The Principal Currency Drains.

The principal currency drains occur during the holiday season and at harvest time, more especially during the latter period, when large amounts of cash are sent into the country to satisfy the requirements of labour. Early in November a demand for gold arises in Scotland, owing to the fact that rents there fall due at Martinmas (11th November); and as the Scotch banks, by the Act of 1845, are compelled to hold gold against notes circulated in excess of their authorised issues, a rather heavy call is made upon the Bank of England, whose returns then show a noticeable decrease in the reserve and bullion. During years of active trade, and, consequently, of brisk demand for loanable capital, these autumnal drains of gold generally force up the rate of interest, thereby making the last quarter of the year the dearest for borrowers.

But we are discussing internal demands only, and as, so long as gold does not leave the country, it is merely a question of certain sums flowing from the London money market and drifting back to it again, this ebb and flow, which is shown by the various ups and downs occurring from time to time in the items of the Bank return, does not create any apprehension. Indeed, these movements occur so regularly at certain times of the year that large borrowers often anticipate them in order that they may tide over such periods with the minimum of inconvenience. It is, however, otherwise when gold is leaving the country in large quantities in order to settle the balance of our indebtedness to other nations, for that may not come back. How it is again enticed to these shores I will endeavour to explain.

We now come to a foreign drain of gold; and this depletion of the currency, we know, flows from the store at the Bank of England into the hands of the foreign creditors of the nation. We export to, and import from, other nations on a gigantic scale, and as our imports are invariably in excess of our exports, it follows that the balance of indebtedness on this score is always very considerably against us; but there are other debts due to this country which from time to time turn the balance in favour of England, and the prices quoted for bills on the various Exchanges are the indexes which tell us whether gold is likely to be either received from, or sent to, the great commercial centres of the world.

Other debts due to this country have been mentioned—debts which either tend to reduce or turn in our favour the balance we owe to foreign countries. England has immense sums invested in foreign securities, and the interest received therefrom acts in this direction. So, too, does the huge sum earned by her ships in the shape of freights. Then, again, London, still earns a large amount in the shape of commissions, even if her position as the Clearing House of the world is now less powerful than formerly, owing to large accumulations of capital in other centres.

On the other hand a considerable amount of foreign capital is invested in English securities, which, when sold on the Stock Exchange, give the foreigner a claim on our stock of gold; and though we, by similar sales of foreign securities, can prevent this temporary drain of specie, the enormous dealings in stocks and shares on the various Exchanges are most keenly watched by the directors of the Bank of England, lest huge realisations of British securities by foreigners should drain the Bank of its gold, with which international indebtedness can alone be settled.

This brings us to the markets for bills of exchange, the prices of which, like those of every other security, are settled by supply and demand. If, at a given date, this country owes a foreign nation considerably more than it has to receive, then bills on England will be plentiful in that country; and, further, they will be cheap, because, as debtors to England have less to remit than the aggregate of bills on England offered for sale, the supply will be in excess of the demand, and English bills, consequently, can be bought at a discount. Conversely, the supply of bills in London on the foreign country will be smaller than the sum English debtors owe therein, and in order to save the expense of exporting gold, such bills will be eagerly sought after, and, as the supply is smaller than the demand, buyers soon drive them to a premium, when the rate of exchange is said to be "unfavourable" to England.

As the balance of our international indebtedness must be cancelled by gold, it follows that the fewer the bills offering the higher will be the prices paid for them; and when, just towards the end, it becomes evident that the supply is limited the bidding is often spirited; but the premium paid cannot exceed for any considerable length of time the expense incurred by exporting and insuring the precious metals between any two countries, as the debtor always has the choice of despatching gold to his foreign creditor, and, naturally, he chooses the cheaper expedient.

The extreme fluctuations are called "gold points," and they mark the limit to premiums procurable on bills of exchange. The table given below will show us those points at which gold will probably either leave or reach this country:

When the rates are near those given in the second column, the Bank, if its reserve be low, begins to consider the advisability of raising its rate of discount, for it is evident that foreign bills are at a stiff premium, and that a demand for gold may be made upon it at any moment. Of course the difference between the "gold points" gives scope for speculation, and some cambists gamble in bills for the rise or the fall just as speculators do in securities. Then, again, the arbitrageurs largely influence prices by buying and selling securities which are dealt in on the Stock Exchanges of more than one country. Wars, revolutions, panics, and social upheavals also cause abnormal fluctuations in the rates.

Let us assume that a drain is threatened from Paris. The gold in an English sovereign is, we can see, worth about 25·22½ francs, and if only 25·12½ is being offered on 'Change, it follows that bullion will soon be exported to France. This the Bank wants to prevent. The cost of transmission of bullion between the two countries is about one half per cent.; therefore, in order to induce French capitalists to invest in English bills of three months' date, the rate of interest in London must be more than two per cent. in excess of that in Paris before it will pay them to ship bullion to this country, if it be the intention of the purchasers to withdraw their capital when the bills mature, as the gain of two per cent. per annum for three months only just balances the loss of 10s. per cent. incurred on specie shipments, while no margin is left to defray possible loss through unfavourable exchanges at the time of withdrawal. Were a purchase of six months' bills contemplated, the difference in the two rates would only have to exceed one per cent. before bullion could be exported profitably.

When, therefore, the Bank of England wishes to influence the foreign exchanges, it raises its rate by one, instead of by one half as is usual when the drain is caused by the currency requirements of this country, or by an increased demand for loanable capital when trade is active and the foreign exchanges favourable. One constantly hears the question: Why has the Bank of England raised the rate by one instead of by one half as it did last time? A glance at the foreign exchange tables will generally supply the answer. If the expenses for transporting and insuring bullion between any two countries are appreciable, then were the Bank rate raised by one half (remembering that an addition of one half per cent. per annum gives a profit of only 2s. 6d. per cent. on a transaction in three months' bills) it is evident that the inducement is not sufficient to attract gold over here for that consideration alone.

By raising its rate, and, if necessary, borrowing in the market in order to bring the market rates in touch with its own, the Bank makes an investment in English bills a profitable transaction; and the greater its excess over foreign rates, the stronger is the inducement to send money to England. Of course, were this country really living on its capital, this influx of gold would only postpone the inevitable day of settlement, for a bankrupt does not increase his wealth by borrowing from one person in order to pay off another. But our receipts do not always coincide with our payments; and when, for instance, gold is sent to the United States in the autumn to help to pay for crops imported here, the Bank of England, by raising its rate of discount, and making that rate a representative one, attracts gold from the Continent, in order to tide over the interval between debts payable by us immediately and debts due to us at a future date.

English bills being a profitable investment, the price of paper on England at once begins to rise, and when the so-called gold point is reached the precious metals are shipped to these shores, because the premium on bills on England is in excess of the cost of despatching bullion. Every rise in the rate of discount here induces foreign holders of long-dated paper on England to retain their purchases. If they bought three months' bills on England when the Bank's discount rate was three, interest at the rate of three per cent. per annum was deducted from the face value of the bill to make it equivalent to a bill due at sight. Should the minimum rate be raised to four per cent., and were the holders then to remit the bills to this country to be discounted, they would have to submit to a deduction at the rate of four per cent. per annum. In other words, they would lose one per cent. per annum on the transaction. Long-dated bills would therefore be held until near maturity in order to avoid this loss.

An accretion to the Bank rate, then, not only attracts gold or capital here, but it also induces foreign holders of long-dated bills on England to keep them in their cases. On the other hand, a fall in the Bank's rate of discount from, say, three to two per cent. might not only slacken the demand for English bills, but it would also cause a considerable number of long-dated bills on England to be sent over here to be discounted, as the foreign holders would naturally be anxious to secure the profit between the three per cent. per annum paid to them, and the two per cent. per annum at which they would then be taken from them. The result might possibly be a temporary drain of gold from this side.

But it is when a home and a foreign efflux of gold occur at the same time that the situation becomes serious, and unless immediate action is taken by the directors of the Bank of England to check the outflow, there is always the danger—so small is our gold reserve when contrasted with our exports and imports—that a balance against us at an unlucky moment may create an awkward tension, which, unless speedily relieved, may possibly produce a crisis.

We like to flatter ourselves that England is always safe; but so large is the amount of bills offering from day to day in the London money market that the very doubt of there not being sufficient capital in the possession of the banks to discount them creates uneasiness; and if it were thought that the Bank of England, which holds the few millions of reserve upon which hundreds of millions of credit rest, could not retain its gold, excitement would reach fever pitch in this country, for everybody's income would be in danger, and the Government, whose supineness allowed such a state of affairs to develop, would be in danger too. But we know that, in the rate of discount, the directors of the Bank possess an effective instrument to prevent such a catastrophe, and have the experience to use it to advantage.

Money begins to leave the Bank for internal circulation during the summer months in order to meet the demands created by the holidays and the harvest, and then in October there is always the probability of a large outflow of gold to the States to help pay for the crops imported therefrom; while the movement of specie to Scotland in November, occurring as it does just at a critical moment, is likely to cause some apprehension, should the Bank's reserve have been depleted earlier, unless the fact that it is merely a temporary transfer to enable the Scotch banks to comply with the Act of 1845 be thoroughly grasped.

The October drain of gold from the Bank when the New York exchange is unfavourable has in it an element of danger, especially if it happen at a time when the reserve at the Bank of England is unusually low; and if loanable capital be then abnormally scarce there is always the risk that the end of the year requirements may produce a tension, which, should credit be bad at the time, may develop into a panic.

If the Bank manage well, however, it fortunately often foresees that the autumnal demands may possibly impose a severe temporary strain upon its resources, and by raising its rate in anticipation of a short period of exceptional demand, it attracts gold to itself in order to be thoroughly prepared for possible large depletions of currency later on, for it is easier to accumulate gold before the event than to check an outflow when the movement is beginning to create uneasiness, and to attract attention to the lack of preparedness on the part of the Bank to meet large withdrawals of specie for export.

It is not my intention to write a treatise on the foreign exchanges, and I am quite well aware that I have only touched on the fringe of a great subject; but if these illustrations help, however slightly, to elucidate certain of those undercurrents which determine prices, then the sole aim of this chapter has been attained.