Chap. XXII: Of the Bank of England and of the Banks of Circulation established on Mercantile Credit

I have examined, with all the care I am capable of, the nature of banks calculating for the melting down of solid property, and the converting of it into paper for the use of circulation.

The nature of such banks is but little known in countries where they have not been established; therefore a distinct account of them may suggest hints, which in time may prove useful.

People who do not employ their thoughts on the theory of trade and credit, are apt to overlook objects of real utility; and those who do, have seldom the opportunity of being informed of the customs of different nations. Were my experience greater, or had I more opportunities to dive into the recesses of this great object, the work I now present to the public would better deserve its attention.

I now proceed to a deduction of the principles upon which are founded those banks which are chiefly calculated for the use of commerce; and as the ground-work of my inquiry, I shall trace some of the principal operations of the bank of England.

The establishment of this great company was formed about the year 1694. Government at that time having great occasion for money, a set of men was found who lent to it about 1,200,000 l. sterling, at 8 per cent for the exclusive privilege of banking for 13 years: with this additional clause, that 4000 l. sterling, per annum, should be given them to defray the expence of the undertaking. This sum of 1,200,000 l. sterling, was the original bank stock. It has been since increased to 11,000,000 l. by farther loans to government, for the prolongation of their privileges; as has been taken notice of in the 16th chapter of the second part.

This stock, as in banks of circulation upon mortgage, is to be considered only as a subsidiary security to the public for the notes they issue: were it the principal and only security for their paper, this bank would then be founded on the principle of public, not of mercantile credit; under which last denomination we are going to point out in what the nature of it differs from those we have already explained.

It is a rule with the bank of England to issue no notes upon mortgage, permanent loan, or personal security. The principal branches of their business may be comprehended under four articles, viz. 1. The circulation of the trade of London: 2. The exchequer business of Great Britain: 3. The paying of the interest of all the funds transferable at the bank: 4. Their trade in gold and silver. I shall now shortly explain the nature of these four great operations; and first as to the circulation of the trade of London.

When we speak of the circulation of trade, we understand the circulation of money paid on the account of trade.

The great occupation of the London merchants engages them to simplify their business as much as possible. For this they commit to brokers every operation which requires no peculiar talents or ingenuity in the merchant himself; and, for a like reason, they commit to the bank and private bankers the care of their cash.

A Scots merchant begins by drawing money from the bank, or from an exchanger, for which he pays interest: a London merchant begins by putting money into the bank, for which he draws no interest at all.

A London merchant, therefore, can give no order upon the bank, unless at a time when he has money lodged in it.

If he has occasion for money at any time, he sends to the bank the bills he has before they become due, and the bank discounts them at certain rates, according to their nature.

If it be a foreign bill, the bank, in discounting it, retains of the sum, at the rate of 4 per cent per annum, for the time the bill has to run; but if the bill be at a longer day than 6o days they will not discount it. So in this case the merchant must keep his bill until it is within 6o days of the term of payment.

The reason for this is evident: the security upon which such bills stand, is purely mercantile. The nearer, therefore, the payment is, the less risk the bank incurs from the failure of those who are bound in it.

The intention of this operation of discounting hills, is plainly to employ the cash of the bank in a way to draw an interest for it; but as merchants allow their money to lie dead for as short a time as they possibly can, the bank must have quick returns for what they advance upon discount, in order to be constantly ready to answer all demands. This is no loss to the bank, and a prodigious advantage to trade, as I shall briefly explain.

The bank is constantly receiving cash from every person who keeps their cash with it. This occasions a constant fluctuation of payments, which of course must leave at all times a considerable sum of other people's money in the bank; because it never is in advance to any one.

By long practice in the trade, this sum of money becomes determinate: let us call it the average-money in the hands of the bank. It is then with this average-money alone, that the bank can discount bills. Now if the trade of London do afford bills to be discounted at different dates within 60 days, sufficient to absorb the whole average-money of the bank, appropriated for discounting; this branch of business would not go forward with the celerity required for the trade of London, did the bank indulge merchants so far as to discount at a longer day.

From this we learn another reason why the bank of England discounts no bill which has more than 60 days to run. The first, mentioned already, is for the greater security of payment; and the second, which we now discover, is in order to be able to discount more bills than otherwise they could do, did they discount at a longer day.

As I am here upon the subject of discounting bills of exchange by the bank of England, an operation it has in common with all the private bankers in the capital, I must answer a question I have frequently heard proposed.

How does it happen, that in a city of so great trade as London, it is possible that people should be found even among merchants, who allow their money to remain in the hands of bankers without interest; when in Scotland, a place of so little trade, interest may always be got for money for the shortest time?

The answer to this question is to be gathered from the very principles of trade itself.

The money which merchants have either in the hands of the bank, or of bankers, though very considerable at all times, is in perpetual fluctuation: it cannot then be lent to any but to a banker, who would consent to pay interest for the sums in hand. But no such banker can be found, nor ever will be found, until all the bankers in London consent to such a regulation. The reason is plain. One principal use the bankers make of the average-money in their hands, is the discounting of bills. Who then could pay interest for money, and discount, in competition with others of the same trade, who have it for nothing?

But suppose the bank, and all the bankers in town, should come to the resolution of giving interest for the money in their hands, what would be the consequence?

I answer, that upon such an alteration, discount would rise above the present rates, to the great prejudice of the trade of the nation; and bankers would lend money in their hands upon a more precarious security for the sake of a higher interest.

All the landed men who reside in London, and many other wealthy people, not concerned in trade, constantly keep their money either in the bank, or in some banker's hand without interest: this enables bankers in general to discount foreign bills at 4 per cent as has been said, even when the rate of interest is rather above this standard. This is, as it were, a contribution from the rich and idle, in favour of the trade of the nation.

Let, therefore, gentlemen who have much idle money, think of any other expedient than that of obtaining interest for it, from those who discount bills in London. Not one of them can afford to do it, and thrive by his business; and the hurt which would result to trade in general, will constantly be a sufficient bar against a general resolution for that purpose.

What has been said, will, I hope, prove satisfactory as to the resolution of the question above proposed, so far as regards London. It remains to be answered, how those who supply the place of bankers in Scotland, and even the banks themselves can afford to pay interest for any sum put into their hands for a short time.

I answer, that as to the Scotch exchangers, as we have called them, the profits on their trade admit of borrowing money at interest, which that of the bank of England and private bankers cannot do. If these last can gain 4 or 5 per cent by discounting of bills, it is all they can honestly expect: every other employment of the money in their hands is precarious, either as to the security or promptitude of calling it in, to answer the demands which are made upon them.

As to Scotland, we have seen how directly contrary to all principles it is, for its banks to borrow money within the sphere of their own circulation. How this diminishes the profits upon their own trade, and hurts the circulation of the country; but although it diminish their profit, it carries along with it no positive loss to them, as would be the case, were a London banker to pay interest for all the money in his hands, when he never can draw any back, except for that part which we have called the average.

Every London banker is obliged to have a certain sum of cash constantly in his chest, the interest of which would be all lost, did he pay for it: whereas the exchangers in Scotland never have a shilling by them; and when any demand is made upon them, they draw the money from the banks, in consequence of their credit by cash accompts.

Besides foreign bills, which the bank of England discounts at 4 per cent they also discount inland bills, and notes of hand between merchants in London, at 5 per cent.

The inland bills to be discounted at the bank must all be payable in London. The bank calls in no money from any distant quarter of the kingdom.

As the discounting of notes of hand between London merchants might operate the same effect, as if the bank should advance them money upon personal security, which would be the case, were the notes of hand drawn for obtaining credit, instead of paying money really due between the merchants, in the course of business; the clerks of the bank keep a watchful eye over this branch of management, and, by examining the reciprocal draughts of merchants between themselves, they easily acquire a knowledge of the state of their affairs, and are thereby enabled to judge how far it is expedient to launch out in discounting either the notes or bills wherein they are concerned.

I shall not pretend to assign a reason why, in the price of discount, the bank makes a difference of 1 per cent between foreign and inland bills of exchange. It may either be an indulgence and encouragement to foreign trade; or it may be upon the consideration of the better security of foreign bills, which commonly pass through several indorsations before they are offered to be discounted at the bank.

I come next to the circulation between the bank and the exchequer.

The bank of England is to the exchequer, what a private person's banker is to him. It receives the cash of the exchequer, and answers its demands.

Cash comes to the exchequer from the amount of taxes. The two great branches of which are the excise and customs. To explain this operation with the more distinctness, I shall take the example of the excise.

The excise is computed to bring in annually from London, and the fifty two collections over all England, nett into the exchequer, above four and a half millions sterling.

The fifty two collectors send the amount of their collections to London eight times a year, almost entirely in bills. As the same may be said of the remittances of all the other taxes, we may from this circumstance observe by the way, that London alone must constantly owe to the country of England a sum equal to all the bills drawn upon it; that is to say, to all the taxes which the country pays: a circumstance not to be overlooked, from which many things may be learned, as will be taken notice of in the proper place.

The bills sent by the fifty two collectors, are drawn payable to the commissioners of excise; they indorse them to the receiver general; he carries them to the bank as they fall due, and gets a receipt for the amount; this receipt he carries to the exchequer, who charge it in their account with the bank, and deliver tallies to the receiver general for the amount of his payments; these tallies he delivers to the commissioners of excise, who enter them in their book of tallies. This operation is performed once every week, and serves as a discharge from the commissioners to the receiver general.

The bank, again, keeps an account with the exchequer, which is settled once every day, by two clerks, who go from the bank to the exchequer for this purpose. When coin is wanted by the exchequer, for payments where bank notes will not answer, the coin is furnished by the bank; when paper will serve the purpose, paper is issued.

Besides this operation in the receipt of taxes, the bank advances to government, that is to the exchequer, the amount of the land or other taxes imposed, which are to be levied within the year. This we see is a loan upon government security for a short term, quite consistent with the principles upon which the bank is established. The large sums the bank is constantly receiving of public money, and the great assistance it obtains from thence in carrying on the other branches of its trade, enable it at present to make advances of money to government at 3 per cent. It observes the same rule with respect to the great companies of the East Indies, and South Sea, for the same reason; but no advances are made to private people; and in the discounting of bills and notes of hand, the regulations above mentioned are adhered to.

Thus the whole amount of taxes is poured into the bank, in the manner we have been describing.

The bank also keeps the transfer books of all the funds negotiated at the bank; and out of the public money in its hand, it pays the interest of these funds for which government allows to the bank a sum proportionate to the expence of this branch of management.

When the bank, as a company, lends to government upon a permanent fund, the capital whereof is not demandable, this operation is foreign to their business as a bank, and is conducted by the company as an article of management of their private property.

Let us now examine by what channels their notes enter into circulation, and the security upon which they stand.

When issued in the discount of bills, they stand upon the principles of mercantile credit, and depend upon the goodness of the bills discounted. When issued upon the faith of taxes to be paid within the year, they stand upon the security of this payment, which is of a very complex nature, as any one may perceive. As long as the inhabitants of England consume exciseable goods, the excise will be paid: as long as trade goes on, customs will be paid: and as long as government subsists, the collateral security of the state will serve to make up all deficiencies in the amount of taxes. No security, therefore, can be better than the notes of the bank of England, while government subsists. The losses that great companies meet with from bad debts, I am informed, are very inconsiderable.

The greatest risk the bank runs, is in discounting bad bills; but by the extent of their business in this branch, and by circulating the cash of all the merchants who keep accounts with them, they acquire so perfect a knowledge of the state of their affairs, that it rarely happens that any one can break for very considerable sums, without the bank's having a previous notice of it. A sudden loss may no doubt happen, without a possibility of being foreseen; but the matter of fact proving that their losses upon bad bills are inconsiderable, we may thence infer, that there is but little mystery to the bank, with regard to the credit of London merchants.

I come now to the last branch of their management, to wit, their trade in gold and silver.

For the circulation of bank notes, coin is necessary. We have seen, in treating of the Scotch banks, how coin is brought it: to wit, in consequence of all the payments made to the bank, in which there must be a proportion of coin equal to what is found in common circulation. What is not paid in coin, comes in, in their own notes, which are thereby taken out of the circle; and consequently make place for a subsequent supply, which issues in the manner we have described.

In times of peace, and a favourable balance of trade, the bank suffers little by the obligation it is under to pay in coin, except as far as the great confusion of the present currency affords an occasion to money-jobbers to melt down the new guineas. The extent of this traffic I am no judge of, and the bank no doubt has an interest in preventing it as far as the laws have provided a remedy against it.

But when large payments are to be made abroad, the distress of the bank is no doubt very great.

In Scotland, the banks, upon such occasions, are totally drained of coin. They have no market for the metals; because they have no mint to manufacture them into coin. It is different with respect to the bank of England; their distress proceeds from another cause.

The exportation of the heavy guineas in time of war, and during a wrong balance upon the trade of England, leaves circulation provided with a light currency only, in which the bank is obliged to pay their notes; and the intrinsic value of the gold in which they pay, regulates the price of the metals they are obliged to buy at market. If they provide them themselves from abroad, they must pay the price of them in bills of exchange. But then the lightness of the currency at home sinks the value of the pound sterling, as it raises the value of the ounce of gold and silver. So the only considerable loss they incur, is in providing the metals, which must ever be considerable, as long as the old guineas remain in circulation.

The loss upon coining silver is still greater than upon gold; because besides the loss incurred by reason of the lightness of the gold, the metals in the silver and gold coin of Great Britain, are not proportional to the value they bear in the London market, where they have been bought; as has been sufficiently explained already in another place.