D. A. (Dalgairns Arundel) Barker.

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The Cambridge Manuals of Science and



i i


ftotrton: FETTER LANE, E.C.

C. F. CLAY, Manager

«Ftinliurg{) : 100, PRINCES STREET

Berlin : A. ASHER AND CO.


#rto gorfe: G. P. PUTNAM'S SONS

Wtmbm arOi Calcutta: MACMILLAN AND CO., Ltd.

All rights reserved

ffambrrtjgc :


With the exception of the coat of arms at
the foot, the design on the title page is a
reproduction of one used by the earliest known
Cambridge printer, John Siberch, 1 5 2 1




THE object of this little book is to provide the
reader with a stepping stone from which,
fortified with a firm grasp of elementary principles,
he may proceed to the study of more ambitious
works. An attempt has been made to give a sketch
of the theory of money in its more practical aspects,
but, owing to limitations of space, many subjects
of importance have been altogether omitted. No
mention has been made of bi-metallism, of index
numbers, of the "cost of production" theory, or,
indeed, of many other questions which will be foimd
discussed in more systematic treatises. To such
treatises, therefore, the reader must go in order to
complete his studies. The classic Lombard Street
of Bagehot and Mr Hartley Withers luminous work
The Meaning of Money present the subject of
monetary theory from the point of view of the
" city man." Similar, but more technical, books are
Mr George Clare's Money Market Primer and
his Foreign Exchanges. Money and Monetary
Problems by Professor Nicholson should be read



by every student. The chapters devoted to bi-
metallism, and other kindred subjects, in Colonel
Walker's Political Economy are extremely lucid and
will be found useful by beginners, whilst the corre-
sponding portions of the late Professor Sidgwick's
Principles of Political Economy afford useful
examples of profound reasoning to the more ad-
vanced reader. Last, there is the monumental work
of Mr Dunning Macleod — The Theory and Practice
of Banking — which, in its historical chapters at any
rate, will richly reward any reader who has leisure
to attempt its perusal. To all the books mentioned
the author himself has to acknowledge his in-
debtedness, but more particularly to the work of
Mr Macleod.

Sacombuky, Ware,

August 12, 1910.



I. Cash and Credit



The Money-Market in Theory

The Hydraulic Model ....

The Foreign Exchanges in Theory

The Foreign Exchange and the Hydraulic Model

The Bill of Exchange .

VII. A Banking Balance-Sheet

VIII. The Foreign Exchanges in Pr
IX. The Bank of England .

X. Gold Reserves.

Index ....








We propose, in this chapter, to take our readers
to a strategic point of the modern commercial system,
to the counter of a country bank, to watch with them
the customers who come there to do business, and to
follow out the consequences of their demands.

The first to appear is a farmer, come to cash a
cheque, in order that he may be able to pay wages to
his men that evening. We will suppose that it is the
autumn of a year in which the harvest has been
unusually good and that the demand for agricultural
labour is eager. The cheque, therefore, is large, but
it is only one of many that have been presented
lately by the farmers of the neighbourhood. Next
comes a builder. He has been employed in repairing
a farm-house which, in less prosperous years, would
have continued in disrepair, and he also wants some
ready money for wages. Next, a shopkeeper who,
under the stimulus of increased sales, wishes to start
a branch in a neighbouring village, and comes to
apply for a loan. Everybody seems to want ready

b. l


money and the manager of the bank finds his balance
dwindling rapidly. Where is he to turn for money ?
Appeals to the other branch banks in the same
neighbourhood would of course be unavailing, for
their coffers are also becoming empty. His sole
resource, therefore, is to telegraph to his London
agent for such a supply of notes and cash as he
requires ; for it is in London that the spare money of
the whole country is kept. In every civilised country
there is a centre at which spare money can most
advantageously be employed. To this centre, there-
fore, the spare money of the country will flow, and
from this centre it must in any emergency be obtained.
The Yorkshire farmer who draws upon his country
banker really draws upon London; the Nebraska
miner who sends gold to a national bank really
supplies New York. The proposition which we wish
to establish is this : — More trade means a need for
more money, and more money can be obtained only
from the monetary centre of the country concerned.
The effects of such a withdrawal from the monetary
centre will be examined at a later stage, but it will
be necessary in the meantime to state more fully and
to subject to certain qualifications the first half of our
proposition ; that more trade means a need for more

Suppose that A has bought goods from B to the
value of £100. A may pay B by giving him a


hundred sovereigns, or by giving him a cheque on a
banker C for £100, or by accepting a (say) three
months bill of exchange for £100 drawn on him by B.
In the first case, when A pays down the £100, there
has been a cash payment and no credit has been
given. In the second case, when A pays by
cheque, there has been a cash payment but credit of
a sort has been given. In the third case, where A
accepts a bill of exchange, B has given three months
credit to A. But the term "credit" as used in the
second case bears a different meaning from that with
which it is used in the third. In the second case
" credit " is synonymous with confidence ; in the third
case " credit " implies not only confidence but also a
willingness to make a loan of money. Where B
accepts a cheque from A he shows his confidence in
the sufficiency of A's banking account and in the
solvency of his banker. Where B agrees to receive
payment in the form of a three months bill of exchange
accepted by A he thereby agrees to wait three months
for payment (thus in reality lending £100 to A for
three months) and also shows his confidence that A
in three months time will be able to repay the loan.
Now, if for any reason, B begins to suspect that A or
his banker is likely to fail he will, as a prudent man,
refuse to accept payment by cheque or by bill, and
will demand the payment of one hundred sovereigns,
the value of which will not be affected by any



misfortune that may happen to A. But the effect of
B's refusal to take a cheque may be different from
the effect of his refusal to take payment by a bill of
exchange. If B refuses to take a cheque A will have
to pay him in gold, and thus there will be a temporary
demand for one hundred sovereigns which would
otherwise not have been needed. If B had not been
suspicious he would have accepted A's cheque, and
paid it into his bank, and there would have been
no demand for money at all. But as it is, A will
have to take the rejected cheque to his bank, take
out gold in exchange, and pay it over to B. It is
true that B may pay the gold back into the same
bank almost immediately afterwards, but still for that
interval the bank has been compelled to provide £100,
and its position was the weaker to that extent,
however short the interval might be.

If, on the other hand, B refuses to take payment
in the form of a bill of exchange, not because he is
suspicious of A's position, but because he is unwilling
to allow A to borrow from him through the means of
a deferred payment, A will be able to pay by cheque,
and the demand for money is not greater than it
would otherwise have been. If B, in addition to
wanting immediate payment, is also suspicious of A
he will demand sovereigns, and the effect, as explained
above, will be a temporary demand for one hundred
sovereigns which would otherwise not have been


needed. We see, therefore, that a refusal to give
credit, where " credit " is synonymous with confidence,
has the effect of causing an increased demand for
cash, but that a refusal to give "credit" where
"credit" implies a loan, has no such effect.

The supply and demand for money, then, is
strongly affected by changes in the state of credit
or confidence. Increasing confidence will mean a
less demand for money; decreasing confidence will
mean a greater demand for money, quite apart from
any changes in the volume of trade. And it may well
be that changes in the volume of trade may be
neutralised by changes in the state of credit so that
increasing trade accompanied by increasing con-
fidence, or decreasing trade accompanied by decreasing
confidence, may lead to no changes in the demand for
money. Our original proposition that more trade
creates a need for more money, is none the less true,
but it might perhaps be stated better : Other things
being equal, more trade creates a need for more
money ; or else, More trade tends to create a need
for more money.

It is sometimes objected that although this
proposition may be true, that although more trade
may tend to create a need for more money, yet that
modern trade is carried on to such a large extent
by the aid of credit instruments, such as cheques,
that the increased demand for money will be of an


insignificant character. A, for example, buys a plot
of land from B and gives him a cheque in payment
which B pays into his bank ; and the transaction is
thus completed without any demand for cash at all.
Such an example, however, is quite misleading, for it
is obvious that a trade boom is not composed entirely
of transactions such as this, but must necessarily
involve many others in which cash payments are
essential. Even if all wholesale dealings were settled
by cheque the corresponding retail transactions would
still be settled principally in cash, and wage payments
must, as a rule, be made in the same way. Under
existing conditions the use of credit instruments
applies to a certain proportion of the total number of
transactions, but that proportion will not be increased
merely because the total number of transactions
increases, and there must, therefore, under such
circumstances be a substantial demand for more
money when trade expands in volume.

More trade, then, tends to create a need for more
money, and this money, as has been observed above,
must generally be obtained from the monetary centre
of the country concerned. When trade is slack and
money accumulates in the coffers of the country
banker, he will send it up to London to find employ-
ment until such time as it will be wanted again in
the country. When trade is brisk the country banker
will get his supplies of gold from London to hold until


the strain is over. It is to London, also, that
borrowers come to find on what terms they can
borrow money. It is the equation of supply and
demand in this monetary centre which we have to



We must now consider the nature of the business
transacted by a typical banking institution situated
at a monetary centre such as that described in the
last chapter; and for such information we turn
naturally to the balance sheets periodically issued by
the bank for the benefit of the public. These balance
sheets, however, contain on both sides details which
are not essential to the limited scope of this chapter
and which may, therefore, for our present purpose,
be omitted. In its most simplified form the balance
sheet may be represented as follows :

Liabilities £ Assets £

Deposits of Cash 4,000,000

customers 20,000,000 Investments ... 2,000,000

Loans to customers 14,000,000

£20,000,000 .£20,000,000

To avoid the complications which would arise if
we had to consider transactions between many
different banks, we will suppose that this represents


the consolidated balance sheets of all the banks at
our monetary centre; the items shown here being
simply the totals of similar items in the individual
balance sheets. The total liability of all the banks,
then, amounts to £20,000,000, and against this lia-
bility they can show £4,000,000 of actual cash,
£2,000,000 invested in securities, and £14,000,000
lent to customers.

Firstly, then, as to the item "deposits of customers."
To the average non-commercial man a bank is merely
an agency for keeping his spare cash and for collecting
the money due on cheques payable to him. For him
a " deposit " really is a deposit, and the use of such a
word naturally leads him to believe that the sum of
£20,000,000 entered under this description has actually
been deposited in the banks by their customers. But
the nature of his mistake is revealed by considering
the case of the commercial man who wishes to borrow
from a bank. This would-be borrower, we will
suppose, is an enterprising man and asks for a good
round sum, say, one million sterling; in which re-
quest the bank manager good-naturedly acquiesces.
Having obtained his loan, the borrower has to decide
what to do with it. He might, in very unusual
circumstances, ask for cash down, but, as a general
rule, the bank will give him a credit on its books,
and he will draw cheques against that credit as
necessity arises. What will be the effect of this


transaction on the balance-sheet? If he asks for
cash the item " cash " will be reduced by one million
sterling and the item " loans to customers " will be
increased by a similar amount, thus:

Liabilities £ Assets £

Deposits of Cash 3,000,000

customers 20,000,000 Investments ... 2,000,000

Loans to customers 15,000,000

.£20,000,000 £20,000,000

But if he merely accepts a credit in the bank's books
the change will be as follows :

Liabilities £ Assets £

Deposits of Cash 4,000,000

customers 21,000,000 Investments ... 2,000,000

Loans to customers 15,000,000

£21,000,000 £21,000,000

In this latter case we see that there has been a
change on both sides of the account, and that the
items "deposits of customers" and "loans" have
both been increased to the extent of one million
pounds. This is, then, the important point, that a
loan by the bank to a customer increases the item
"deposits," and that "deposits" therefore are not
made up, as they might seem to be, merely of idle
balances and savings, but also of credits given by the


But we have not yet arrived at the end of the
transaction. The borrower would not have asked for
a loan unless he wished to spend the money, so we
may presume that he will shortly draw cheques on
the lending bank to the amount of one million pounds.
In consequence of this, his credit for one million will
be extinguished and the amount of " deposits of
customers " at that bank will be reduced by a similar
amount. But if, as will very likely be the case, the
cheques drawn by the borrower are payable to
residents in the same monetary centre, the recipients
of the cheques will send them to banks of this centre
and the amount of customer's deposits at these banks
will be increased by the sum of one million pounds.
Considering all the banks of this centre as one we
see, therefore, that the consolidated balance-sheet
will still show " deposits of customers " to the amount
of twenty-one million pounds. It may be objected
that some of the cheques drawn by our millionaire
borrower might have been sent to persons resident
in the country and paid by them into a country bank.
But even then, owing to the tendency of money to
collect at the monetary centre, the country banker
would probably use the cheque to obtain a credit for
that amount with his central agent, and the result
would be the same as if the cheque had originally
been paid into one of the central banks. Even if the
borrower wishes to use his credit to pay a creditor


living in a foreign country he will do so by buying
a bill on that country from a bill-merchant, and will
pay for the bill with a cheque. The bill-merchant
will pay that cheque into his banking account, and
so, as before, the sum total of customers' deposits
remains at the amount of twenty-one million pounds.
Twist the matter as we may, the loan of one million
has increased customers' deposits by an equal

It would appear, then, that provided a borrower
is willing to take his loan in the form of a credit on
the bank's books, and provided that the person to
whom he gives cheques return these cheques to a
bank for collection, the process of credit-making may
go on indefinitely, since its only effect is to increase
the items " deposits of customers " and " loans." And
since the banks benefit by the credits which they
give, and the customers of the banks benefit by the
credits which they get, it appears, further, that the
process of credit-making would go on indefinitely
unless it were stopped by some powerful and universal
forces. The nature of these forces has to a certain
extent been indicated by the qualifications of the
above statement, but, to make the matter more clear,
we will give an example of their working. For this
purpose let us take the case of a very small borrower,
one who is content to apply for the modest sum of
£100, and let us consider how this loan will affect


the banks according to the different ways in which it
may be used. In practical life the ways of using
money vary from expenditure on fireworks to ex-
penditure on raw materials for the purposes of in-
dustry; but for our present purpose, fortunately
enough, there is no necessity to attempt any definition
of luxuries or necessaries, of investment or ex-
penditure. It is sufficient to avoid the difficulty by
taking extreme cases and neglecting all intermediate
forms. As already explained the primary effect of
the loan has been to increase the total of customers'
deposits by £100. In the first place, then, suppose
that our borrower decides to spend his money on
fireworks. If he pays by cheque, and the seller of
fireworks, as he probably will do, sends the cheque
to his own bank, the total of customers' deposits will
remain increased by an amount of £100 as in the
case of the millionaire borrower. The buyer may,
however, elect to draw one hundred sovereigns from
his bank, and pay for the fireworks in cash. If he
does this, the item "deposits of customers" will be
reduced by the amount of £100 to its former level,
and the item "cash" will be reduced by a similar
amount. But this state of affairs will not last long.
The firework seller will find money accumulating in
his till, and shortly after the purchase he will send
(say) £100 in cash to the bank. This will increase
the items "deposits of customers" and "cash" and


the consolidated balance-sheet will finally be precisely
the same as if only cheques had passed.

But now suppose that our borrower, instead of
spending his money on luxuries, decides to use it
in engaging some labourers for the more intensive
cultivation of his farm. He engages, then, three
labourers at thirteen shillings a week, and uses his
borrowed money to pay their wages. In order to be
able to pay his increased wages bill he will have to
withdraw from his bank thirty-nine shillings more
than he used to do. But at the end of the year, if he
has laid his plans well, he will find that his increased
receipts are at least sufficient to enable him to cover
the payment of interest to the bank and to continue
to employ the three extra men without borrowing
any more money. As long as this investment of
£100 remains, three more labourers will remain
employed than there would otherwise have been, and
this extra employment leads to a greater demand for
cash. In consequence of more earning there is more
spending ; the local shops do a brisker trade and keep
a larger sum in their tills. All this implies that the
money drawn out of the bank by means of the
borrower's cheque does not all drift back to the bank
via the pocket of the labourer and the till of the
shop ; part of it, indeed, will do so, but part will
remain in circulation, and will, to that extent,
diminish the items "deposits of customers" and


" cash." But when the loan was used to buy fireworks
we saw that neither of these items were affected.
It is the variations of the latter item which are of
greatest importance, and roughly speaking, we may
say, therefore, that loans which are used by the
borrowers for reproductive purposes will cause a
demand for cash, while loans used merely for un-
productive expenditure will not do so. But most
loans are used for reproductive purposes and therefore
imply a demand for cash, and it is this demand which,
as we shall see, puts a limit to that indefinite ex-
pansion of credit which otherwise would be to the
advantage of both banks and customers 1 .

There is, however, another aspect of the question
to be considered. Suppose that at the end of the
year the manager of the bank considers that he is
lending too freely, and refuses to renew the loan of
£100. The farmer, if he cannot borrow from else-
where, will be unable to continue to employ the three
extra men whom he had engaged on the strength of
the loan. Consequently his weekly wage-bill will be
decreased, and so will the taking of the shops once
patronised by the dismissed labourers. There will

1 Another potent check to the indefinite expansion of credit will
be explained at a later stage. It lies in the action of the foreign
exchanges. An expansion of credit tends to cause a rise of prices
and so to produce an outward flow of gold. Then the bankers, in
order to maintain a proper proportion of cash to liabilities, will have
to contract their credits.


therefore be a small but definite decrease in the
amount of money required for wage payments and
retail transactions, and the money so displaced will
drift back to swell the cash reserves of the banks at
the monetary centre. Thus we reach the conclusion
that a contraction of loans, in so far as it causes
a contraction of trade, will tend to increase cash
reserves. In this connection it is necessary to
observe that a contraction of loans is sometimes
spoken of as a contraction of credit ; that the term
"credit," as already noticed, has two meanings and
that its indiscriminate use is therefore likely to cause
confusion. In one case a contraction of credit means
a contraction of loans, and so may be an indirect cause
of increased cash reserves. In the other case a contrac-
tion of credit connotes a feeling of insecurity which
may cause an unusual demand for payments in coin,
and so tend to diminish the cash reserves of the bank.
The term "cash" implies actual money in the
coffers of the bank. This reserve of cash is the only
perfectly reliable reserve which a banker can keep.
In times of acute panic he may be unable to sell his
securities, and equally unable to call in his loans to
customers, but the gold in his vaults cannot depreciate
in value, and it cannot run away. If, therefore, we
wish to get a rough indication of the financial
strength of a bank we must work out the proportion
of "cash" to "deposits of customers." Some banks


are more cautiously conducted than others and show
a higher proportion of cash to liabilities, but broadly
speaking, it may be said that bankers as a body will
not permit this proportion to fall below a certain
figure. Loans for productive purposes, as we have
explained above, necessarily imply an increased
demand for cash, and this can only be obtained from
the banks. But a continuous fall in the amount of
cash in the banks, whether accompanied or not by a
change in the amount of deposits, will rapidly reduce
the proportion of cash to liabilities to a dangerously
low figure, and there will be an immediate check to
the extension of credit. The most daring of bankers
will cease to lend when his cash reserve has shrunk
beyond a certain point. On the other hand, the most
cautious will increase his loans when cash becomes

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Online LibraryD. A. (Dalgairns Arundel) BarkerCash and credit → online text (page 1 of 9)