It followed as a necessary consequence that the volume of legal tender currency had to be greatly increased. As prices rose wages rose with them, and so much more "cash" was needed in order to pay for a turnover of goods which, fairly constant in volume, demanded more currency because of their inflated prices. As the Committee says in its Report (page 5): "Given the necessity for the creation of bank credits in favour of the Government for the purpose of financing war expenditure, these issues could not be avoided. If they had not been made, the banks would have been unable to obtain legal tender with which to meet cheques drawn for cash on their customers' accounts. The unlimited issue of currency notes in exchange for credits at the Bank of England is at once a consequence and an essential condition of the methods which the Government have found necessary to adopt in order to meet their war expenditure."

The effect of these causes upon the amount of legal tender currency (other than subsidiary coin) in the banks and in circulation is summarised by the Committee in the following table:—

"The amounts on June 30, 1914, may be estimated as follows:—

"Fiduciary Issue of the Bank of England L18,450,000

"Bank of England Notes issued against gold coin or bullion 38,476,000

"Estimated amount of gold coin held by Banks (excluding gold coin held in the Issue Department of the Bank of England) and in public circulation 123,000,000 "Grand total L179,926,000

"The corresponding figures on July 10, 1918, as nearly as they can be estimated, were:—

"Fiduciary Issue of the Bank of England 18,450,000 Currency Notes not covered by gold 230,412,000 "Total Fiduciary Issues [1] L248,862,000 Bank of England Notes issued against coin and bullion 65,368,000 Currency Notes covered by gold 28,500,000 Estimated amount of gold coin held by Banks (excluding gold coin held by Issue Department of Bank of England), say 40,000,000 "Grand total L382,730,000

"[Footnote 1: The notes issued by Scottish and Irish banks which have been made legal tender during the war have not been included in the foregoing figures. Strictly the amount (about L5,000,000) by which these issues exceed the amount of gold and currency notes held by those banks should be added to the figures of the present fiduciary issues given above.]

"There is also a certain amount of gold coin still in the hands of the public which ought to be added to the last-mentioned figure, but the amount is unknown."

It will be noted that the gold held by the banks (other than the Bank of England) and by the public has declined from L123 to L40 millions, according to the Committee's estimate, while, on the other hand, the circulation of bank notes has risen by L27 millions and the issue of currency notes has taken place to the tune of L259 millions (at the date of the Report; it is now nearly L300 millions), making a net addition to legal tender currency of over L200 millions. When we also remember that there has been a very heavy coinage of silver and copper, that the Bank of England's deposits have risen by over L100 millions and the deposits of the other banks by nearly L700 millions, and all this at a time when most of the industrial activity of the country was going into the production of destructive weapons and the support of those who were using them, the behaviour of commodities of ordinary use in rising by nearly 100 per cent. seems to be an example of remarkable moderation. With all this new buying power in the hands of the community there is little wonder that some people should think that we have enormously increased our wealth during this most destructive and costly war, and should then feel hurt and disappointed when they find that this new buying power is robbed of all its beauty by the fact that its efficiency as buying power is seriously diminished by its mere quantity.

Such being the state of affairs—a great mass of new credit and currency based on securities—it is clear that our currency has been deprived for the time being of that direct relation with its gold basis that used in former time to regulate its volume according to world prices and our international trade position. As the Committee says, "It is not possible to judge to what extent legal tender currency may in fact be depreciated in terms of bullion. But it is practically certain that there has been some depreciation, and to this extent therefore the gold standard has ceased to be effective." Very well, then, what has to be done to get back to the old state of things under which there was a more or less automatic check on the creation of credit and the issue of currency? This check worked by a system which was elastic and simple. It was not entirely automatic, because its working had to be controlled by the Bank of England, which, by the action of its discount rate, could, more or less, quicken or check the working of the machine. Legal tender currency could only be increased by imports of gold; and exports of gold reduced the available amount of legal tender currency; and since a stock of legal tender currency was essential to meet the demands upon them that bankers made possible by creating credits, there was thus an Indirect and variable connection between the country's gold stock and the extent to which bankers would think it prudent to multiply credits. If credits were multiplied too fast, our currency was depreciated in value as compared with those of other countries and the exchanges went against us and gold either was exported or began to look as if it might be exported. If it was exported the legal tender basis of credit was reduced and the creation of credit was checked. If the Directors of the Bank of England thought it inadvisable that gold should be exported they could, by raising the rate of discount and taking artificial measures to control the supply of credit, produce, without the actual loss of gold, the effects which that loss would have brought about.

The keystone of the system was the rigid link between legal tender currency and gold. This was secured by the provisions of the Bank Act of 1844, which laid down that above a certain line—which was before the war roughly L18-1/2 millions—every Bank of England note issued should have gold behind it, pound for pound. In other words, the Bank of England note was, for practical purposes, a bullion certificate. The legal limit on the fiduciary issue (that is, the issue of L18-1/2 millions against securities, not gold) could only be exceeded by a breach of the law. The many critics of our banking system seized on this hard-and-fast restriction and accused it of making our system inelastic as compared with the German arrangement, under which the legal limit could at any time be exceeded on payment of a tax or fine on any excess perpetrated. These critics might have been right if legal tender currency had been the only, or even the predominant, means of payment in England. But, as every office boy knows, it was not. Legal tender—gold and Bank of England notes—was hardly ever seen in commercial and financial transactions on a serious scale. We paid, sometimes, our retail purchases of goods and services in gold; and Bank notes were a popular mode of payment on racecourses and in other places where transactions took place between people who were not very certain of one another's standing or good faith. But the great bulk of payments was made in the cheque currency which our bankers had developed outside of the law and could create as fast as prudence—and an eye to the supply of legal tender which every holder of a cheque had a right to demand—allowed them to do so. While cheques provided the currency of commerce, another form of "money" was produced, again without any restriction by the Act, by the pleasant convention which caused a credit in the Bank of England's books to be regarded as "cash" for balance-sheet purposes by the banks. These advantages gave the English system a freedom and elasticity, in spite of the strictness of the law that regulated the issue of paper currency, that enabled it to work in a manner that, judged by the test of practical results, had one great advantage over that of any of the rival centres. It alone in days before the war fulfilled the functions of an international banker by being ready at all times and without question to pay out the gold that was, in the last resort, the final means of settling international balances.

It is the object of Lord Cunliffe's Committee to restore as quickly as possible the system which, has thus been tried by the test of experience, "After the war," they say in their Report, "our gold holdings will no longer be protected by the submarine danger, and it will not be possible indefinitely to continue to support the exchanges with foreign countries by borrowing abroad. Unless the machinery which long experience has shown to be the only effective remedy for an adverse balance of trade and an undue growth of credit is once more brought into play there will be very grave danger of a credit expansion in this country and a foreign drain of gold which might jeopardise the convertibility of our note issues and the international trade position of the country.... We are glad to find that there was no difference of opinion among the witnesses who appeared before us as to the vital importance of these matters." The first measure that they put forward as essential to this end is the cessation at the earliest possible moment of Government borrowings. "A large part of the credit expansion arises, as we have shown, from the fact that the expenditure of the Government during the war has exceeded the amounts which they have been able to raise by taxation or by loans from the actual savings of the people. They have been obliged therefore to obtain money through the creation of credits by the Bank of England and the Joint Stock banks, with the result that the growth of purchasing power has exceeded that of purchasable goods and services." It is therefore essential that as soon as possible the State should not only live within its income but should begin to reduce indebtedness, especially the floating debt, which, being largely held by the banks, has been a cause of credit creation on a great scale. "The shortage of real capital must be made good by genuine savings. It cannot be met by the creation of fresh purchasing power in the form of bank advances to the Government or to manufacturers under Government guarantee or otherwise, and any resort to such expedients can only aggravate the evil and retard, possibly for generations, the recovery of the country from the losses sustained during the war." With these weighty words the Committee brushes aside a host of schemes that have been urged for putting everything right by devising new machinery for the manufacture of new credit. That new credits will be needed for industry after war is obvious, but what else are our banks for, if not to provide it? They can only be set free to provide it on the scale required if, by the necessary reduction of the floating debt, they are relieved of the locking up of their funds in Government securities, which has been one of the bad results of our bad war finance.

It goes without saying that the Committee does not recommend the continuance in peace of the differential rates for home and foreign money that were introduced as a war measure with a view to lowering a rate at which the Government borrowed at home for war purposes. It would evidently be too severe a strain on human nature to attempt to work such a system, except in war-time, when the artificial conditions by which the market was surrounded made it both feasible and desirable to do so. With regard to the note issue, the Committee proposes a return to the old system and a strictly drawn line for the amount of the fiduciary note issue, the whole note issue (with the exception of the few surviving private note issues) being put into the hands of the Bank of England, all notes being payable in gold in London only and being made legal tender throughout the United Kingdom. These suggestions are subject to any special arrangements that may be made with regard to Scotland and Ireland. An early resumption of the circulation of gold for internal purposes is not contemplated. The public has become used to paper money, which is in some ways more convenient and cheaper; and the luxury of a gold circulation is one that we can hardly afford at present. Gold will be kept by the Bank of England in a central reserve, and all the other banks should, it is suggested, transfer to it the whole of their present holdings of the metal. In order to give the Bank of England a closer control of the bullion market the Committee thinks it desirable that the export of gold coin or bullion should, in future, be subject to the condition that such coin or bullion had been obtained from the Bank for the purpose. This measure would give the Bank of England a very close control of the bullion market, so close that there is a danger that if this control were too rigorously exercised, gold that now comes to this country might be diverted, with a view to more advantageous sale, to other centres. The amount of the fiduciary issue is a matter that the Committee leaves open to be determined after experience of post-war conditions. They "think that the stringent principles of the Act (of 1844) have often had the effect of preventing dangerous developments, and the fact that they have had to be temporarily suspended on certain rare and exceptional occasions (and those limited to the earlier years of the Act's operation, when experience of working the system was still immature) does not," in their opinion, invalidate this conclusion. So they propose that the separation of the Issue or Banking Departments should be maintained, but that in future if an emergency arose requiring an increase in the amount of fiduciary currency, this should not involve a breach of the law, but should be made legal (as it is now under the Currency and Bank Notes Act of 1914), subject to the consent of the Treasury.

It is not proposed at present to secure the circulation of paper instead of gold by legislation. The Committee considers that "informal action on the part of the banks may be expected to accomplish all that is required." If necessary, however, it points out that the circulation of gold could be prevented by making the notes convertible, at the discretion of the Bank of England, into coin or bar gold. The amount which, in the opinion of the Committee, should be aimed at for the central gold reserve is L150 millions (a sum which is already almost in sight on its figures quoted above); and "until this amount has been reached and maintained concurrently with a satisfactory foreign exchange position for a period of at least a year," it thinks that the policy of reducing the uncovered note issue "as and when opportunity offers" should be consistently followed. How this opportunity is going to "offer" is not made clear; but presumably a reflow of notes from circulation can only happen through a fall in prices or a reduction in bank deposits by the liquidation of advances made to the Government, directly or indirectly, by the banks.

Concerning the difficult problem of replacing the Bradbury notes by Bank of England notes of L1 and 10s., an ingenious suggestion is made by the Committee. It observes that there would be some awkwardness in transferring the issue to the Bank of England before the future dimensions of the fiduciary issue have been arrived at; and it suggests that during the transitional period any expansion in Treasury notes that may take place should be covered, not as now, by Government securities, but by Bank of England notes taken from the Bank. By this means any demands for new currency would operate in the normal way to reduce the reserve of the Banking Department, "which would have to be restored by raising money rates and encouraging gold imports," and so a step would have been taken to getting back to a business basis in the currency system and away from the profligate printing-press policy of the war period.

Such are the suggestions made by this distinguished body for the restoration of our currency. Little has been said against them in the way of serious criticism, but their conservative tendency and the fact that they practically recommend a return to the status quo has caused some impatience among the financial Hotspurs who proposed to begin to build a new world by turning everything upside down. In matters of finance this process is questionable, interesting as the result would undoubtedly be. To get to work on tried lines and then, when once industry and finance have recovered their old activity, to amend the machine whenever it is creaking seems to be a more sensible plan than to delay our start until we have fashioned a new heaven and earth, and then very probably find that they do not work. If the machine is to be set moving, it can only be done by close co-operation between the Bank of England and the other banks which have grown by amalgamation into institutions the size of which seem likely to make the task of central control more difficult than ever. On this important point the Committee is curiously silent. But it recommends the adoption of a suggestion made by a Committee of Bankers, who proposed that banks should in future be required "to publish a monthly statement showing the average of their weekly balance-sheets during the month." (Will this requisition apply to the Bank of England?) This is a welcome suggestion as far as it goes, but unless something is done by co-operative action to make the Bank rate more automatic in its influence on the actions of the other banks, the difficulty of making it effective seems likely to be considerable.

Getting the currency right is a most important matter for the future of our financial position. Another is the question of our debt to foreigners. Most of this debt we owe to America, and we only owe it because we had to finance our Allies. We surely ought to be able to arrange with America that anything that we have to do in giving our Allies time before asking for repayment they also should do for us—within limits, say, up to thirty years. In view of all that they have made and we have lost by this war waged for the cause of all mankind, this would seem to be reasonable concession on America's part.



XVII

MEETING THE WAR BILL

January, 1919

The Total War Debt—What are our Loans to the Allies worth?—Other Uncertain Items—The Prospects of making Germany pay—The Right Way to regard the Debt—Our Capital largely intact—A Reform of the Income Tax—The Debt to America—The Levy on Capital and other Schemes—The only Real Aids to Recovery.

A table published week by week by the Economist shows that from August 1, 1914, to November 9, 1918, the Government paid out L8612 millions sterling. From this we have to deduct an estimate of the amount that the Government would have spent if there had not been a war, so that we are at once landed in the realm of conjecture. The last pre-war financial year saw an expenditure of L198 millions, and it is safe to assume that this figure would have swollen by a few millions a year if peace had continued, so that we may take at least L860 millions from the above total as normal peace expenditure for the 4-1/2 years. This gives us L7752 millions as the gross cost of the war, as far as the period of actual fighting is concerned. From this figure, however, we are able to make some big deductions. There are loans to Allies and Dominions, and some other much more readily realisable assets than these. We do not know the actual figure of the loans to Allies and Dominions during the war period, because they are not included in the weekly financial statements. The amount that we borrow abroad is set out week by week—at least, that is believed to be the meaning of the cryptic item "Other Debt"—but the amount that we lend to Allies and Dominions is hidden away in the Supply Services or somewhere, and we only get occasional information about it from the Chancellor in the course of his speeches on the Budget or on Votes of Credit. In his last Vote of Credit speech, on November 12, 1918, Mr Bonar Law gave the chief items of the loans to Allies, and a very interesting list it was. The totals up to October 19, 1918, were L1465 millions to Allies and L218-1/2 millions to Dominions. The Allies were indebted to us as follows:—Russia, L568 millions; France, L425 millions; Italy, L345 millions; smaller States, L127 millions.[1]

[Footnote 1: Parliamentary Debates, Vol. 110, No. 114, p. 2560.]

Some of these debts may be written off at once, and that cheerfully, seeing that they have been lent brothers-in-arms who have been hit much harder than we have by the war, and had nothing like our financial strength. The question is, what figure ought we to put on this asset in deducting it from gross war expenditure in order to arrive at a guess at the real cost? We take our loans to Dominions, of course, as good to the last penny. Mr Bonar Law, in his Budget speech last April, took our loans to Allies at half their face value. Strict bookkeeping would probably demand a lower figure than 50 per cent.; but let us follow the ex-Chancellor's example and take loans to Allies, which we will estimate at L1480 millions up to November 9th, as good for L740 millions, and loans to Dominions at L220 millions up to the same date, a total of L960 millions, to be deducted from gross war cost. Concerning L740 millions of this sum, however, there is a certain amount of doubt. No one questions for a moment the solvency of France and Italy, but in view of the pressure that the war has exercised on their producing power, and, in the case of France, the complication added by the uncertainties of the position in Russia, in which French investors are so deeply interested, one cannot feel sure that they will be able at once to make interest payments. Much will depend on the sums that they are able to recover from Germany against their bill of damages, on which more anon. But in any case it seems likely that a general scheme of interest funding, as between the Allies, may have to be adopted for some years to come.

As to the other assets that we have to set against our gross expenditure during the fighting period, they were enumerated by the Chancellor in his Budget speech last April in the following terms;—

Balances in agents' hands, debts due, foodstuffs, etc L375 millions. Land, securities, buildings and ships 97 " Stores in Munitions Department (cost price 325 millions) taken at 100 " Additions this financial year 100 " Arrears of taxation 500 " —- Total[1] L1172

[Footnote 1: Parliamentary Debates, Vol. 105, No. 33, pp. 698-699.]

It will be remembered that in his Budget speech the Chancellor was proceeding on the assumption that the war would last till March 31st next—the date at which our financial year ends—and would then be convenient enough to stop. Happily for us, the valour of our soldiers and those of our Allies, the splendid success of our Fleet and our merchantmen In bringing over American troops and their food and equipment with astonishing speed, and the straightforward diplomacy of President Wilson, combined to achieve victory nearly five months earlier than the most sanguine had dared to expect. With the very pleasant result—though it is a small matter when compared with the end of the killing of the best of our manhood—that the financial position is very greatly improved. With regard to the figures given above, it should be observed that the "debts" are advances to Dominions, but on quite a different basis from our loans to them, being money owed by them against goods and services supplied.[1] They and the balances in the hands of agents are both as good as gold. Concerning the others, one is entitled at first sight to feel a good deal of scepticism, since such articles as land, buildings, ships and stores, bought or built by Government during a war, are likely to find an extremely sluggish demand when the war is over. However, Mr Bonar Law assured the House that his valuation of these amounts had been arrived at on a conservative basis, and, what is better still, in his Vote of Credit speech on November 12th, he was able to state that revised estimates had shown that their value would be "far greater" than he had previously expected. So perhaps we are entitled to take them at L1300 millions.

[Footnote 1: Parliamentary Debates, Vol. 105, No. 33, p. 698.]

If so, we get the following results for the cost of the fighting period:—

Total Government expenditure, August 1, 1914, to November 9, 1918 L8612 millions. Less estimate of normal peace expenditure 860 " ——- 7752 " Less Loans to Dominions 220 millions. Less Loans to Allies (half face value) 740 " Realisable assets 1300 " —— 2260 " —— Net cost of period L5492 "

If war cost would be good enough to cease with the fighting we should thus now be able to see, more or less, how we stand. During the fighting period the Government raised by taxation the sum of L2120 millions,[1] from which we have again to deduct L860 millions as an estimate for normal peace taxation, if the war had not happened, leaving L1350 millions as the net war taxation, and L4142 millions as the net addition to debt from the war.

[Footnote 1: Economist, Nov. 16, 1918.]

But, of course, there are still some large and uncertain sums to come in to both sides of the account. There is the cost of maintaining our Army and Navy during the armistice period, the cost of demobilisation, and the cost of putting an end to war munitions contracts running for many months ahead, holders of which will have to be compensated. Who has enough assurance to venture on an estimate of the cost of these items? Shall we guess them at something between L1000 and L1500 millions? And when we have made this guess are we at the end of the war's cost? Ought we not to include pensions to be paid, and if so, at what figure? Fifty millions a year for thirty years? If so, there is another L1500 millions. And interest on war debt, and for how long?

On the other side of the balance-sheet, the only asset that has not yet been included in the calculation is the sum that we are going to receive from Germany, Some cheery optimists think that it is possible for us and for the Allies to make Germany pay the whole of our war cost. If so, we have halcyon days ahead, for not only shall we be able to repay the whole war debt but also to pay back to the taxpayer all the L1350 millions that he produced during the war, unless, as seems more likely, the Government finds other uses, or abuses, for the money, and sets its motley horde of wasters to work again. But this problem, of course, is not going to arise. It would not be physically possible for Germany to pay the whole of the Allies' war cost, except in the course of many generations, and, moreover, the Allies have bound themselves not to make any such demand by the rider that they added to President Wilson's peace terms, in giving their assent to them as the basis on which they were prepared to make peace. Early in November they stated that President Wilson's reference to "restoration" of invaded countries should, in their view, be expanded into a claim for compensation "for all damage done to the civilian population of the Allies and to their property by the aggression of Germany by land, by sea, and from the air."[1] This is letting Germany off lightly; but, after stating their readiness to make peace on the basis of the fourteen points, if amended as above (and also with regard to the Freedom of the Seas question) it is not possible for the European Allies, as the Prime Minister's late manifesto says they propose to do[2] to expand this claim for civilian damage into a demand for the whole of their war cost up to the limit of the capacity of the Central Powers to pay, without a serious breach of faith. So that the question of how much we can get out of Germany is complicated by the further uncertainty of the size of the bill for damages that we can present. It will be big enough. We know that the Germans have sunk 8-1/2 million tons of British ships during the war. As to the price at which, for "restoration" purposes, we shall value those ships and their cargoes, and all the civilian property damaged by aircraft and bombardment, this is a matter which it would be obviously improper to discuss; but we may be sure that the bill will mount up to many hundreds of millions, and it remains to be seen whether, after Belgium and France have presented their account, it will be possible for us to secure payment even for all the civilian damage that we have suffered.

[Footnote 1: Times, November 7, 1918.]

[Footnote 2: Times, December 6, 1918.]

It thus appears that the net cost of the fighting period has been somewhere in the neighbourhood of L5500 millions, taking our loans to Allies at half their face value; and that the armistice and demobilisation period is likely to cost another L1000 to L1500 millions more, to say nothing of pensions and debt charge that will go on for years (unless the supporters of Levy on Capital have their way and wipe the debt out), and that against this further expenditure we can set whatever sum is recovered from Germany.

Seeing that our total pre-war debt was L710-1/2 millions, or, omitting what the Government returns call the Other Capital Liabilities, L653-1/2 millions, these figures of war debt and war cost are at first sight somewhat appalling. But there is no reason why they should terrify us, and there are several reasons why they are, when looked at with a discriminating eye, much less frightening than when we first set them out.

In the first place, we have always to remember that these figures are in after-war pounds, and that the after-war pound is, thanks to the profligate use by our war Governments of the printing-press and the banking machine, just about half the size, when measured in actual buying power, of the pre-war pound. Any one who pays L100 in taxes to-day thereby surrenders claims to about the same amount of goods and service as he did if he paid L50 in taxes before the war. So that in making any comparison between the position now and the position then we have to divide the figures of to-day by two.

In the second, we need not be misled by the Jeremiahs who tell us that now that we have won the war we have before us the task of paying for it. This is not true, or true only to a small extent—to the extent, that is to say, to which we shall, when all these assets and liabilities have been settled up and balanced, be afflicted with a foreign debt. Let us leave this question on one side for the time being, and consider what the position really is with regard to that part of the war's cost that has been raised at home. In so far as that has been done, the war cost has been raised by us while the war went on. In fact, all the war cost has to be raised by somebody while the war goes on, because the war is fought with stuff and services produced at the time and paid for at the time. But when Americans lend us money to pay for some of the stuff that they send us, they pay at the time and we, or our posterity, have to pay them back later on; this is the only way in which we can make posterity pay for the war, and then it only means that our posterity pays America's. It is not possible to carry on war with wealth that is going to be produced some day. The effort of self-sacrifice that war demands has to be made by somebody during its progress—otherwise the war could not be fought.

That effort of self-sacrifice we have already made in so far as we have paid for our war cost out of money raised at home. That money has been raised in three ways—by taxation, by borrowing saved money, and by inflation. When it is raised by taxation the sacrifice is obvious, and, in nearly all cases, inevitable: we pay our larger war taxes and so we have less to spend on ourselves, and so we go without things. A few people raise money to pay taxes during war by borrowing or drafts on capital, but they are probably so exceptional that their case need not be considered. We transfer our buying power to the Government to be used for the fighters, and so we set free the labour and material that used to go in providing us with comforts and pleasures; our competition for goods is reduced, and so the Government is able to get what it needs out of the nation's production, which is pro tanto relieved of our demand. The same thing happens when the Government gets money for the war by borrowing money that we save. We reduce expenditure, and transfer buying power to the State and diminish our demand on the nation's production, or that of its foreign supplies. If the whole war cost had been met by these two methods there need have been little or no increase in prices here, and the cost of the war would have been about half what it has been. Of the two methods, taxation is obviously the cleaner, simpler and more honest. By borrowing, the State hires those who have a margin to put part of it at the disposal of the State at a time of national crisis, instead of taking it from them outright. As most of the taxation involved by the subsequent debt charge falls on those who have a margin (as it obviously should) the result is that the people who subscribed to the loans are afterwards taxed to pay themselves interest and to repay themselves their debt.

This subsequent taxation falls on them all alike in proportion to their ability to pay, or would if the income tax was more equitably imposed; those who have subscribed their fair share to the loans have an offset, in the interest that they receive, against the taxation; those who subscribed less are properly penalised, those who subscribed more are properly benefited. If only the income tax did not make the position of fathers of families so unjust, the whole arrangement would look, at first sight, quite fair, though rather absurd and clumsy, involving all this subscribing and taxing and paying back instead of an outright tax and having done with it. But in fact a very grave inequity is involved by this business of borrowing for war, and laid upon just the people whom we ought, above all, to treat most fairly, namely, those who fight for us. The soldiers and sailors risk their lives for a pittance during the war, while their brothers and sisters and cousins and uncles and aunts, left at home in security and comfort, earn bloated profits and wages, and put them, or part of them, into War Loans; then when the fighters come back, very likely with their business and connection ruined or lost, they are expected to contribute to the taxation that goes into the pockets of debt-holders.

Inflation, the third method of paying for war, again produces the same effect of a reduction of consumption by the civilian population, but in a roundabout manner, which works at first without being noticed, and so is particularly dear to the adroit politician. By it nobody transfers buying power to the Government, but the Government and the bankers, who are generally most reluctant accessories to the transaction, between them create new buying power, which, coming into a restricted market for goods in addition to all the existing buying power, simply forces everybody to consume less because the money in their pockets fetches less goods owing to the rise in prices.

The evil attached to this system is obvious enough. It amounts to a tax on the general consumer in proportion to his consumption, and so it lays the sacrifice on the shoulders of those least able to bear it. No Government would have the courage to impose such a tax openly and frankly. All the warring Governments in varying degrees have used this roundabout device of imposing it, very likely being quite unaware of the fraud on the consumer that they were perpetrating. Our own Government, in fact, having first added by this process to a rise in the price of bread, then reduced it by a special subsidy—a pleasant touch of Alice in Wonderland finance. This mode of taxing by raising prices hits, of course, all those who live on fixed incomes and salaries and wages. Those who can strike, or take more out of the consumer, can evade it, and so it falls on the weakest shoulders and incidentally produces friction, discontent and dangerous suspicion. But even it works at the time when it happens. Each creation of new buying power gives the Government, for the moment, control of so much in goods and services at the expense of the consumer; but when once the new buying power has been distributed by the State's payments it is in the hands of the nation as a whole. If the process ceased, the nation would still have control of the whole of its output, which is its income, though the injustice involved, to those who are not strong enough to resist the effects of higher prices, would continue.

Thus, whatever means—straightforward or devious—are used for financing war, it is paid for while it goes on by the warring country if the financing is done at home, or by its foreign creditors if the financing is done abroad. And it is, necessarily, almost entirely paid for out of income, that is, out of current production. It is curious to find that many people still seem to think that the whole cost of the war has come out of capital. Luckily for us it could not be done, or only to a very small extent. Our capital mostly consisted of railways, factories, ships, roads, agricultural land, machinery, houses and other things that could not be taken and shot out of a gun. These things we have still got, and though many of them are not in such good shape as they were, some of them are much better equipped and organised. We have drawn on our stocks of materials and goods—how far it is impossible to say; we have lost 8-1/2 million tons of shipping by war losses; in the meantime we have built, bought and captured 5-1/2 millions of new tonnage, and we have a claim against the Germans for such tonnage. On capital account we have suffered by wear and tear in so far as our upkeep has been neglected owing to lack of labour during the war, and by depletion of materials and stocks, and also, of course, by the fact that if the war had not happened, we should, if pre-war calculations were correct, have put some L1700 millions into new investments at home and abroad during the 4-1/4 years of fighting and some more hundreds of millions during the after-war period of Government borrowing and restriction on private investment. But a very large part of the money that went into victory would otherwise have gone not to capital account but into the pleasant frivolities, embellishments and vulgarities that made life an amusing absurdity in days before the war.

If, then, the war sacrifice was made during the war, in so far as its cost was raised at home, how far is it true that we are now faced with the business of paying for it? If taxation were equitable it would only be to the extent that those who ought to have made the sacrifice and did not, will in future have to pay interest to those who did, or their representatives. So that the first thing we have to do is to make taxation equitable, that is, lay it on the taxpayer in proportion to his ability to pay. There will still remain the injustice to those who have fought for us, which might be cured, or amended, by special exemptions. With taxation on a really sound basis no further sacrifice would be involved by the debt charge, and no diminution of the nation's wealth or consuming power, which will depend, as always, on its output of goods and services; but only a transfer of consuming power from taxpayers to debt-holders in accordance with the sacrifice made by the latter during the war. What we produce as a nation we shall consume as a nation, subject to the extent that we financed the war during its course by operations abroad.

These operations were twofold. We sold to foreigners part of our holdings of foreign securities, thereby and to this extent paying for war cost out of capital—out of the investments made by ourselves and our forbears in America and elsewhere. Mr Bonar Law, in a recent interview in the Observer, stated that we had sent back to the United States practically the whole of our holdings of American securities to be sold or pledged as collateral for loans, and that the value of them was three billion dollars—L600 millions sterling. Any of them that have only been pledged can presumably be used to meet the loans raised as they fall due, and so will lighten our burden in the matter of repayment. These loans raised abroad are the second mode of foreign financing. By it we had raised up to November 9th nearly L1300 millions, as shown by the Economist's table, and to that extent we have pledged our future production and that of our posterity, to meet the annual service for interest and repayment. On the other hand, all this sum and more we have (as shown above) lent to our Allies and Dominions, so that the ex-Chancellor was well justified in his boast that we had only borrowed to finance our Allies, and that we had been self-sufficient for our own war cost.[1]

[Footnote 1: Budget Speech, Parliamentary Debates, vol. 105, No. 33.]

In other words, all that we needed for the war we were able to produce ourselves, or to obtain in exchange for our produce and assets. On paper, therefore, our position as a creditor country is only impaired by our sales of securities. But that is only so on paper. In fact, the loans that we have raised abroad are good debts that have to be met to the last penny, and are a first charge on our future output, but the advances that we have made to our Allies, much harder hit than we are by the war, are assets on which we cannot depend. They were taken in our balance-sheet above at half their face value, but there is much to be said for writing them off altogether and tearing up the I.O.U.'s of our foreign brothers-in-arms. Their need is greater than ours, it would be little satisfaction to receive interest and repayment from them, and the payment due from them, involving difficult problems of taxation for them, would not help the good relations with them which, we hope, may be a lasting effect of the war. And such an act of renunciation on our part would do something towards a restoration of the spirit with which we entered on war, a spirit which has been seriously demoralised during its course, largely owing to the results of our faulty finance, which encouraged profiteering in all classes.

In any case, there is our position. We have a big debt to meet at home and abroad, and we are weakened on capital account by foreign indebtedness, wear and tear of plant and dimunition of stocks and materials. Wear and tear and depletion we can soon make good if we set to work and work hard, if our bureaucracy takes away the fetters of its restrictions and controls (instead of making further additions to the "Black List" even after the armistice!), and if our ruling wiseacres will refrain from trying to stimulate industry by taxing raw and half-raw materials. For the debt charge many pleasant and simple fancy strokes are suggested. The Levy on Capital is popular, especially with those who do not own any, but its advocacy is by no means confined to them. Mr Pethick Lawrence has published a persuasive little book about it, but I cannot see that he meets the objections to it. These are, the difficulty of valuation, the fact that in many cases it would have to be paid by instalments, and so would be merely another form of income tax, its sparing of the waster and penalising of the saver, and, consequently, the grave danger that it would check accumulation and so dry up the springs of capital. Mr Stilwell has produced a "Great Plan to Pay for the War," by which all the belligerents and neutrals who have been involved in expense by the war would receive World Bonds from an International Congress for what they have spent owing to the war, and would then pay one another any international debts by exchanging these World Bonds, and deal with the home debt by paying it off in new currency raised on the World Bonds. But, surely, to pay off war debt with a huge addition to currency, making war's inflation many times worse, would be a disastrous beginning to that new era which is alleged to be dawning.

By hard work, sparing consumption of luxuries, and a big industrial output, we can soon make the debt charge look smaller and smaller as compared with our aggregate income. Our foreign debt we can only meet by shipping goods and rendering services. But since it was all raised to be lent to our Allies and our lending of it was essential to a victory which has rid mankind of a terrible menace, it is surely reasonable that our creditors should not press for repayment in the first few difficult years, but should fund our short-dated debts into loans with twenty-five or thirty years to run. As to the home debt, we can only lighten its burden on the taxpayer by making taxation equitable. To this end reform of the income tax is an urgent need. We have to lighten its pressure much more effectively on those who are bringing up families, and by collecting it through employers make it an effective and just tax on those of the working class whose earnings and family liabilities make them fairly subject to it.



XVIII

THE REGULATION OF THE CURRENCY

February, 1919

Macaulay on Depreciated Currency—Its Evils To-day—The Plight of the Rentier—Mr Goodenough's Suggestion—Sir Edward Holden's Criticisms of the Currency Committee—His Scheme of Reform—Two Departments or One in the Bank of England?—Not a Vital Question—The Ratio of Notes to Gold—Objections to a Hard-and-fast Ratio—The Limit on Note Issues—The Federal Reserve Act and American Optimism—Currency and Commercial Paper—A Central Gold Reserve with Central Control.

Everyone has read, and most of us have forgotten, the great passage in Macaulay's history which describes the evils of a disordered currency. "It may well be doubted," he says, "whether all the misery which had been inflicted on the English nation in a quarter of a century by bad Kings, bad Ministers, bad Parliaments and bad judges was equal to the misery caused in a single year by bad crowns and bad shillings.... While the honour and independence of the State were sold to a foreign Power, while chartered rights were invaded, while fundamental laws were violated, hundreds of thousands of quiet, honest and industrious families laboured and traded, ate their meals and lay down to rest in comfort and security. Whether Whigs or Tories, Protestants or Jesuits were uppermost, the grazier drove his beasts to market, the grocer weighed out his currants, the draper measured out his broadcloth, the hum of buyers and sellers was as loud as ever in the towns, the harvest-time was celebrated as joyously as ever in the hamlets, the cream overflowed the pails of Cheshire, the apple juice foamed in the presses of Herefordshire, the piles of crockery glowed in the furnaces of the Trent, and the barrows of coal rolled fast along the timber railways of the Tyne. But when the great instrument of exchange became thoroughly deranged, all trade, all industry, were smitten as with a palsy.... Nothing could be purchased without a dispute. Over every counter there was wrangling from morning to night. The workman and his employer had a quarrel as regularly as the Saturday came round. On a fair-day or a market-day the clamours, the reproaches, the taunts, the curses, were incessant; and it was well if no booth was overturned, and no head broken.... The price of the necessaries of life, of shoes, of ale, of oatmeal, rose fast. The labourer found that the bit of metal which, when he received it was called a shilling, would hardly, when he wanted to purchase a pot of beer or a loaf of rye bread, go as far as sixpence."

From some of the evils thus dazzlingly described we are happily free in these times. We are not cursed with a currency composed of coins which are good, bad and indifferent, with the result that the public gets the bad and indifferent while the nimble bullion dealers absorb and export the good. There is nothing to choose between one piece of paper and another, and all that is wrong with them is that there are too many of them. But the general result as it affects the labourer who wants to purchase a pot of beer or anyone else who wants to buy anything is very much the same. A bit of metal that is called a shilling has about the value of a pre-war sixpence and a bit of paper that is called a Bradbury fetches half as much as the pound of five years ago. Compared with what other peoples are suffering from the same disease arising from the same surfeit of money in one form or another, this nuisance that we are enduring is not too terribly severe. It has entailed great hardship on a class that is small in number, namely, those who have to live on fixed incomes. The salary-earner and the rentier have borne the brunt, while the wage-earner and the profit-maker have been able to expand their earnings, in paper, at least to a point at which the depreciation of currency have left them no worse off. Seeing that the wage-earners are those who do the dreariest and dirtiest jobs, and that the profit-makers are those who take the risks of industry and the enormous responsibility of organising enterprise, they are the classes whom it is clearly most desirable to encourage. The rentier in these days gets less than no sympathy, but we make a great mistake if we think that we can with impunity crush him between the upper and nether millstone of fixed income and rising prices. With his help we have equipped industry at home and abroad. We can, if we choose, by depreciating the currency still further, lessen still more the reward that we pay him for that benefit. He may kick, but he cannot abolish the equipment with which he has already provided industry. But if we make his life too hard he can strike like the rest of us, and by refusing to provide for any further expansion in industrial equipment, he can hold up production until we have devised some new method of laying up capital. Currency depreciation is good for the debtor and bad for the creditor; if it goes too far it kills the creditor and reduces business to chaos.

We are a very long way from the chaos to which many of our Continental neighbours have already reduced their monetary systems; but there is fortunately a very general feeling that we are a country with a reputation and a prestige on this point; and the business world is growing restive concerning the delay on the part of those responsible in putting an end to a state of things which may have been justified by the war's exigencies (though there is much to be said for the view that in fact it only added to the war's difficulties) but is now clearly as out of date as the censorship, which, like it, nevertheless, continues to flourish. This state of things arises from the arrangement tinder which an unlimited supply of legal tender currency can be manufactured by the Government, which encouraged to continue the system by the fact that each note issued is in effect a loan to itself without interest. At the meeting of Barclays Bank on January 27th, Mr. Goodenough demanded that the issue of currency notes by the Government should be stopped forthwith, and that if it were necessary to provide more currency it would be better for the banks to be allowed to issue notes themselves. This suggestion involves, of course, a complete reversal of the principles on which our monetary system has grown up, since it has long been based on a note-issuing monopoly in the hands of the Bank of England. But these are topsy-turvy days, in which greyheaded precedent is very justly at a heavy discount; and Mr Goodenough's suggestion very practically gets over a big difficulty that stands in the way of stopping the stream of Bradburys. This difficulty lies in the fact that if the banks were pulled at by their customers for currency and could not supply them with Bradbury notes, they would be forced to take notes from the Bank of England, with a bad effect on the appearance of its reserve. If the business of issuing notes were put into the hands of the clearing banks, their power to do so would be limited by the extent of their assets, or of such of their assets as were thought fit to rank as backing for their notes. In other words, the note-issuing business would once more have to be regulated on banking principles and controlled by the price asked, for advances, instead of expressing the helplessness and improvidence of an impecunious and invertebrate Government. In this manner the new departure might be a convenient halfway-house on the way from chaos back to sanity. But probably it is too revolutionary and goes too straight in the teeth of the Bank of England's privilege to receive much practical consideration; and there is the question whether the public would take the new paper readily and whether it could be made legal tender.

Sir Edward Holden, in one of those masterly surveys of world finance with which he now instructs the shareholders of the London Joint City and Midland Bank, assembled at their annual meeting, gave much of his attention to an attack on the report of Lord Cunliffe's Committee on Currency. This was only to be expected, since the Committee had made recommendations on lines which were largely conservative and did not embody any of the reforms or changes which had been previously advocated by Sir Edward. Being on this occasion chiefly critical, he did not make very clear in his latest speech the precise proposals that he favours. For them we have to go back to his speech of a year ago, as reported in the Economist of February 2, 1918, p. 171, where he stated that "if the Bank (of England) had been working on the same principles as other national banks of issue, there would have been little ground for anxiety," and that these principles are:—

1. One bank of issue and not divided into departments.

2. Notes are created and issued on the security of bills of exchange and on the cash balance, so that a relation is established between the notes issued and the discounts.

3. The notes issued are controlled by a fixed ratio of gold to notes or of the cash balance to notes.

4. This fixed ratio may be lowered by the payment of a tax.

5. The notes should not exceed three times the gold or the cash balance.

As will be remembered, the Cunliffe Committee recommended that the division of the Bank of England into an Issue Department and a Banking Department, should be retained; that the old principle by which above a certain fixed limit all notes should be backed by gold, should also be retained, but that if at any time a breach of this rule should be found necessary it should be possible, with the consent of the Treasury, and that Bank rate "should be raised to a rate sufficiently high to secure the earliest possible retirement of the excess issue." Since it was formerly only possible to exceed the limit on the fiduciary issue by a breach of the law, under the Chancellor of the Exchequer's promise to get an indemnity for it from Parliament, and since Treasury tradition insisted on a 10 per cent. Bank rate whenever such a breach was permitted or contemplated, it will be seen that the Cunliffe Committee proposed some considerable modifications in our system and hardly justified Sir Edward's assertion that it "proposed that the Bank should continue to work under the Act of 1844 as heretofore."

At first sight there seems to be a good deal of difference between Sir Edward's ideal and Lord Cunliffe's, but is not the difference to a great extent superficial? Whether the Bank be divided into two departments, each presenting a separate account, or its whole business be regarded as one and stated in one account, seems to be rather a trifling question. And the arguments put forward for their several views by the two champions are not strikingly convincing. Sir Edward wants only one account, because he thinks the consequence would be a stronger reserve and fewer changes in bank rate. But a mere change of bookkeeping such as the amalgamation of the two accounts would not make a half-pennyworth of difference to the extent of the Bank's responsibilities and its ability to meet them, and it is on variations in these factors that movements in bank rate are in most cases decided. On the other hand, Lord Cunliffe and his colleagues argue that the main effect of putting the two departments into one would be to place deposits with the Bank of England in the same position as regards convertibility into gold as is now held by the note. On this point Sir Edward's answer is telling: "In reply to this statement, I say that the depositors at the present time can always get gold by drawing out notes from the reserve and taking gold from the Issue Department. There seems to be little difference between the depositors attacking gold direct and attacking the gold through the notes in the reserve. If the Bank cannot pay the notes when demanded the whole machinery stops." Quite so. The notion that the holder of a Bank of England note has now a stronger hold over the Bank's gold than the depositor seems to be baseless. He can exercise his hold more quickly perhaps, though even this is doubtful. Since banknotes are not legal tender at the Bank of England, it is not quite clear that the depositor would even have to take the trouble to go first to the Banking Department for notes and then to the Issue Department for gold. He might be able to insist on gold in immediate payment of his deposit. Still less convincing is the Committee's argument that "the amalgamation of the two departments would inevitably lead in the end to State control of the creation of banking credit generally." Their report might have explained why this should be so, for to the ordinary mind the chain of consequence is not apparent. On the whole it is hard to see much good or harm to be achieved by changing the form of the Bank return. It might make the Bank's position look stronger, but it could not make it really stronger. Nor would it really impair the strength of the note-holder's position as against the depositor, because even now there is no essential difference. It would substitute a more businesslike and simple statement for a form of accounts which is cumbrous and stupid and Early Victorian—a relic of an age which produced the crinoline, the Crystal Palace and the Albert Memorial. On the other hand, to alter a statistical record merely for the sake of simplicity and symmetry is questionable. Unless we are getting more and truer information, it is a pity to make comparisons between one year and another difficult by changing the form in which figures are given.

A more essential difference between the two policies lies in Sir Edward's advocacy of a ratio—three to one—between notes and gold, and the Committee's support of the old fixed line system. By the latter, if gold comes in, notes to the same extent can be created, and if gold goes out notes to the amount of the export have to be cancelled. Under Sir Edward's policy the influx and efflux of gold would have an effect on the note issue which would be three times the amount of the gold that came in or went out. This at least is the logical effect of his statement that "the notes should not exceed three times the gold or the cash balance." This law does not seem to be quite consistent with his view that the fixed ratio of gold to notes may be lowered by the payment of a tax; but presumably the tax would come into operation before the three to one part was reached, and at three to one there would be a firm line drawn. On this assumption the Committee's argument is a very strong one. "If," says its report (Cd. 9182, p. 8), "the actual note issue is really controlled by the proportion, the arrangement is liable to bring about very violent disturbances. Suppose, for example, that the proportion of gold to notes is actually fixed at one-third and is operative. Then, if the withdrawal of gold for export reduces the proportion below the prescribed limit, it is necessary to withdraw notes in the ratio of three to one. Any approach to the conditions under which the restriction would become actually operative would then be likely to cause even greater apprehension than the limitation of the Act of 1844." Certainly if, during a foreign drain, for every million of gold that went out, another two millions of credit, over and above, had to be cancelled, it is easy to imagine a very jumpy state of mind in Lombard Street and on the Stock Exchange. Sir Edward and the Committee seem to be agreed as to a limit on the note issue, but of the two limiting systems the old one advocated by the Committee, though apparently more severe, would seem to have much less alarming possibilities behind it.

A point on which the commercial world does not seem to have made up its mind, however, is whether there should be a limit at all. Under the old Act there was a limit which could only be passed by a breach of the law. Under the Cunliffe proposal the limit could be passed with the consent of the Treasury. Sir Edward has not told us of what machinery he proposes for the passing of the limit which he lays down; but in view of the great apprehension that an approach to the limit point would, as shown by the Committee, produce, it is clear that there would have to be a way round. In Germany there is no limit; you pay a tax on the excess issue and go on merrily. In America it would seem that the German system has been taken for a model. In his speech on January 29th Sir Edward quoted Senator Robert Owen, who was the principal pioneer of the Federal Reserve Bill through the Senate, as follows:—"The central idea of the system is elastic currency issued against commercial paper and gold, expanding and contracting according to the needs of commerce.... It is of great importance that the volume of these notes should contract when the commerce of the country does not require the notes to be circulation, and the reserve board can require them to be returned by imposing a tax upon the issue.... Under the reserve system a financial panic is impossible. People will not hoard currency nor hoard gold when they know that they can get currency or get gold when required.... America no longer believes a financial panic possible, and therefore the business men, being perfectly assured as to the stability of credits, do not hesitate to enter manufacturing and commercial enterprises from which they would be deterred under old conditions of unstable credit." Well, let us hope the Senator is right and that America is right in believing that a financial panic is no longer possible there. But one cannot help feeling that such a belief may be rather dangerous in the minds of people so ready to take rose-coloured views as our American cousins. The Federal Reserve system has worked beautifully in a period in which American finance has had nothing to do but rake in the enormous profits of American production at the expense of warring Europe and lend part of them, to be spent in America, to the Allied belligerents. It may work equally well if and when the problem to be faced is different, but it will be interesting to see—for those of us who live to see—what sort of a tax will be needed to "require" America, in one of its holiday moods, to return currency that it thinks it needs and the Federal Reserve Board regards as redundant.

Another point on which Sir Edward lays great stress, in his attack on the Bank Act of 1844 and the Committee which supports its main principles, is the beauty of the bill of exchange as backing for a note issue, as opposed to Government securities. "There is," he says, "no automatic system for the redemption of currency notes as would be the case if they were issued against bills of exchange, which in due course would have to be paid off." Again, "it seems to me that notes should not be issued against Government securities which may or may not be paid off, but against bills of exchange which must be met at due date." This advantage about a bill of exchange is a very real one to the individual holder who can always put himself in funds by letting the contents of his portfolio "run off"; but is there much in it as a safeguard against excessive issue of currency in times of exuberance? In such times bills that fall due are pretty sure to be replaced by new ones drawn against fresh production—since over-production is a common symptom of commercial exuberance—or against a resale of the goods on which the original bills were based. As long as anyone who can show produce can be certain to get credit and currency, the notion that the maturing of bills of exchange can be relied to restrict currency expansion within safe limits is surely a dangerous assumption. The principle of a fixed limit, to be broken in case of real need, but only after some ceremony has been gone through giving notice of the fact that a crisis has been reached, seems rather to be required by the psychology of speculative mankind. But even if Sir Edward's preference for bills of exchange as backing for notes has all the merits that he claims that is no reason for urging the repeal of the Bank Act to secure their use. Because the Bank Act does not forbid it: it merely says, "there shall be transferred, appropriated and set apart by the said governor and company to the Issue Department of the Bank of England securities to the value of," etc. It is the practice of the Bank to put Government securities into the Issue Department, but the terms of the Act do not compel them to do so, and if an excess issue were needed they would seem to be empowered to put any bills that they discounted into the assets held against the note issue. On the whole the terms of the Act leaving them freedom in the matter, except with regard to the "Government debt" of L11 millions, which is specially mentioned as to be transferred to the Issue Department, seem to be preferable to a special stipulation in favour of bills of exchange.

But the most important difference between Sir Edward Holden and the Cunliffe Committee seems to be in their attitude towards the gold reserve and the relation between the Bank of England and the rest of the items that compose the London money market. The Committee, working to restore the conditions which made our market the centre of the world's finance, endeavoured to give back the control of the central gold reserve to the Bank of England by suggesting, among other things, that the other banks should hand over their gold to it. They omitted to discuss the serious question of the greater difficulty that the Bank is likely to find in future in controlling the price of money in the market, owing to the huge size that the chief clearing banks have now reached. But a central gold reserve under central control was evidently the object at which they aimed. Sir Edward will have none of this. He says that if this were done the position of the Joint Stock banks would be weakened, though he does not explain why, since they would obviously hold notes in place of their gold and so would be able to meet their customers' demands, now that the latter are accustomed to the use of notes for pocket money. He points out that "the gold which was held by the Joint Stock banks before the war proved most useful.... At the beginning of the war the banks paid out gold, satisfied the demands of their customers for small currency, and thus eased the situation until currency notes became available." He seems to have forgotten that the banks, or most of them, refused to part with their gold, paid their customers in Bank of England notes which, being for L5 at the smallest, were of little use for pocket money, and so drove them to the Bank to get gold; and we had to have a prolonged bank holiday and a moratorium. Sir Edward is in favour of three gold reserves, one to be held by the Government, one by the clearing banks, and one by the Bank of England. If there were differences between the three controllers of the reserve at a time of crisis the consequence might be disastrous.

In view of the admiration expressed by Sir Edward for the new American system which is so clearly based on central control it is rather illogical that he should be so strongly in favour of independence on this side of the water. His opinion is that "the policy of the Joint Stock banks ought to be to make themselves independent of the Bank of England by maintaining large reserves in their vaults." Independence and individualism are a great source of strength in most fields of financial activity, but in view of the great problems that our money market has to face there seems to be much to be said for co-operation and central control, at least until we have got back to a normal state of affairs with regard to the foreign exchanges.



XIX

TIGHTENING THE FETTERS OF FINANCE

March, 1919

The New Meaning of Licence—The Question of Capital Issues—Text of the Treasury Regulations—Their Scope and Effect—The Position of the Stock Exchange—Wider Issues at Stake—Should Capital be set Free?—The Arguments for and against—Perils of an Excessive Caution—The New Committee and its Terms of Reference—The Absurdity of prohibiting Share-splitting—The Storm in the House of Commons—Disappearance of the Retrospective Clause—A Sample of Bureaucratic Stupidity.

A contrast between liberty and licence is a pleasant alliterative commonplace beloved by political writers, especially those with a reactionary bias. In the light of recent events it seems to be going to take a new meaning. Licence will soon be understood, not as the abuse of liberty, to which democracies are prone, but as a new weapon by which our bureaucracy will do away with liberty by tightening the shackles on our economic and other activities. For imports and exports the licence system is already familiar; if the mines and railways are to be nationalised we may have to be licensed before we can burn coal or go away for a week-end; if the Eugenists have their way a licence will be necessary before we can propagate the species; and before we can get a licence to do anything we shall have to go through an exasperating process of filling in forms innumerable, inconsistent, overlapping and incomprehensible. Finance is the latest victim of this melancholy tendency. Under the guise of an attempt to give greater freedom to it a system has been introduced which makes a Treasury licence necessary, with penalties under the Defence of the Realm Act, for doing many things which have hitherto been possible for those who were prepared to forgo the privilege of a Stock Exchange quotation. Let the story be told in official language, as uttered through the Press Bureau, on February 24th, in "Serial No. C. 10917."

"In view of the changed conditions resulting from the conclusion of the armistice, the Treasury has had under consideration the arrangements which have been in force during the war for the control of New Issues of Capital.

"The work of scrutinising proposals for new Capital Issues has been performed during the war by the Capital Issues Committee, the object being to refuse sanction for all projects not immediately connected with the successful prosecution of the war. The decisions of the Treasury, taken upon the advice of this Committee, have, however, not had any binding force, beyond what is derived from the emergency regulations of the Stock Exchange, which forbids dealings in any new Issues which have not received Treasury consent.

"While it is not possible under existing financial conditions to dispense altogether with the control of Capital Issues, it has clearly become necessary to reconsider the principles upon which sanction has been given or refused in order that no avoidable obstacles may be placed in the way of providing the Capital necessary for the speedy restoration of Commerce and Industry, and the development of public utility services.

"In view of the numbers of the proposals for fresh Issues of Capital which are to be expected, it is necessary to provide further machinery for dealing with them and for making the decisions upon them effective.

"A regulation under the Defence of the Realm Act has accordingly been made prohibiting all Capital Issues except under licence from the Treasury, and the Capital Issues Committee has been reconstituted with new Terms of Reference, which are as follows:—

"'To consider and advise upon applications received by the Treasury for licences under Defence of the Regulation (30 F) for fresh Issues of Capital, with a view to preserving Capital during the reconstruction period for essential undertakings in the United Kingdom, and to preventing any avoidable drain upon Foreign Exchanges by the export of Capital, except where it is shown to the satisfaction of the Treasury that special circumstances exist.'

"It will be an instruction to the Committee that, in order that applications may be dealt with expeditiously and to enable oral evidence to be given in support of them when desired by the applicant, that the Committee should sit by Panels consisting of three members, the decision of the Panels to be subject to confirmation by the full Committee.

"All applications for licences most be made, in the first instance, in writing on a Form which can be obtained from the Secretary of the Capital Issues Committee, Treasury, S.W. 1.

"Before any application is refused the Committee will give the applicant an opportunity of giving oral evidence in support of his case."

The notice then proceeded to recite the terms of D.O.R.A. 30 F, of which more anon. Next day came a supplementary announcement, "Serial No. C 10938," as follows:—

"With reference to the recent announcement in the Press that all applications for Treasury licences must be made in writing on a form obtainable from the Secretary of the Capital Issues Committee, Treasury, S.W. 1, delay will be avoided if intending applicants will state which of the following forms they require:—

"Form No. 1. Issue by a proposed New Company to start a fresh business.

"Form No. 2. Issue by an Existing Company (other than for the purpose of capitalising profits).

"Form No. 3. Issue by an Existing Company for the purpose of capitalising profits.

"Form No. 4. Conversion of a Firm into a Limited Company which does Not involve the introduction of fresh capital.

"Form No. 5. Conversion of a Firm into a Limited Company which Does involve the introduction of fresh capital.

"If none of the above Forms appears to be applicable (as, e.g., in amalgamations, sub-divisions of shares, etc.), a statement of the facts should be submitted in writing."

Before we go on to consider the new regulation, 30 F, let us try to see what is the real effect of the document above quoted. It was evidently intended to be a relaxation of the control of finance. This is shown by the sentence which says that the matter was to be reconsidered "in order that no avoidable obstacle may be placed in the way of providing the capital necessary for the speedy restoration of commerce and industry, and the development of public utility services." And yet it was thought necessary to give legal force and attach penalties to regulations that have worked during the war quite sufficiently well to secure a much stricter control than is now required. The explanation of this apparent inconsistency is probably to be found in the desire of the Government to meet a grievance of the Stock Exchange. Hitherto the only penalty that befell those who made a new issue without getting Treasury sanction was that the securities issued could not be dealt in on the Stock Exchange. The practical effect of this was that those who acted without Treasury sanction could only issue securities subject to this serious drawback, and so an effective but not altogether prohibitive bar was put on the process. If this bar was not strong enough in war-time it ought clearly to have been strengthened long ago; if it was strong enough, then why should it be strengthened now?

From the Stock Exchange point of view it is easy to make out a good case for working through licence and penalty rather than through the banning, of the securities effected, from sanction for dealings. By thus being used as an official weapon the Stock Exchange penalised itself and its members. By saying "no security not sanctioned by the Treasury shall be dealt in here," its Committee restricted business in the House and drove it outside. This grievance was obvious and was plentifully commented on during the war. If the Committee had pressed the point vigorously it could probably have forced the Government long ago to abolish the grievance by making all dealings in new issues that appeared without Treasury sanction illegal and liable to penalty. A patriotic readiness to fall in with the Government's desires was probably the reason why the Stock Exchange refrained from embarrassing it, during the war, by too active protests against a grievance that was then more or less real; though it should be noted that even if the grievance had been amended, the Stock Exchange would not necessarily have got any more business, but would only have succeeded in stopping a very moderate amount of business that was being done by outsiders. But when all is said that can be said for the justice of the case that can be made by the Stock Exchange, the question still arises whether it was advisable, at a time when relaxation of restrictions was desirable in the interests of the revival of industry, to draw tighter bonds which had been found tight enough to do their work. That the Stock Exchange should suffer from limitations from which outside dealers were exempt was certainly a hardship. On the other hand, since the armistice there has been a considerable expansion in Stock Exchange business. Oil shares, Mexican securities, industrial shares, insurance shares, and others in which capitalisation of reserves and bonus issues have been used as an effective lever for speculation, have enjoyed spells of considerable activity. With this revival in progress, in spite of many obvious bear points, such as industrial unrest at home, Bolshevism abroad, the continuance of heavy expenditure by the Government, and the hardly slackened growth of the national debt, it seems to have been scarcely necessary in the interests of the House to have made regulations which, though perhaps demanded by abstract justice, imposed new ties on enterprise at a time when complete freedom, as far as it was consistent with the best interests of the country, was most of all desirable.

How far, we have next to ask, is it necessary for the best interests of the country to restrict the freedom of capital issues? If we look back at the terms of reference under which the reconstituted Committee is to work, we see that the officially expressed objects are (1) preserving capital for essential undertakings in the United Kingdom, and (2) preventing any avoidable drain upon Foreign Exchanges by the export of capital. There is certainly much to be said for both these objects. When we lend money to foreigners we give them the right to draw on us now in return for their promises to pay some day; in other words, we make an invisible import of foreign securities, and in the present state of our trade balance all imports, whether visible or invisible, need careful watching. It is also very evident that at a time when capital is scarce there is much to be said for keeping it for essential industries, especially those which produce necessaries and goods for export, and not allowing it to be swept up by borrowers who are going to devote it to making expensive fripperies on which big profits are probable.

There remains a very big other side to both these questions. All over the world there is a demand for goods which have not been produced, or only in greatly reduced quantities, during the war. This demand is only effective in so far as willing buyers can pay; some of them have the needful cash in hand or waiting in London or elsewhere to be drawn on, but a great number of would-be buyers want to be financed, and will have to be financed by somebody if the needs that they feel are to be translated into actual purchases. In other words, in order that the wheels of industry are to be set turning as fast as they might, if they had a full chance, somebody has to lend freely. Now, it is surely most of all important in the national interest that those wheels should begin spinning as fast as possible, and the question is whether we are more likely to serve that interest best by keeping a meticulous eye on the course of exchange and buttoning up our pockets to foreign borrowers or by leaving capital free to seek its market, knowing that every time we give the foreigner the right to draw on us we stimulate our export trade, because his drawing must finally mean a demand on us for something—goods, securities or gold—and goods are what people are in these times most anxious to take. If we are going to leave all the financing to be done by America and fear to import promises to pay lest they should be followed by demands on our gold, shall we not be rather in the position of Barry Lyndon, who was given a gold piece by his mother when he went out into the world, with strict injunctions always to keep it in his pocket and never to change it? Regard for our gold standard is most necessary, but the gold standard is not an end in itself, but merely an important part of a machine which only exists to serve our industry. If we are so careful of the machine, which is a mere subsidiary, that we check the industry which it is there to serve, we shall be like the dandy who got wet through because he had not the heart to unfurl his beautifully rolled-tip umbrella.

Again, it looks very sound and sensible to keep capital for purposes that are essential, but, on the other hand, it is so enormously important to set industry going as fast as possible that almost any one who will do anything in that direction is entitled to be given a chance. In war-time, when labour and materials were so scarce that they could not turn out all the munitions that were necessary, such a restriction was clearly inevitable. Now, when labour and materials are becoming more plentiful, and the scarce commodity is the pluck and enterprise that will take the risks involved by getting to work on a peace basis, it may be argued that any one who will take those risks, whatever be the stuff or services that he proposes to produce, should be encouraged rather than checked. It is again a question of the balance of advantage. If we are going to be so careful in seeing that capital is not put to a wrong use that we take all the heart out of those who want to make use of it, we shall do more harm than good. If by leaving capital free to go into any enterprise that it fancies we can give a start to industry and promote a spirit of courage and enterprise among its captains, it will be well worth while to do so at the expense of seeing a certain amount of capital going into the production of articles that the community might, if it made a more reasonable use of its purchasing power, very well do without. The same question arises when we consider the desire of the Government, not expressed in the above statement, but very freely admitted by Mr Bonar Law, in discussing it in the House of Commons, to keep capital to be lent to it rather than expended in, perhaps unnecessary, industry. Here, again, it is clearly in the interest of the taxpayer that Government loans should be raised on the most favourable terms possible. But if, in order to do so, we starve industry of capital that it needs, and so check the production on which all of us, Government and citizens alike, ultimately have to live, we shall be scoring an immediate advantage at the expense of future progress—spoiling a possibly brilliant break by putting down the white ball for a couple of points.

There is thus a good deal to be said for setting capital free, before we have even arrived at the most serious objection to regulating it under Treasury licence. This objection is the exasperation, delay and uncertainty involved by this control. Even if we had an ideally wise and expeditious body to decide about capital issues it might not be the best thing to set it to work. But when we remember that in order to see that the wrong sort of issue is not made, all issues will have to pass through the terribly slow-working process of official selection before the necessary licence is finally granted, it begins to look still more likely that we should do well to run the risk of letting a few goats through the gate, rather than keep all the sheep waiting outside for months, with the probable result that many of them may lose altogether their chance of final salvation. It will be noted from the official statement that the arbitrary methods of the old Committee are to be modified. It has long been a by-word among those who had dealings with it; they abused it in quite sulphurous language and were wont to quote it as an example of all that bureaucratic tyranny is and should not be, thereby doing some injustice to our bureaucrats, seeing that the Committee was manned not by officials but by business men, clothed pro hac vice in the thunder of Whitehall. The new Committee is to sit by panels of three, so as to expedite matters, and so as to allow applicants the privilege of giving oral evidence. This is an innovation that will save some exasperation, but it will hardly accelerate matters, especially as the decision of the panels will be subject to confirmation by the full Committee, so that all the work will have to be done twice over. There is thus much reason to fear that delay, so fatal in business matters, will be an inevitable offspring of the efforts of the new Committee, and the list of different forms on which applications are to be made, given above, shows that all the paraphernalia of red tape will dominate the proceedings.

Now for the terms of the new Regulation under the Defence of the Realm Act.

"1. The following regulation shall be inserted after Regulation 30 EE:—

"30 F. The following provisions shall have effect in respect of new capital issues and to dealings in securities issued for the purpose of raising capital:

"(1) No person shall, except under and in pursuance of a licence granted by the Treasury—

"(a) issue, whether for cash or otherwise, any stock, shares or securities; or

"(b) pay or receive any money on loan on the terms express or implied that the money is to be or may be applied at some future date in payment of any stock, shares or securities to be issued at whatever date to the person making the loan; or

"(c) sub-divide any shares or Debentures into shares or Debentures of a smaller denomination, or consolidate any shares or Debentures of a larger denomination; or

"(d) renew or extend the period of maturity of any securities; or

"(e) purchase, sell or otherwise transfer any stock, shares or securities or any interest therein, or the benefit of any agreement conferring a right to receive any stock, shares or securities, if the stock, shares or securities were issued, sub-divided or consolidated, or renewed or the period of maturity thereof extended, or the agreement was made, as the case may be, at any time between the 18th day of January, 1915, and the 24th day of February, 1919, and the permission of the Treasury was not obtained to the issue, sub-division, consolidation, renewal or extension or the making of the agreement, as the case may be.

"(2) No person shall except under and in pursuance of a licence granted by the Treasury—

"(a) buy or sell any stock, shares or other securities except for cash or when the purchase or sale takes place in any recognised Stock Exchange, subject to the rules or regulations of such exchange.

"(b) buy or sell any stock, shares or other securities which have not remained in physical possession in the United Kingdom since the 30th September, 1914.

"(3) A licence granted under this regulation may be granted subject to any terms and conditions specified therein.

"(4) If any person acts in contravention of this regulation, or if any person to whom a licence has been granted under this regulation subject to any terms or conditions fails to comply with these terms or conditions, he shall be guilty of a summary offence against these regulations.

"(5) In this regulation the expression 'securities' includes Bonds, Debentures, Debenture stock, and marketable securities."

It will be seen at once that the terms of this document, on any interpretation of them, go far beyond the intentions expressed in what may be called the official preamble and in the new Committee's terms of reference. One of the clauses seems, with all deference to its august composers, to be merely silly. This is (1)(c) forbidding sub-division of securities. If a L10 share is split into ten L1 shares this operation cannot make the smallest difference to the supply of capital for essential industries or cause any drain on the Foreign Exchanges. I am assured by those who have delved into the official intention that the reason for the objection of the old Committee to splitting schemes, on which this new prohibition is based, was that splitting made shares more marketable and popular and so more likely to compete with War Bonds. But a mere sale of shares, split small and so popularised, does not absorb any capital. That only happens when, money is put into some new form of industry. If A, who holds ten L20 shares, is enabled to dispose of them to B because they are split into 200 L1 shares, then, A instead of B has got the money and has to invest it in something. The amount of capital available for investment is not diminished by a halfpenny. This regulation is just a piece of short-sighted tyranny which exasperates without doing the smallest good to anybody.

More serious, however, was clause (1)(e) under which any securities that have been issued, split, consolidated or renewed without Treasury sanction since January, 1915, were not to be dealt in, in future, without a licence. The result of this clause, if it had stood, would have been that all loans under which such securities had been pledged would have had to be called in because the collateral became unsaleable, except after all the ceremonies had been gone through and a licence had been got. It was also possible to argue that the prohibition to renew or extend the maturity of any security meant that no loans of any kind could be renewed, and that no commercial bills could be renewed, without a licence. It is true that No. 5 paragraph says what the expression "securities" includes, but it does not state definitely that bonds, Debentures, Debenture stock and marketable securities are the only things included. It was a pretty piece of drafting, and raised a pretty storm in the House of Commons on February 27th, when a somewhat lurid picture of its effects was drawn by Sir H. Dalziel and Mr Macquisten. Mr Chamberlain not being then legally a member of the House, it fell to the lot of Mr Bonar Law to explain that the Government had really meant to give greater freedom, in making new issues, that the evils anticipated had not been intended, that he hoped the House would not judge the Government too harshly for not making unsanctioned issues illegal from the beginning, and that a new Order would be issued removing the retrospective effect of the new regulation. And so amendment was promised of a measure which would have had very awkward and unjust effects. It may be argued that it would only have affected people who had done, during the war, what they were asked not to do, namely, make issues without Treasury sanction. If the old Committee had been a reasonable and expeditious body this argument would have had great weight. But, in view of its caprices and dilatoriness, there was a good deal of excuse for those who decided to do without Treasury sanction and take the consequence of being unable to market their securities on the Stock Exchange. To propose to add a new penalty and cause the cancelling of all the financial arrangements made in connexion with such issues during four years was simply piling blunder on blunder. Luckily, the protests of the Government's own supporters sufficed to undo the worst of the mischief; but the whole affair is only another argument in favour of the earliest possible ridding of finance and industry from control that is so clumsily exercised.



XX

MONEY OR GOODS?[1]

December, 1918

[Footnote 1: This was the latter of two articles contributed to the Times Trade Supplement in answer to a series in which Mr Arthur Kitson had attacked our banking and currency system suggested an inconvertible paper currency.]

"Boundless Wealth"—Money and the Volume of Trade—The Quantity Theory—The Gold Standard—How is the Volume of Paper to be regulated?—Mr Kitson's Ideal.

In the November Trade Supplement an endeavour was made to answer Mr Kitson's rather vague and general insinuations and charges against our bankers concerning the manner in which they do their business. Now let us examine the larger and more interesting problem raised by his criticism of our currency system.

In his article in the June Supplement he told us that "if the British public had any grasp of the fundamental truths of economic science they would know that a future of boundless wealth and prosperity is theirs." This is a cheery and encouraging view and, let us hope, a true one. But, that boundless wealth can only be got if we work for it in the right way. Can Mr Kitson show it to us, and what are these "fundamental truths of economic science"? It is easier to talk about them than to find any two economists who would give an exactly—or even nearly—similar list of them. Mr Kitson glances "at a few elementary truths." "Wealth," he says, "is the product of two prime factors, man and Nature, generally termed labour and land. With an unlimited, or practically unlimited, supply of these two factors, how is it that wealth is and has been hitherto so comparatively scarce?" But is the supply of "man" unlimited in the sense of man able, willing, and properly trained to work? And is the supply of "Nature" unlimited in the sense of land, mines, and factories fully equipped with the right machinery and served and supplied by adequate means of transport? Surely the failure In production on which Mr Kitson so rightly lays stress is due, at least partly, to lack of good workers, good organisers, good machinery, and good transport facilities. Workers who restrict output, employers who despise science and cling to antiquated methods, the opposition of both classes to new and efficient equipment, and large tracts, even of our own land, still without reasonable transport facilities, have something to do with it. And lack of capital—this answer to the question Mr Kitson flouts because, he says, "since capital is wealth," to say that "wealth is scarce because capital is scarce is the same as saying that wealth is scarce because it is scarce." But is it not a "fundamental truth of economic science" that capital is wealth applied to production? Wealth and capital are by no means identical. When a well-known shipbuilding magnate laid waste several Surrey farms to make himself a deer-park, the ground that he thus abused was still wealth, but it is no longer capital because it has ceased to produce good food and is merely a pleasant lounging-place for his lordship. May not the failure of production be partly due to the fact that, owing to the extravagant and stupid expenditure of so many of the rich, too much work is put into providing luxuries—of which the above-mentioned deer-park is an example—and too little into the equipment of industry with the plant that it needs for its due expansion?