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LOMBARD STREET

WALTER BAGEHOT

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Subtitle: A Description of The Money Market: This printing does not name the publisher or date - it is in a easy to read large format paperback. The pages are not numbered, there is no table of contents - price was $5.00 from Amazon, a bargain.

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Reviewer's Comment:
The author was a practicing banker as well as influential author and editor in financial affairs. His understanding of finance and banking is based on his personal, practical experience as a banker, but it is timeless. His writing skill, as a professional author, choice of vocabulary and adroit, sly humor makes the reading of his prose enjoyable but necessarily exacting.
He offers his recommendations on what practical changes might be made to improve the financial system of his time, but they should be the basis of banking today. He is not well known enough nor are his many ideas understood today. He is famous for one statement of advice on what a central bank should do when there is a financial crisis. This is known as a central bank being the 'lender of last resort'. The panic takes place because in the normal daily financial markets banks and bill brokers and others have created so much credit on which market exchanges have been based that a mismatch between assets and liabilities has expanded to the point that one or some institutions have liabilities that cannot be reduced by exchange of the assets they maintain, and trust in their solvency has been questioned. Since there is a financial network in which individual's assets are other individual's liabilities and in the reverse. The reduction (or elimination) of liabilities generates the reduction of assets held by other individuals and institutions.
Mr. Bagehot's famous advice is that the central bank (that is the Bank of England) should step in and provide or guarantee loans, in exchange for quality securities, to support worthy (not insolvent) banks sufficient to maintain or return the critical trust by the public that everyone will not loose their assets due to others inability to pay off their liabilities - all of which is denominated in the relatively tiny supply of gold coins held as bank reserve by the BoE. Note that Bagehot's recommendation does not expand the already too expanded credit market.
This book describes the situation, how it was created, who are the individuals who conduct financial activities; what they actually do in contrast to what they are theoretically presumed to do. What have been the results. He provides cogent financial data on the reality of the 'money supply' - that is, credit instruments and coinage in gold. The reader today likely will be surprised - and hopefully enlightened when considering Bagehot's depiction of reality when considering the financial world today. That is especially the world of today's central banks.

I not only recommend, but urge, everyone interested in today's financial system, especially the central banks to study this remarkable text. The $5.00 investment is almost nothing, but the hours you will spend to absorb the content will be well worth your effort. The reality analyzed by Bagehot is complex, the content of his analysis and commentary is complex, and both are little known to individuals who should know it today. I can only offer a brief summary of the varied content of this book plus a few of my comments on points of interest. I add some references I consider useful below my comments.

 
 

 A summary:

Lombard Street: A Description of the Money Market (1873) is a book by Walter Bagehot.
Bagehot was one of the first writers to describe and explain the world of international and corporate finance, banking, and money in understandable language. The book was initially printed in Great Britain by Henry S. King & Co. in 1873.

Overview:
The book was in part a reaction to the financial collapse of Overend, Gurney and Company, a wholesale discount bank located at 65 Lombard Street, London, from which the book draws its title. When this bank suspended payments on 10 May 1866, panic spread across London, Liverpool, Manchester, Norwich, Derby and Bristol.

Lender of last resort:
Lombard Street is known for its analysis of the Bank of England's response to the Overend-Gurney crisis. Bagehot's advice (sometimes referred to as "Bagehot's dictum") for the lender of last resort during a credit crunch is summarized by Charles Goodhart as follows: Lend freely. At a high rate of interest. On good banking securities.
(Nonetheless, Goodhart emphasizes that many of these ideas were spelled out earlier by Henry Thornton's book The Paper Credit of Great Britain.) Bagehot's dictum has been summarized by Paul Tucker as follows: "to avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at ‘high rates’".
In Bagehot's own words (Lombard Street, Chapter 7, paragraphs 57–58), lending by the central bank in order to stop a banking panic should follow two rules:
First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.
Secondly. That at this rate these advances should be made on all good banking securities, and as largely as the public ask for them. The reason is plain. The object is to stay alarm, and nothing therefore should be done to cause alarm. But the way to cause alarm is to refuse some one who has good security to offer... No advances indeed need be made by which the Bank will ultimately lose. The amount of bad business in commercial countries is an infinitesimally small fraction of the whole business... The great majority, the majority to be protected, are the 'sound' people, the people who have good security to offer. If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed. But if securities, really good and usually convertible, are refused by the Bank, the alarm will not abate, the other loans made will fail in obtaining their end, and the panic will become worse and worse.

 

Chapter I, Introductory
- The author states his purpose: "I venture to call this Essay "Lombard Street", and not the "Money Market" or any such phrase, because I wish to deal and to show that I mean to deal, with concrete realities." He dismisses the abstract theories propounded by many authors. He mentions the Act of 1844, that has generated too much argumentation between it supporters and attackers. They both consider that the Act has created the major operations of the English Money Market. He comments: "The briefest and truest way of describing Lombard Street is to say that it is by far the greatest combination of economical power and economical delicacy that the world has even seen. Of the greatness of the power there will be no doubt. Money is economical power." He continues by noting that it has much more "immediately disposable and ready cash than any other country." He provides a statistic of the quantity of deposits in the banks of London, Paris, New York and the German Empire with London containing more than twice the total of the other three. And in addition there are more deposits that are not revelled in many other banks. He agrees that there is much more money in those other countries and the world than is officially accounted, but it is not available for use in the money market. British monetary power is evidenced by the huge volume of lending by British banks to all and sundry. In contrast to earlier times, during which it was difficult for obtain capital to invest in even the most potentially profitable new enterprise, now (mid 19th century) such capital is so available that obtaining it is not a real concern. But such loans are not the key function. He continues: "But though these occasional loans to new enterprises and foreign States are the most conspicuous instances of the power of Lombard Street, they are not by any means the most remarkable or the most important use of that power. English trade is carried on upon borrowed capital to an extent of which few foreigners have an idea, and none of our ancestors could have conceived." He includes an example of the use and power of capital put to use by credit."
This reality is something that Dr. McCloskey ignores in her three books that focus on the beliefs of the bourgeois as the critical source of the Industrial revolution. And Murray Rothbard and his libertarian acolytes simply cannot understand this. But, while, as Bagehot points out, it was a small method in Europe, it was a major one throughout American financial, and industrial history.

His example is as follows: "If a merchant have 50,000 L. (that is pounds sterling), all is own, to gain 10% on it he must make 5,000L., in a year, and must charge for his goods accordingly, but if another has only 10,000L., and borrows 40,000L., by discounts (no extreme instance in our modern trade), he has the same capital of 50,000L., to use, and can sell much cheaper. If the rate at which he borrows be 5 percent, he will have to pay 2,000L., a year; and if, like the old trader, he make 5,000L., a year, he will still after paying his interest, obtain 3,000L., a year, or 30 percent, on his own 10,000L."

It is critical today that everyone understand this power of capital consisting of borrowed credit. Bagehot expands on the result by describing the 'democratic structure of English commerce." The result has been the loss of social and political power of the wealthy (including land owners) and the increase in power of the merchant, business, middle class.
If virtually anyone with good standing and initiative can borrow capital to equal the deployable capital of the great lords, the result is obvious. Bagehot claims a defect that has been shown is the decline in public morality - 'the constant leveling of our commercial houses is, too, unfavorable to commercial morality." At the same time, a country dependent for economic innovation and expansion by the activities of the ancient wealthy aristocracy, will lack such progress. That is because such wealthy individuals prefer to sit on their wealth, not invest it at risk. His summary is that Lombard Street in the 'great go-between' the middle-man who matches investable savings by those who have it and the needed investable capital of those entrepreneurs who produce expanding quantities of goods and services - and the infrastructure that enables such expansion. However, he warns, there never was a country in which the proportion of ready cash (meaning real assets) to the volume of credit (imaginary capital) supporting the economy, was so small. So TRUST is the watchword.

 
 

Chapter II, A General View of Lombard Street
Mr. Bagehot describes the actual (material) structure of the banking system. It consists of the Bank of England, Private Banks, Joint Stock Companies, and bill brokers. He divides his account into two sections. The first part is a description of the function of banks. He quotes David Ricardo on this: a remarkable statement with study. According to Ricardo, the banker "begins as soon as he uses the money of others', as long as he uses his own money he is only a capitalist. Thus the Lombard Street denizens hold large volumes of other people's money either on deposit or running account.
Here is the central point today. "In the continental language, Lombard Street, is an organization of credit, and we are to see if it is good or bad organization in its kind, or if, as is most likely, it turns out to be mixed, what are its merits and what are its defects?"
Wonderful, that is exactly what we must do today. The entire economy today is created and based on CREDIT far more than it was in Bagehot's time, and he believed it was huge then.
He continues, "The main point on which one system of credit differs from another is 'soundness'. Credit means that a certain confidence is given, and a certain trust reposed. Is that trust justified?" For banks the volume of the credit is often very large and the time interval for repayment may be short and unexpected.

Actually credit creates debt, and debt is a promise to produce something of value equal to the value of the credit, plus an amount reflecting the value of the TIME interval consumed. Can the borrower produce that something? An additional and critical problem is that both the credit-debt and the existing and future produce are 'valued' in 'money' and the 'value' of 'money' itself varies over time.

Bagehot continues with discussion of the relationship of the bank's processes to the home country's currency and the nation's laws about it currency system. He points out, for instance, that in the United States (this is the 1880's) the currency includes 'greenbacks' which are guaranteed by the government. But in England the legal tenders are gold and silver coins plus Bank of England notes. These latter are different from 'greenbacks' and they are limited with a legal requirement that the bank retain a 'reserve 'of specified gold and silver. The Bank of England "CANNOT INCREASE THE CURRENCY IN ANY MANNER."
BINGO!
He continues with specific amounts of assets and liabilities in the banking system. The amazing answer is that private banks need not retain any reserve, but only need sufficient currency to meet daily requirements for giving and taking in the course of each day's activities. Meanwhile the Bank of England must retain the nation's financial reserve and that reserve of real gold and silver cash in its vault is only a third of the size of its liabilities. All the other banks keep their reserves on deposit at the Bank of England. The reality is that capital left in bank vaults is dead, it gains neither interest nor profits from production. Therefor banks and other holders of capital will seek to invest it in expected profitable enterprises. He continues further, noting that London is also the clearing house for foreign countries which generate liabilities as well.
"A large deposit of foreign money in London is now necessary for the business of the world."
But that system is subject to the same conditions as TRUST is in the domestic financial system. A 'run' on England would require substantial export of gold. But the trust in the capability of the British financial system is so great that no one, foreign or domestic, imagines otherwise. And this belief is based on no legal authorities.

Now the world has 'petrodollars'. It was the profit that Great Britain made on being the center of the world's financial system that greatly enhanced its profits from export of manufactured goods. And the United States today has replaced GB. And it was the foreign governments - mainly French - that drained the US gold supply, forcing President Nixon to default by ending the connection between the value of the dollar and the value of gold. Nevertheless,

Bagehot wants to state reality. "The result is that we have placed the exclusive custody of our entire banking reserve in the hands of a single board of directors not particularly trained for the duty - who might be called 'amateurs' who have no particular interest above other people's in keeping it undiminished - who acknowledge no obligation to keep it undiminished who have never been told by any great statesman or public authority that they are so to keep it or that they have anything to do with it who are named by and are agents for a proprietary which would have a greater income if it was diminished..." Quite a potential for concern.

Bagehot moves to section II of the chapter. In this section he describes the nature, sources, and potential results of the sudden financial demands that might force the country, that is its bank, to take actions to prevent such demands from damaging the British banking system. This comes down to raising the interest rates to prevent the desire by others of an out flow and encourage in inflow of bullion. He recounts the historical incidents in which the British did not perform. He terms it "a more miserable history can hardly be found than that of the attempts of the Bank....".
He turns to domestic drain on bank reserves. These, he notes, arise from somewhat different causes and are more difficult to stem. He concludes, "the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely. The first instinct of everyone to the contrary." To be able to do that the good banker will accumulate his reserve in good times so he can assure the public that he has sufficient cash to satisfy all normal demand. He devotes pages to this discussion. He writes that: "A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it." He discusses the actions of banks and bill brokers with a hint that a financial panic is coming. They stop giving discounts on any paper they still accept but stop accepting paper as well. They cannot and do not create new money. And any bank or bill broker who has deposited money (cash) in another similar place calls for its return. Thus the crash of liquidity expands.

He provides the exact response of the Bank of England in the 3 events:
1847 loans on 'private securities' from 18,963,000L to 20,409,000L
1857 from 20,404,000L to 31,350,000L
1866 from 18,506000L to 33,447,000L
Note that these 'loans' were not issuing 'free credit' - they were exchanges of bank credit or cash in gold for qualified, worthwhile securities. What they did was exchange fixed capital assets take in for liquid capital assets with value secured by the BoE.
So Bagehot writes that the BoE did its duty to quell a panic. But it did not acknowledge that it was its duty and there was no law that would claim that it had a duty. This leads him to a lengthy discussion of the potentially critical situation. Then he proposes three remedies.
1. There should be a clear understanding between the Bank and public that it will act by replenishing needed foreign accounts and/or lend in times of internal panic.
2. The government of the Bank itself should be improved by reducing the 'amateur' clement and increase the professional element.
(But the results shown in the FED by professionals is negative.)
3. In addition to making the BoE stronger, make the entire banking system stronger so it does not rely so completely on the BoE.
In the following chapters Bagehot elaborates on the causes and result of the current banking system.

 
 

Chapter III. How Lombard Street Came to Exist, and Why It Assumed Its Present Form
This is a fascinating historical essay, a detailed description of modern banking (Lombard Street is a popular name because the Bank of England and other financial institutions have congregated on the street that became named "Lombard because the medieval agents - representatives - of the Italian (Lombard) banks were located there. "How" and why the banking system current in England in 19th century developed as it did is the complex subject Bagehot undertakes. His description of the history is not what most people today recognize. Banks have three functions; to transfer financial accounts (credit and liability) between institutions, especially foreign ones; to issue bank notes (that is lending capital in the form of credit to those who ask for it); and taking deposits of financial assets from the public. He includes comments on many other topics as well.
His opening remark is itself priceless. "In the last century, a favourite subject of literary ingenuity was 'conjectural history', as it was then called. Upon grounds of probability a fictitious sketch was made of the possible origin of things existing." He elaborates on the results of this kind of thinking applied to banking and refuses to engage in it. "Conjectural history would be inclined to say that all banking began thus but such history is rarely of any value. The basis is false."

How wonderful can this idea be?? Shelves are loaded with 'professional' accounts - theories about economic behavior, about the origin of money - even about what money is are based on the same 'conjectures' resulting from deductive thinking rather than inductive analysis. The mussing of famous authors, who could not know the past as it was still opaque, continue to be cited as authoritative proof by 'experts' today, of their elaborate quantitative "econometric' algorithms - equations filled with variables - frequent resort to the Latin 'save all' - "all things being the same'. Then the controversies over theories are supported by 'ad homium', vitriolic attacks.

Bagehot elaborates: "Hypothetical history, which explains the past by what is simplest and commonest in the present, is in banking, as in most things quite untrue. The real history is very different. New wants are mostly supplied by adaptation, not by creating or foundation. Something having been created to satisfy an extreme want, it is used to satisfy less pressing wants, or to supply additional conveniences." ... "The first banks were not founded for our system of deposit banking or for anything like it. They were founded for much more pressing reasons, and having been founded, they, or copies from them, were applied to our modern uses."
For his purposes he need not discuss ancient banking, about which little was know in 1870 anyway.
"The earliest banks of Italy, where the name began, were finance companies". They created foreign bills of trade (paper). From there he described and excellent history of the development of more and more wide spread banking systems that added more functions as well. He cites the problem merchants and banks had with payments in a myriad of foreign coins having different and often dubious values. "again, a most important function of early banks is one which the present banks retain, though it is subsidiary to their main use; viz, the function of remitting money." Money being coins. The bank takes the coins, and sends its value in a bill of exchange with its corresponding foreign bank. It was by supplying these other uses and proving themselves trustable that banks then began to be seen by the public as a safe place to deposit its cash. He includes specific quantities of the deposits in French, German and UK banks. In his section II, he elaborates on the BoE and its "note issue." He tells the sordid story of the time that King Charles II simply refused to honor his deposits with the gold smiths, (the actual protobanks of England at that time. This was called "shuting up the Exchequer'. This "monstrous robbery" destroyed the credit of (trust in) the Stuart monarchy. Which lead to the Glorious Revolution and the offer by Parliament to the Dutch stadholder, William III. But that king was waging war on France and had about zero credit in England, thus being nearly impossible to obtain a loan.
The ingenious work around was developed. Wealthy or owners-so individual merchants and aristocrats were induced to form a bank in which they deposited 1,200,000L at 8%; . They were the owners and were titled Governor and Company of the Bank of England. This was 'loose' capital for which these gentlemen apparently had no pressing alternative so the 8% interest was something. The Bank then received special and unique privileges as the Bank of England. Bagehot describes these. The bank could then lend to the sovereign at a higher interest rate. That was the start. The 18th century witnessed much further development during which time the debt of the government rose to unprecedented heights to finance its many wars with France.

 
 

Chapter IV, The Position of the Chancellor of the Exchequer in the Money Market:
Remember that the BoE was created as a private bank with shareholders, yet performs the public service of holding the government's money and the reserve of money that should defend the money market. One result is that the public expects the Government to assist the bank in any case of financial emergency.
He concludes that: "this is the sort of anticipation which tends to justify itself, and to casue what it expects."

"Nothing can be truer than the economical principle that banking is a trade and only a trade, and nothing can be more surely established by a larger experience than that a Government which interferes with any trade injures that trade. The best thing undeniably that a Government can do with the Money Market is to let it take care of itself."
"But a Government can only carry out this principle universally if it observe one condition: it must keep its own money."
That was the central financial idea of one US President, Andrew Jackson.
The Exchequer is the British treasury that used to pay and receive taxes and other income. The Chancellor is a member of Parliament, a government cabinet minister somewhat like a US Secretary of the Treasury. The office has had many changes since the early 12th century.
Bagehot describes some of the major changes in the B0E and its relation to the government Exchequer. He writes that the system has 'grave evils'.
1. By being created by state aid it is more likely than a natural system to require state help.
2. Because being a one reserve system it reduces spare cash in the Money Market, which makes the market more delecate.
3 Because a one reserve system supervised by one board of governors makes the market dependent on their wisdom.
4. Because that board of governors will be pressed by the shareholders to generate high dividends, and keep a small reserve when the public insterest requires a large reserve.

 

Chapter V, The Mode in Which the Value of Money is Settled in Lombard Street:
Bagehot is using the term 'money' in the official definition meaning that it IS coined currency. This confuses then and today this concept with the idea that 'money' is a general metric that quantifies the 'value' of all things traded in markets.
Yes, 'money' in his sense has value and its value changes and must be established (settled by specific institutions) continually. By 'money' he (everyone then) thinks only of gold currency. And gold is a commodity. The problem since silver and gold were adopted as currency is that they are both commodities which have value in raw form and a different value when minted into a coin that has a different face value.
Bagehot writes that the public considers that the BoE has a special power to fix the value of money. But, he writes, the value of money like that of all other commidiies, is set by supply and demand. He means mney as currency. But the value of money on Lombard street is influenced by the Bank of Egland as the most important dealer in money,which can set a minimum value it will accept. he explains the cause being there is not enough money on Lombard Street to discount all the bills, which forces the dealers to go to the BoE, which can fix its own rate. But its ability is limited. He describes the complex interactions in the markets as, for instance, where to the bank issue a sizable amount of bank notes (credit) the individuals who obtained it would use it to buy, generating a rise of prices that would then generate more individuals into raising prices.
The value of money does change. His conclusion: "The fluctuations in the value of money are therefore greater than those on the value of most other comodities. At times there is an excessive pressure to borrow it, and at times an excessive pressure to lend it, and so the price is forced up and down.".

 

Chapter VI, Why Lombard Street is often Very Dull, and Some times Extremely Excited -
By 'dull' he means normal financial conditions and by 'excited' he means an expected or already occuring panic. Or he means good times with expanding standard of living and bad times in a depression. He devotes the chapter to analyzing these conditions. His critical point is based on two principles:
1. 'That as goods are produced to be exchanged, it is good that they should be exchanged as quickly as possible. "
2 "That as every producr is mainly occupied in producing what others want, and not what he wants himself, it is desireable that he should always be able to find, without effort, without delay, and without uncertainty, others who want what he can produce.".
His key concept is time. Time is an asset that has value.
He describes how all segments of the economy including industry are interrelated. Over either a very short time or eventually changes (such as a depression) in one industry will be influenced by changes in the others. He especially notes changes in agriculture, because in the 19th century agriculture was still a dominant industrry. Various industries also have different inputs of labor or raw materials.
He mentions the history of many panics, such as the famous South Sea fiasco, but also many more that are rarely mentioned in historical literature today. Each involved gulible individuals who 'invested' (actually speculated) by exchanging their capital for promises. He includes the most famous of all that is currently being cited: "For an Undertaking which shall in due time be revealed". He does not mention that Isaac Newton, also lost a forltune in such a 'bubble'. Bagehot describes the panic of 1867 in great detail, including dta on the price of wheat, the quantity of iron exported, and the role of the money supply.
Here are several of his comments:
"But though plentify money is necessary to high prices, and though it has a natural tendency to produced these prices, yet it is not of itself sufficient to produce them." To lower prices it is necessary to have a 'satisfactory' way to employ the money. He writes that: "augmented money" comes from the savings of the people, "And will be invested in the manner which the holders for the time being consider suitable to such savings."

But today the 'augmented money' is not coming from the savings of people but is given free of exchange by government. And much of it is not being invested but used to fund consumption of previously produced assets created by others.
He also notes: "The rise has also been aided by the revival of credit. This, as need not be at length explained is a great aid to buying, and consequently a great aid to the rise of Prices."
But apparently it does need to be explained to economists at the FED.
Another cogent comment:"And in so far as the apparent prosperity is caused by an unusual plentifulness of loanable capital and a consequent rise in prices, that prosperity is not only liable to reaction, but certain to be exposed to reaction. The same causes which generate this prosperity will after they have been acting a little longer, generate an equivalent adversity."
Further: "In consequence, a long-continued low rate of interest is almost always followed by a rapid rise in that rate". He provides a lenthy explaination of how and why this takes place.
Another truism: "The good times too of high prices almost always engender much fraud."
Finally he again stresses that the entire banking structure is based on trust. It needs to maintain a sizable reserve of real 'money' (meaning, again at that time, currency denominated in the value of gold) - not fiat money.

 

Chapter VII, A More Exact Account of the Mode in Which the Bank of England has Discharged Its Duty of Retaining a Good Bank Reserve, and of Administering It Effectively
In this chapter Bagehot publishes details on the 'mode in which the BoE operates. This includes the stateemts and actions of its Board of Governors during times of panic. He cites his own articles in the 'Economist' and comments that many of those directors did not like them. They revealed too much. His advice stated then: "I consider it to be the undoubted duty of the Bank of England to hold its banking deposits (reserving generfally about one-third in cash) in the most avalable securities; and in the event of a sudden pressure in the money mrket, by whatever circumstace it may be caused, to bear its full shre of a drain on its resources."

The governors denied they had such duty and didn't like his idea about their reserve.
He includes the statements and specific comments by BoE officials. He also includes resolutions and actions of Parliament. He recounts incidents in the historical record, such as 1825. "Under such circumstances, the Bank directors inevitably made mistakes of the greatest magnitude."

He focuses on the Banking Department of the Bank. I shouldexplain the interwesting way theBoE was organized into two separate department, one for 'banking', meaniing investing and loaning; and the other for currency, meaning operating a daily source of cash for the immediate needs of its depositors, and for which it only held a cash reserve adequate to insure a daily reserve to keep incoming deposits equal to outgoing withdrawals of deposits. That daily action had no effect on the size of the national money supply.
In the US that significant distinction used to be the law that seperated investment banks from depositary banks but it was abolished during the Clinton adminstration.

The British structure became critical during the panics of 1847 and of 1857 when Parliament had to issue a 'licence' authorizing the BoE to 'borrow' currency from its currency reserve to save its banking reserve which had declined in fall of 1857 from 4,024,000L on October 10th to 957,000L on November 13. Fortunately, Bagehot observes, that while the BoE denies the duty it has begun to act. In the case of a run on its gold overseas it has raised its interest rate to reduce export of capital and encourge import of same. For example, he cites the condition in 1866 when a drain of gold was begining due to the collapse of the Overend and Gurney private financial firm and the BoE had retained a substantian banking reserve that assuted the public. But, he notes. in 1870 the Bank of France suspended specie payments generating demands on the market for bullion.

Just like in 1971 when the French government demanded gold from the US, forcing Pres. Nixon to abrogate the link between the dollar and gold.

Bagehot questions whether the directors of the BoE realize the danger they are in, stating 3 specific defects. The critical action of the BoE with its gold reserve is to preserve the functioning credit market.

The same problem that faced the FED and Treasury in 2008.

Bagehot discusses the, then, existing controversy among officials and politicians was about what the BoE can do or should do. It fundamentally was about - should the Bank remain a private one with independence. The arguments, themselves, involve understanding or lack thereof, of the nature of financial panics, the role of any bank, and the nature of currrency and credit. His explaination is too lengthy and complex for summarizing here.

But one of the specifics he discusses is the manner in which the BoE can and has raised ready cash in a panic is by exchanging some of its cash reserve for secure, valuable, securities (stock in companies or debentures).

This also is what in which the FED did suddenly resort. But it has continued to due emergency measures far after the financial emergency ended and for an entirely different purpose - to provide credit for givernment fiscal policy - both for the welfare state and to create a 'green' economy. Bagehot believes: 'As we have seen, principle requires that such advances, if made at all for the purpose of curing panic, should be made in the manner most likely to cure that panic.... unfortunately, the Bank of England do not take this course".

 

Chapter VIII, The Government of the Bank of England
In this chapter Bagehot describes the internal functioning of the BoE and its senior officers. The lasting concept is that everything must be based on the quality of the the individuals.

 

Chapter IX, The Joint Stock Banks
This is the term meaning private banks that are owned by shareholder investors. The BoE is a special, large joint stock bank with unique privileges. He identifies three categories:
1 Those in which the capital is used not to work the business but to guarantee the business. Thus a banker's business - his proper business - does not begin while he is using his own money: it commences when he begins to use the capital of others." In these the banker's own capital is sufficient to convince the public that their deposits in or loans to the bank are safe.
2. These banks have some sort of exclusive privilelge which is based on good judgment.
3rd. Banks that have a business both large and simple, they employ more money than most individuals or small banks have. All the banks can be very profitable because they a small amount of their own capital versus much larger amount of other people's capital and they pay interest on that other people's capital that is less than the interest they charge on the investments and loans they create out of other people's capital. Bagehot includes data showing the profits banks have, and their dividends. Their own capital in the bank grows with the earnings they retain.
He presents the total for the jointstock banks in London. They have 30,000,000L in deposits; their capital is not more than 3,000,000L; they have invested 31,000,000L and this leaves only 2,000,000L as their reserve against liabilities. He judges that in general these banks are governed by astute, experienced men. Of interes is that he points out that rural banks have more need of study because the laws governing real property are complex. But banks in large cities should practically run themselves with good managers. His conclusion: As the size of the banks and finance industry has increased the ratio of its ready reserve capital to its liabilities (especially short term) has decreased , the reserve is very small.
Here is the 'kicker': Now, no cause is more capable of producing a panic, perhaps none is so capable, as the failure of a first-rate joint stock bank in London." Therefore the banking system is of 'primary importance to us all."

Lehman, anybody??

 

Chapter X, The Private Banks
A 'private bank' is indeed private. It has been created by an individual owner, a man of substance and known quality and integrity. He becomes entrusted with the money of his friends and neighbors. He is well known to everyone. The original London bankers were such: "He represented a certain union of pecuniary sagacity and educated refinement which was scarcely to be found in any oher part of society." Frequently ownership and of course control was hereditary. Bagehot believes that: "Banking is a watchful, but not a laborious trade." The banker can devote much of his time and thinking to other issues. He considers it a 'happy life."
That was then.
BUT not now. 'I fear, we must doubt of it"; meaning the continuance of that old class. "In 1810 there were 40 private banks in Lombard Street but now there are 3". And no new ones. Modern conditions prevent the creation of new 'private banks'. In addition, it is typical of hereditary systems (such as monarchies) that include banks that the following generations lack either the skill or character - or both - of the founding generations. He examines again the joint stock banks and indicates that the comparison favors their continued replacement of the private banks.

 
 

Chapter XI, The Bill Brokers:
Mr. Bagehot explains their role in the finance industry. They are "specially qualified dealers who can lend from their own capital or can borrow cash from banks. They exchange good paper, bonds or stock securities for negotiable credit (which functions as money) that the bill brokers deposit at the bank in exchange for the cash from the bank. He continues: "They act thus as intermediaries between the borrowing public and the less qualified capitalist, knowing better than the ordinary capitalist which loans are better and which are worse." The desired purpose of this is to move capital that is inactive (in the hands of the capitalist that has no direct investment use for it) to the entrepreneur, for instance manufacturer, who needs the capital to expand production. He provides an example: "Many stock brokers transact such business upon a grand scale. they lend large sums on foreign bonds or railway shares or other such securities, and borrow those sums from bankers, depositing the securities with the bankers, and generally, through not always giving their guarantee." and, "By far the greatest of these intermediate dealers are the bill brokers." Note that the credit in the form of a loan of cash has not been giver for nothing, It has been an exchange of a valuable security for cash. And the bill broker has also made an exchange, the security received for the loan is exchanged in turn for a loan from a bank. It is the bank that is the source of the currency (money). But the bank is making its loan (credit) to the bill brokers in much greater quantity that the amount of actual (real) currency (gold coin) in its vault. So the process is creating liquidity in the market on the basis of imaginary money.
The whole system rests on (survives) the trust by all involved in the quality of the individuals - their trustworthiness. And it depends on the future capability of the receiver of the credit-cash - the entrepreneur, to make the profits from production that are expected. All these transactions are 'discounted' meaning the difference between the value of the exchanged capital and the actual quantity exchanged - that amounts to interest.
Of course the system depends on the fact that the borrower needs the capital for some purpose and it should be a worthy one. Everyone relies especially in not only the trustworthiness of the bill brokers but also their knowledge and skill at choosing to lend only to profitable enterprise. When something goes wrong and people become concerned (even panic) their demands on the enterprises (or individuals) (either the bill brokers or the banks or both) who have issued a greater value of promises than the value of the real reserves they have on hand. Mr. Bagehot discusses this process in the context of a discussion about whether the reserve (in real currency) should be centered in one institution (central bank - such as the Bank of England) or can be held by multiple institutions such as many private banks.
Mr. Bagehot describes all this in complex but clear detail.

 
 

Chapter XII, The Principles Which Should Regulate the Amount of the Banking Reserve to Be Kept by the Bank of England:
The previous discussion leads to this topic. The question - how large in currency (that meant gold) should the Bank of England hold to assure the safety of the British economy in cases of panic or other need. Bagehot explains with data in previous chapters that the bank holds in gold a very tiny fraction of the total credit money that is used as the liquidity that finances the markets. And, morever, that 'market' is now world-wide as British capital (credit) is exchanged everywhere and the BoE stands ready to support it. This is a contentious issue with many strongly opposed opinions held by many commentators and authorities.

Bagehot poses to himself the question he faces - OK what is your actual opinion about the required quantity of reserves the BoE should retain.? At risk of injuring his own reputation he replies. "I should say that at the present time the mind of the monetary world would become feverish and fearful if the reserve in the Banking department of the Bank of England went below 10,000,000L." He admits that present day thought considers that sum to be too large. But he notes that he also advises that the governing body of the BoE should be strengthened. So to prevent the reserve from falling to 10,000,000L the daily sum should be 11,000,000L or 11,500,000 L. And this means that the Bank should begin to 'take precautions' if the sum reaches 14- 15,000,000L. If the pressure is coming from foreigh sources, the Bank should begin to raise interest rates.

 
 

Chapter XIII, Conclusion
Bagehot admits that he has identified a 'deep malady' and 'only suggested a superficial remedy." He rejoins that he has prefered that the banking system as a whole be changed from its present situation in which the entire reserve is held in one place, the BoE. He wants the banks each to have and manage their own reserves and be liable for its adequacy. But he recognizes that his prefered change is impossible. The change would disrupt the entire money market system. He again states facts. "the total of deposits in the banking system is 60,000,000L supported by good securities. (in other words is is NOT liquid) But they have virtually no cash in reserve to comply with depositors demands in a panic. They could not sell the securities to raise cash as there would be no buyers. Thus the response would fall to the BoE. But, as he noted previously, the system cannot be changed. He can only hope for 'palliatives'. But eventually the BoE was nationalized.

Nor can the FED system in the US be changed. Although there are at least as many futile critics today as there were in England in 1870.

 
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Wikipedia entry on Lombard Street

 
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James Grant, Bagehot: The Life and Times of the Greatest Victorian - The definitive biography of Walter Bagehot in the context of British financial industry and its functions during his time.

 
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Perry Mehrling, The New Lombard Street: How the Fed Became the Dealer of Last Resort

 
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Anatole Kaletsky, Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis

 
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Charles Goodhart

 
 

Anatole Kaletsky,

 
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Nomi Prins, Collu$ion, How Central Bankers Rigged the World

 
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Peter Zeihan, The End of the World is Just the Beginning: Mapping the Collapse of Globalization

 
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Peter Zeihan, The Absent Superpower

 
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Peter Zeithan,Disunited Nations

 
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Peter Zeithan, The Accidental Superpower

 
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Peter Zeihan and Lauren Goodrich, A Crucible of Nations: The Geopolitics of the Caucasus,

 
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Lawrence White, The Theory of Monetary Institutions

 
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Anat Admati & Martin Hellwig, The Banker's New Clothes: What's Wrong with Banking and What to Do about It

 
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Charles W. Calomiris & Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises & Scarce Credit

 
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Danielle DioMartino Booth,FED UP, An Insider's Take on Why the Federal Reserve is bad for America

 
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Peter Conti-Brown, The Power and Independence of the Federal Reserve

 
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Martin Katusa, The Colder War: How the Global Energy Trade Slipped from America's Grasp

 
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Martin Katusa, The Rise of America: Remaking the World Order,

 
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Gregory R. Copley, The Art of Victory: Strategies for Personal Success and Global Survival in a Changing World

 
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Gregory R. Copley, The New Total War of the 21st Century, and the Trigger of the Fear Pandemic

 
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Ziad K. Abdelnour, Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics

 
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Robert D. Blackwell & Jennifer M. Harris, War by Other Means: Geoeconomics and Statescraft

 
 

 William Bonner & Lila Rajiva, Mobs, Messiahs, and Markets:

 
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