shall not demand my money in a lump sum at a moment’s notice; that there will be no run. It also hopes that if I do demand it, it will at once demand the return of its loan, or part of its loan, from those who have borrowed from it, and thereby get the two hundred sovereigns it owes to me. It will then be in a position of having still on loan money, or credit, based apparently on no gold.

If it is not based on gold, it is based, however, on some kind of wealth. Those who have borrowed from the bank leave securities, Consols, say, as collateral for the loan. If they do not repay the loan, the bank has the securities, which it can sell in the market for cash.

If it has no gold, it has something it can exchange for gold.

It now becomes a little clearer that what the bank has actually done is not to create £1800 out of nothing, but to liquefy £1800 of the nation’s wealth. Is this process of liquefaction granting credit or creating currency? It looks more like a creation of currency than a creation of credit. If the bank lent without security, then it could with greater logic and reason be called a creation of credit. But it does not so lend.

If gold is wealth and Consols are wealth, then it lends wealth, whether it lends gold or Consols. Therefore, what the banks apparently do is to lend one man’s wealth to another man, taking a commission from the borrower for the services rendered. If Consols were made legal tender, like sovereigns, we should not say that lending Consols was creating credit.

Selling Consols in the market is not creating credit. The selling of Consols to a banker for a consideration is not different essentially from selling them in the market. The borrower virtually sells them to the banker, and so long as the banker holds them he is not creating credit.

If a man hands over to me his mansion for a loan, that mansion is mine till he repays the loan. He has sold it to me temporarily. By lending him the money I possess I do not lend him credit. I may part with all my money, but I have the mansion, which I can sell for money. If I cannot sell it, I may lose much. But that will depend upon my wisdom and foresight. I, at least, have something of some value in the shape of the mansion.

It is so with banks. Their security depends upon the nature of the wealth they liquefy. If it be the best wealth their security is sounder than if it be the worst wealth. It is not necessary, and it should certainly never be necessary, in the real interests of the community, to liquefy only one kind of wealth.

Banking security should rest, therefore, chiefly upon the highest wealth of the nation and not solely, as some contend, upon that limited species called legal tender. This aspect of the problem will be elaborated in later chapters.

Let us take another look at our modest current account. We draw cheques against this current account. We pay our income tax, our rent, our tradesmen, with these cheques. The cheques are accepted readily and unquestionably by all. Why? Because the cheques, the paper, have intrinsic value? No. But because they have trust in our _best_ banks and trust in our possession of the money in these banks. A cheque on the _worst_ banks would not be so readily accepted.

But we all know that the sovereigns are not actually there. Does the drawing of a cheque create credit? Or is the drawing of a cheque merely the evidence that we actually have what we profess to have? In drawing a cheque we do what the banks do when they grant a loan. When we pay for a suit with a cheque we receive the suit in exchange. When a banker draws a cheque and receives Consols or bills of discount, he really buys the Consols and buys the bills. But some contend that he buys the Consols with nothing. So it can be contended that we bought our suit with nothing in the event of the bank smashing.

The cheques we draw become currency, become, in the essential meaning of the word, money. They are not legal tender; but legal tender is only a small portion of the nation’s currency, that portion arbitrarily selected by the legislature for a specific, but important purpose.

That that selection is wise is a view not unanimously held by economic thinkers.

But it is a selection that must control the policy of bank management to a paramount extent. This does not exclude, however, the scope and expediency of legislative reform.

We cannot draw cheques against our deposit accounts. But though we can withdraw these deposits the bank can insist, as I have said, on certain notice. This notice, however, is never insisted upon. It would be injudicious to insist upon it. It would be injudicious because it would give rise to the suspicion that the bank was unsoundly managed and in a bad way. And suspicion is the surest way towards the destruction of a bank.