The London Money Market.

It is usual, when describing the Money Market, to assert that it consists of the numerous banks in the City of London; but it seems to me that, in reality, the money market extends throughout the United Kingdom, for wherever there is a bank or a branch bank there is a market for money. Moreover, the demand arising for loanable capital in the provinces largely influences the rates of interest ruling from time to time in London, because, if demand is brisk in the country, the banks have less to lend in London, consequently the rate advances there.

When reference is made to the money market the London short loan fund is invariably meant, and we now have to consider how this fund is formed. The banks, which are liable to the public for huge sums of money at call and short notice, are obliged to keep a certain proportion of cash in their tills and strong rooms and with the Bank of England in order to be prepared for any sudden demand that may be made upon them.

Their cash in hand is, of course, required to meet the ordinary demands of a banking business, and that deposited with the Bank of England is held as a reserve fund against those risks of withdrawal from which a credit institution owing immense sums at call is never free. Roughly speaking, a well-managed bank would keep, say, six per cent. of its public liabilities in legal tender on the premises, and a further ten to twelve per cent. at its credit in the books of the Bank of England. The latter accumulation might be called the bank's real reserve, for it is upon this that it would have to rely during a run.

Secondly, from eighteen to thirty per cent. of its liabilities to the public would be invested in first class securities. Those of and guaranteed by the British Government are in great request for this purpose, as the Bank of England would not hesitate to advance against such investments should a company find itself compelled to meet a sudden drain upon its resources. Every prudent banker therefore takes care that a large proportion of these securities is included in his list, which would also contain Metropolitan and other Corporation Stocks, English Railway Debentures, Colonial Government Securities, and so on. A banker's list, in short, should be a so-called "gilt-edged" one.

Thirdly, a banker lends a certain proportion of his deposits in the London money market. Some banks have eight per cent. there, some fourteen per cent., and others from fifteen to twenty per cent., though the larger and better managed companies generally employ from seven to fourteen per cent. therein. A certain amount of this "call money," however, represents money which has been lent to jobbers and brokers on the Stock Exchange for "carrying over" purposes at the various settlements, but by far the larger part of it is money which has been lent to the bill brokers and discount houses.

In no sense can this asset in the balance sheets of the banks be looked upon as a reserve. It is money invested in the London short loan market—money lent to the bill brokers, who, in times of bad credit, might not be able to repay it on demand. Just at the very moment when bankers are most in need, this asset is the least available; therefore, it is about the worst possible form in which the reserve of a credit institution, owing large sums at call, can be invested.

As a credit bank's debts are due at call and short notice, a true reserve can only consist of legal tender, and the till money, which is required in the ordinary course of business during normal times, certainly cannot be classed with that reserve. When considering what is a bank's real cash reserve, we ought to deduct from four to five per cent. from the ratio of cash in hand and with the Bank of England to liabilities, for a trader would not include the cash required from day to day in his business with any reserve he might accumulate against accidents.

Reverting to investments, we might take Consols as an illustration of their liquidity. During normal times Consols can be sold for cash at any moment, but it is otherwise in a time of panic, when practically everybody wants either to sell them or to borrow upon them. The market is then disorganised, and people require either gold or large credits at their bankers—not securities. Hence, even Consols are unsaleable when a panic develops into a crisis.

As the Bank of England holds the cash reserve of the nation, it alone can advance against securities in the midst of a crisis, and those banks which were caught short would then have to apply to the Bank for help. The Bank certainly would not lend upon any but gilt-edged securities during a time of stress, and if their customers then made a call upon them those companies which held second-rate investments would have to close their doors, as they could not obtain assistance from any other source. A strong list of securities is, therefore, essential to every bank that is anxious to protect its customers against disaster.

These three assets (cash in hand and at the Bank of England, money at call and notice, and investments) constitute a bank's so-called liquid assets. The ratio of total liquid assets to liabilities maintained by the best English banks ranges from 43 to 78 per cent. The last-named figures, which are quite exceptional in their strength, were published by Stuckey's Banking Company. The remainder of a bank's resources is employed in making advances and loans, and in discounting bills for its clients, whilst a small proportion is locked up in premises.

We can now form some idea as to what the short loan fund of the London money market really is. Immense sums are collected at the head offices of the banks in London through their metropolitan and provincial branches; and, as the demands of trade are always uncertain—now brisk, then slack—it is impossible for them to invest all their surplus capital in securities; consequently, a certain portion of it finds remunerative employment in this channel.

A huge stream of credit is constantly circulating through the three kingdoms, and London, so to speak, is the heart of the system. In years of active or good trade this stream increases in volume, and during years of depression it contracts; yet it is difficult to say whether or not the resources of the banks (the floating capital of the country) are appreciably lessened during a period of temporary depression, although the national turnover unquestionably is, as may be seen by the Clearing House returns. During years of rising prices and increasing trade activity profits are augmented, and, consequently, the resources of the banks are swollen; but when the profits are invested within the country, a similar amount of credit is returned to the banks by those who have sold their securities, and though less capital is created when trade is dull, it is questionable whether the resources of the banks then shrink very greatly, unless foreign securities are largely purchased.

We have seen that this stream of credit flows to London, and as demand throughout the country is not sufficiently strong to attract it all back again, a large fund of loanable capital accumulates in the hands of the London banks, and flows from them to the bill brokers, who employ it in discounting bills of exchange. But though by far the greater part of the London short loan fund is accumulated in this manner by the banks, other firms and companies also discharge their surplus capital into it. The pool, of course, is not a stagnant one, for capital is constantly flowing in and out.

The India Council, for instance, lends large sums in the London short loan market. The numerous foreign and colonial banks in London do the same, and so, too, do many of the large insurance companies and merchants, while during slack times money finds its way from the Stock Exchange to the bill broking houses. At first sight it seems strange that bankers should advance money to the bill brokers, and so provide their rivals with capital with which to compete against them, especially as the banks have discount departments of their own.

Let us, however, consider the position of the bill broker in relation to the Bank of England and the money market.

Towards the beginning of the nineteenth century the broker acted as agent for the country bankers, but this connection was naturally severed when the country firms opened accounts with the London bankers, and the broker, whose knowledge of bills was extensive, then transacted business for himself. Through holding out for high rates, the London private bankers drove a large amount of business into the hands of the bill brokers, who, by confining their attention solely to this class of credit document, came to be largely trusted by the joint stock companies, which could not obtain servants with the special training of their rivals.

In no other country has the bill broker such influence as in England. In Paris, for instance, the customer discounts with his banker, who re-discounts with the Bank of France; but in London, for reasons already stated, bills find their way to the bill brokers, who re-discount either with the banks or with the Bank of England. Moreover, all the best bills get into the hands of the bill brokers, who, at one time, only discounted the acceptances of the banks and the larger houses; but they now take small trade bills, and, should the banking business grow less profitable, it is questionable whether the banks might not endeavour to dispense with the middleman whom they now encourage.

We next have to consider the London money market as a whole. First we find a system which comprises Lombard Street and Threadneedle Street. In other words, the London banks, by keeping accounts with the Bank of England (Threadneedle Street), have placed that institution in the centre of the system, and we know the Bank derives great power from this situation; but its power is not innate—it is derived through and is dependent upon Lombard Street. This group we will call "the money market" or "the market."

Then we have the bill brokers, of whom we will speak as "the outside market." Every morning the bill broker goes from bank to bank inquiring at what rates he can borrow; and if Lombard Street (the London banks) cannot supply him with all the capital he requires, then he is compelled to apply to the Bank of England, which, however, he always endeavours to avoid, because the Bank invariably charges him a higher rate than do the other banks.

The Bank of England is a great bank of discount: consequently, the brokers are its rivals; so it is hardly reasonable to expect the Bank to charge the same rates to them as to its own clients, seeing that the brokers, by their competition, reduce the Bank's business. When trade is brisk loanable capital is in considerable demand, and the banks, therefore, have less money to lend to the bill brokers, who consequently are then driven to the Bank, which holds the bankers' balances.

But the Bank of England's position is an extremely delicate one; and when the resources of Lombard Street are temporarily exhausted and demand centres upon itself, it has to take care that its ratio of reserve of notes and cash in the Banking Department does not sink too low in proportion to its liabilities. Should the demand upon its resources prove considerable, it raises its rate until the pressure is reduced. As a large part of the trade of this country is conducted through the medium of bills of exchange, it is absolutely essential that there should always be a market for good bills. Otherwise, panic and failures would be the result; so, were the Bank to refuse to take bills from the brokers at a price, our credit system would collapse at once, unless the banks themselves, determined to crush the brokers, offered to deal direct with the holders. But the experiment would be a most risky one to make. Moreover, it could not be attempted at a critical moment.

When Lombard Street is not lending freely, or cannot lend further with comparative safety, the Bank, by raising its rate of discount from time to time, reduces the merchant's profit on each transaction, until at last money becomes so dear that he finds that he is making little or no profit on his goods. He therefore produces less, and, consequently, discounts less, when the pressure upon the Bank relaxes.

So long as money may be obtained, let the price paid for it be what it may, a sense of security pervades the community; but were it whispered during a period of temporary tightness that the Bank refused to discount good bills at any price, our credit system would be in imminent danger, for the trade of the country would be at a standstill. Further, did such a state of affairs continue for many days, the crash would come, and the Bank of England would then be swept away with the rest of the market. Our present system is so delicately poised that the Bank simply dare not refuse to take good trade bills from the brokers.

We next come to the other side of the picture. The broker, when he goes his rounds, sometimes finds that the surplus resources of the banks are abundant, and that they are ready to let him have even more than he requires. When he makes this discovery, he begins to higgle, to try to ascertain the lowest rate certain banks are prepared to accept; for the difference between the rate at which he discounts bills for his own customers and the rate at which he re-discounts or borrows, is his margin of profit, and he is naturally anxious to make it as wide as possible. (The poor man, be it remembered, does not visit Lombard Street simply because he finds the air pure and the society of bank officials congenial.) He therefore does his best to discover those banks which are in funds, and, having found them, to induce them to lend as cheaply as possible. This he can do when loanable capital is cheap and abundant, and the Bank of England probably doing but little business. Possibly, though the Bank rate is at two and a half, bills are being taken by the brokers at one and a half. Then the Bank, in order to get business, either lowers its rate of discount or else, by selling stock, endeavours to lessen the resources of Lombard Street.

If the Bank adopt the latter expedient, it usually sells Consols for cash, and buys them back for the account, thereby temporarily reducing "bankers' balances," and attracting business to itself. The banks, having less to lend, raise their rates, which then approximate more closely to the Bank rate.

The brokers often complain bitterly of this interference by the Bank of England with the market's supply of loanable capital, asserting that this artificial enhancement of rates by the reduction of bankers' balances through the sale of stock affects their business injuriously, and benefits the Bank but little; and it certainly is difficult to see how the Bank of England can make a profit out of the transaction.

On the other hand, when the market rate is appreciably below the Bank rate, it is impossible to attract foreign gold to London; and the Bank, by borrowing on Consols, and making its rate representative, is acting in the public interest, should it be desirable either to attract gold to this country or to prevent its leaving these shores.

We can now see that the Bank of England, though it states its minimum rate, is often powerless to transact business thereat; and, recognising that its own rate is out of touch with the market rate, the Bank often discounts bills for its own customers at the rates ruling in the open market, as, were it to refuse to do so, its clients would naturally take their bills to the cheapest house. When, however, Lombard Street is empty, and the bill brokers are compelled to approach the Bank which holds the final reserve, the Bank of England is frequently in a position to charge its rivals one per cent. above its declared minimum, and the bill brokers quite naturally feel a little sore. For this reason they try every source of supply before making application to the Bank.

As security against loans made to them the brokers usually deposit either bills which they have discounted in the ordinary course of their business or gilt-edged securities, but sometimes the bill broker's credit is so good that the banks lend him money at call practically without security. When securities are deposited they are of course returned directly the loan is paid off.

There is also another little point to which attention may be drawn: to wit—that, although the market we are discussing is a special market, yet if a borrower's credit be good it is generally possible to obtain an advance either at or about Bank rate.