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Rh England it consisted before the war of gold sovereigns and half- sovereigns and Bank of England notes, which could be tendered up to any amount; silver coins, which could be tendered for payments of not more than forty shillings; and bronze coins up to 12 pence. Since, as will be seen, the amount of Bank of England notes that could be issued depended strictly upon the amount of gold held by the Bank, it thus followed that the amount of gold at the Bank of England and in the hands of the other banks limited the amount of banking currency which the banks were able to create, owing to the fact that this banking currency was convertible on demand into legal-tender cash. This was the justification for the statement that the basis of British credit was gold; but it should be remembered that this statement only conveys half the facts of credit creation. Gold was the basis of credit in so far as it limited the amount which the bankers could prudently make themselves liable to provide if called upon; but another and very important part of the basis of credit consisted of the wealth and standing of the borrowers and the security which they were able to offer for the repayment of the loans, advances and discounts through the creation of which new credit was produced and new banking money was put into circulation.

Returning now to the group, described above, that conducted credit operations in the City of London before the war, we find at the centre of it the Bank of England, whose strength and pres- tige depended on the fact that it was banker to the British Government and so was believed to be able always to rely upon its support in time of crisis, and also to the great joint-stock banks which had covered England with their branches and held, as we shall see, a balance at the Bank of England as part of their cash reserve, another very important item in which was their holding of Bank of England notes. The issue of these notes was strictly regulated by the terms of the Bank Act of 1844. Up to 18,450,000 (originally 14,000,000) notes could be issued against securities; beyond this sum every note had to be backed by its equivalent in coin and bullion; according to the terms of the Act, one-fifth of this bullion might consist of silver, but this power had never been exercised since 1861; after that date the metallic backing of the Bank of England's note issue always consisted of gold. The securities held against the 18,430,000 notes the fiduciary issue as they are usually called, which have no metallic backing have always been Government securities, but this restriction is not imposed by the Bank Act, which only instructed the Bank to transfer to its issue department securities, of which the public debt of n millions (a book debt from the Government to the Bank) should form part.

No such legal restrictions limited the extent to which the Bank of England and the other banks of the country could create credit for their customers. In its issue department, which con- ducts the note issue, the Bank of England was tied hand-and- foot by the Act of 1844. In its banking department it was free to create credit to any extent that its own prudence permitted, and it is this fact that gave the London monetary system the elasticity combined with control which was one of its chief claims to efficiency. The Bank could not, without breaking the law, expand its note issue without an equivalent expansion in its holding of bullion, but it could, according to its own judgment, by making advances and discounting bills, expand the amount of credit in its books held by the other banks; and these book credits at the Bank of England were regarded by the other banks and by the whole financial and commercial community as prac- tically the equivalent of legal-tender cash at least for balance- sheet purposes. To make the matter clearer, specimens are here appended of a pre-war Bank of England return and a balance- sheet of the largest joint-stock bank.

BANK OF ENGLAND

Account for the Week ended Wednesday, July 15 1914. ISSUE DEPARTMENT

BANKING

Proprietors'Capital 14,553,000 Rest. . . 3,431,484 Public Deposits. 13,318,714 Other Deposits. 42,485,605 Seven-day and other Bills. . 29,010

DEPARTMENT Government Securities n ,005,126 Other Securities. 33,623,288 Notes .... 27,592,980 Gold and Silver Coin 1,596,419

73.8i7.8i3

73,817.813

Notes Issued

56,908,235

56.908,235

Government Debt. Other Securities. Gold Coin and Bullion

11,015,100

7,434,900

38,458,235

56,908.235

LONDON CITY AND MIDLAND BANK

Paid-up Capital

Reserve Fund

Current, Deposit and other Ac- counts (including Undivided Prof- its). ..

Acceptances. .

Balance Sheet, June 30 1914 (Condensed and simplified)

. 4,348.650 3,700,000

95,027.439 7.353.HO

110,429.199

Cash in Hand and at

Bank of England 15,128,192 Money at Call and

Short Notice. Investments Bills of Exchange Advances, Loans and

other Accounts Liability of Customers

for Acceptances Premises

12,510,356

8,835,697 10,230,300

54,081,382

7,353,110 2,290,162

110,429,199

In an ordinary bank balance-sheet the first item on the " Assets " side consisted of: " Cash in hand and at the Bank of England," which were put together under one heading as if there were no practical difference between a holding of legal- tender cash and a credit in the books of the Bank of England. By means of this convention, cash at the Bank of England could be very easily expanded, through advances made by it which became cash at the Bank of England in the balance-sheets of the other banks, whenever there was need for an abnormal amount of money at seasons such as the end of each quarter and especially the last day of the year, owing to heavy payments then made and the large number of balance-sheets, both banking and other, which are then drawn up. These advances were seldom or never made directly to the other banks. The second line in the assets in their balance-sheets consisted of: " Money at call and short notice," which were usually made to discount houses and stock- brokers, though other borrowers, such as Indian and Colonial banks and foreign banks and financial firms, also took large sums at times from the English banks. By calling in some of this money at times of stringency the banks used to compel the dis- count houses to borrow from, or discount bills at, the Bank of England, and stockbrokers to borrow from it, in order to repay them: the fresh credit so produced was paid into the accounts of the banks and so increased their holding of cash at the Bank of England. This system worked with very great ease and elasticity, but was obviously liable to abuse and tempted the bankers to create credit, perhaps sometimes too freely, relying on this power to replenish their resources as described. The same result was produced when the Government found it necessary to borrow from the Bank of England at times when its expenditure was temporarily larger than its revenue. If, for example, the Govern- ment borrowed 2 millions from the Bank on " Ways and Means " or " Deficiency " Advances, in order to pay for battleships or meet the interest on Consols, the Bank of England gave them so much credit in its books, which it paid out to shipbuilders or Consols holders in the form of cheques on the Bank, and those who received this newly created money paid the cheques into their own accounts at their own banks, which thus received an addition to their cash at the Bank of England. Thus, whether the borrowing was done by the Government or by the financial community, the result was usually an addition to the other de- posits in the banking department of the Bank of England, with a corresponding increase in the securities on the other side. If the Government were the borrower the increase would be under Government securities; if the borrowing was done by other customers the increase would be in " other " securities. It should be noted that the " other deposits " in the Bank of England's banking department include many other accounts besides those of the other banks. The public deposits are exclu- sively those of the British Government; the accounts of any