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Bible Encyclopedias

1911 Encyclopedia Britannica

Money Market

"MONEY MARKET 17.732*). - Like most of the terms current in business or in economics, the phrase " money market " is used in different senses. It sometimes means the whole financial machinery as applied to the creation, collection and distribution of both credit and capital, and so includes not only the banks, accepting houses and discount houses, but also the stock exchange, bullion brokers, dealers in foreign exchange, company promoters, and all others who handle the business of lending and investing money and transferring it from one country to another. The subject of the present article, however, is the money market in the narrower sense of the phrase, covering the machinery of the creation and distribution of credit - that is to say, of banking money which can be produced for the use of borrowers by banks and financial firms and companies. Loan issuers, company promoters, and stockbrokers do not exercise this power of creating money; they collect money saved by the public or borrowed by the public from bankers, and hand it over to governments, municipalities or industrial and commercial users to be used by official borrowers for public works, or for military expenditure, or to cover a deficit, and by industry and trade in developing production and distribution. The money market, however, in its strict and narrower sense not only collects money but creates and expands its supply. In England, where before the World War the money market had been developed to a very high point of elasticity and specialization, it worked by means of a ring of banks grouped round the Bank of England as its centre, with the assistance of accepting houses, a group of private firms of high standing, who performed an important function in the creation of bills of exchange, and the discount houses or bill-brokers, a group of joint-stock companies and private firms, which specialized in buying and selling bills of exchange, using for this purpose money largely borrowed from the banks.

In any country which founds its monetary system on a scientific basis the power of the banks to create credit cannot be expanded indefinitely; some check must be imposed either by law, or, as in England, by convention, tradition and the prudence of the bankers. Caution on their part is stimulated by the fact that they have always to be ready to meet demands upon them in legal-tender cash; and so the amount of credit which they can prudently create is limited by the amount of legal-tender cash that they have available or can obtain if required.

Legal-tender cash means cash that can be legally tendered, and must be received by the creditor, in payment of a debt. In England it consisted before the war of gold sovereigns and halfsovereigns 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 prestige 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 £r4,000,000) 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 £18,450,000 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 11 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 conducts the note issue, the Bank of England was tied hand-andfoot 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 practically the equivalent of legal-tender cash at least for balancesheet purposes. To make the matter clearer, specimens are here appended of a pre-war Bank of England return and a balancesheet of the largest joint-stock bank.

Notes Issued .

. £56,908,235

Government Debt .


Other Securities


Gold Coin and Bullion





Proprietors' Capital £14,553,000


Government Securities £11,005,126

Rest 3,431,484

Other Securities. 33,623,288

Public Deposits

. 13,318,714

Notes. .


Other Deposits

. 42,485,605

Gold and Silver Coin


Seven-day and

other Bills .

. 29,010



Paid-up Capital


Cash in Hand and at

Reserve Fund


Bank of England


Current, Deposit

Money at Call and

and other Ac-

Short Notice. .


counts (including

Investments. .


Undivided Prof-

Bills of Exchange






Advances, Loans and

other Accounts .


Liability of Customers

for Acceptances


Premises.. .


Bank Of England Account for the Week ended Wednesday, July 15 1914 Issue Department London City And Midland Bank Balance Sheet, June 30 1914 (Condensed and simplified) £110,429,199 £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 stockbrokers, 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 discount 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 Government 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 deposits 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 exclusively those of the British Government; the accounts of any other public body, such as the Indian Government and Colonial Governments or British municipalities, and all the private customers who bank with the Bank of England, are included with the other banks in the " other deposits." On this basis of " cash in hand and at the Bank of England " the other banks had built up the great organization which had covered England with a network of branches which collected, distributed and created cash and credit for the community. The specimen balance-sheet given above needs little explanation. On the liabilities side we have the capital subscribed by the shareholders to start the business, which is only a liability in the sense that it would have to be repaid or accounted for if the bank were wound up. The reserve fund has been accumulated out of past profits and is also a liability only in the sense that it is the property of the shareholders and has to be accounted for. A liability in a much more real sense is the item of current and deposit accounts which makes up the greater part of the total. This is money deposited by the public and liable to be withdrawn on demand in the case of current accounts, or after notice of seven days or some other short period in the case of deposit accounts. On the other side of the account we see: " Cash in hand and at the Bank of England," " Money at call or short notice," which has been lent, as already described, to discount houses, stockbrokers, and other professional dealers in money. The " Bills discounted " are bills of exchange, most of which are probably drawn on other banks or the great London accepting houses, though they also include a considerable number of local bills discounted for industrial customers. With a portfolio of bills of this kind, arranged so that a certain proportion fell due every day, a bank could always replenish its cash by refraining from buying new bills to take the place of those maturing. " Investments " are the bank's holding of British Government and other securities, usually of a kind which it would expect to be able to realize by sale on the Stock Exchange in the case of any sudden demand upon it for cash. The large item of " Loans and advances " expresses the activity of the bank in financing industry and trade by lending money to customers. Here again it should be noted that, just as the Bank of England, by lending money or discounting bills, increased the amount of its own deposits, so the other banks by the same process increased the aggregate of general banking deposits. The borrowing customer gets a credit (say for £ro,000) from his bank A, against which he would draw a cheque to make the payment for the purpose for which he borrowed the money. If the cheque was paid to a customer of the same bank its deposits would be increased by £ro,000 and its loans and advances by the same amount, its cash total being unaffected. If the recipient of the cheque banked with another bank, B, then the cheque would, through the machinery of the clearing-house, transfer io,000 of cash at the Bank of England from bank A to bank B, and B's cash and the amount of its deposits will both have been increased by io,000. Bank A would have had its cash at the Bank of England diminished by io,000, but its loans and advances would have been increased by this amount and its deposits would be unaltered by the transaction; and as long as this loan was outstanding the increase that it had thus effected in the aggregate of banking deposits would remain. It will be noted that the item of acceptances which appears among the liabilities is exactly balanced on the assets side by " liability of customers on account of acceptances." This item arises out of the creation of bills of exchange which had been accepted by the banks on behalf of customers who had directed those from whom they bought goods to draw upon the bank, so putting into their hands a first-class security which could be easily negotiated. By thus placing its name at the disposal of a customer the bank earned a commission, and the customer was, of course, bound to put the bank in funds before the bill fell due; and the bank's liability to meet the bill was thus offset by the customer's liability to provide it with the wherewithal. By this means home and international trade were financed by the creation of bills of exchange, which have been called the currency of international trade, and the banks, as has been shown above, were enabled, by buying these bills under discount, to provide themselves with a convenient and liquid form of security which could be relied upon to produce cash at its due date. The special function of the banks, however, and the one with which the public is most familiar, was their provision of facilities for deposit, the creation of deposits by advances, and the transfer of such deposits from one to another by cheque. By this means they provided the commercial community with a money or currency that was safer and more convenient to handle than legal-tender cash. Bank deposits thus became potential currency which could be turned into actual currency by drawing a cheque.

The function of the accepting houses has already been described when the accepting business done by the banks was explained. The accepting houses accepted on behalf of customers in exactly the same way as the banks, but in their case this business was generally their chief if not their sole activity. Some of them, however, applied the connexions which they thus acquired abroad in acting as issuers of foreign loans. By accepting bills which were used in commercial payments all over the world they also were, in a sense, creators of credit and currency as long as their paper was readily taken and discounted. Many of the bills drawn on them were against goods or securities or gold going from one foreign country to another, or were drawn in anticipation of shipments of goods, or merely against the credit of the drawer and acceptor. In the two latter cases they were usually called " finance bills." The position of the discount houses, also, is already to a great extent apparent. They, using their own capital and to a much greater extent money borrowed from banks and others, bought bills of exchange accepted by banks, accepting houses, merchants and traders, and either held them until maturity or sold them to banks and others who required a short investment that could be relied upon to become cash at due date. By the rate at which they borrowed from day to day or for short periods from the banks they established the rate for money in the market, and by the rate at which they bought bills they established the discount rate. As their most important lenders and their most important buyers of bills were the banks, it followed that the extent to which the banks were prepared to lend the money and buy bills had an important influence in fixing rates for loans and discounts.

Since there was no control by law in England over the extent to which the banks could create credit and since, as has been shown, they were able easily to increase their holding of cash at the Bank of England by calling in loans from the discount houses and so compelling them to borrow from the Bank of England, a temptation which was thus put before the banks to create too much credit had to be corrected by constant vigilance on the part of the Bank of England. In the case of all material commodities, cost of production is an influence against excessive supply at too low a price; in the case of credit, the creation of which is a matter of book-keeping, this consideration hardly arises, since no more clerical work is involved by an advance of a million than by one of a thousand pounds. Consequently an artificial check had to be provided by the regulation of the money market by the Bank of England. If the banks created too much credit, with the result that the discount rate in London declined to a point that was not justified by England's position in international trade, an excessive number of bills of exchange on London would be created and, being offered in foreign centres, would turn the foreign exchanges against London. Ultimately this process would correct itself because the depreciation of the exchanges would at a point cause exports of gold from England, so reducing the basis of credit and compelling the banks to restrict its creation. But it was not considered safe to leave the market to its own devices until this tardy remedy worked. The Bank of England, as custodian of the country's chief gold reserve, was accustomed when the exchanges threatened gold exports to raise its official rate of discount, so giving notice to the discount houses that if they were obliged to borrow from it they would have to pay more for the accommodation, and making them more careful about buying bills at too low rates. But if, owing to the flood of cheap money with which the discount houses were pro vided by the ether banks, this warning did not suffice, the Bank of England was accustomed to take further action by borrowing money itself in the market and so artificially restricting the supply. By this means the level of rates in London was raised, with the result in normal times that a demand for bills on London was stimulated among foreign capitalists who wanted to lend funds there, the exchanges turned in London's favour, the threat of gold exports was reduced and, if the policy was maintained with sufficient determination, gold imports finally resulted, thus materially reinforcing the basis of credit.

Effect of the World War. - Such was the delicate machine into which war crashed like a bomb into a greenhouse. Its effects were immediate, and began, in fact, some days before a shot had been exchanged on the field of battle. England declared war on Tuesday, Aug. 4, but on the preceding Friday, July 31, the London Stock Exchange, which had remained open for business all through the Napoleonic wars, decided that it had to close before this war had even begun. The bourses of continental Europe had already set the example and the London Stock Exchange, which had been subjected to an enormous flood of continental selling, was unable to continue alone to bear the brunt of these realizations. It should be noted that the New York Exchange, though it was not then the international market that it has since become, but chiefly confined its operations to dealing in American securities, immediately followed London's lead. The effect on the banking position of the closing of the market in securities was twofold: In the first place the banks were unable to increase their cash resources by realizing their investments; in the second place they were unable to call in loans from stockbrokers and other customers who had given Stock Exchange securities by way of collateral pledge, owing to the inability of the borrowers to realize their security.

Thus one of the banking assets, which had been regarded as more or less liquid, had become unrealizable and frozen - partly, perhaps, owing to the action of the banks themselves, which were said to have increased the pressure of realization on the Stock Exchange by ruthless calling-in of loans, thus compelling their customers to sell securities pledged. This freezing process developed rapidly. The market in foreign exchange was already in a demoralized condition, and the consequence was that foreigners who owed money to England were unable to remit it, however hard they might try.

It has already been explained that, owing to the great international acceptance business which London has developed, the London banks and accepting' houses accepted bills drawn by foreigners against shipments of goods from all parts of the world to England or in many cases from one oversea country to another, while a certain number of bills were also drawn, not against shipments of goods at all, but sometimes in anticipation of such shipments and sometimes merely in order to create credit against the wealth and prestige of the parties. The solvency of the London accepting houses thus depended to a certain extent on the ability of foreign customers to remit funds for meeting bills of exchange at their due date. Even when bills had been accepted on behalf of an English customer, who had arranged the credit for a foreigner, the position was almost equally unpleasant, because the British customer might be unable to supply the acceptor with the necessary funds if the foreign drawer was unable to remit. Thus the break-down of the machinery of foreign exchange indicted a twofold blow upon the banks, because it raised considerable doubt concerning the value of the bills of exchange, which, as has already been shown, formed an asset on the highly liquid nature of which they had been wont to rely, and it also affected them as large acceptors themselves.

With their investments thus locked up by the closing of the stock market and their loans against securities an unrealizable asset and many of their bills of exchange a doubtful quantity, the London banks found themselves faced with an abnormal demand for cash on the part of the public. An extra demand for cash is, of course, usual during the last days of July, when many people are preparing to start for a holiday of many weeks and a still greater number are taking advantage of the Bank Holiday at the beginning of August for a few days' change. And some witnesses of this crisis have maintained that the public did not lose their heads and run upon the banks, but only asked for their usual cash requirements for the holiday; in some cases, however, bankers have admitted that the public were certainly taking more than usual, in the belief or delusion that their money would be safer in their own keeping than in that of the banks. And there is at least no doubt that the banks, very naturally frightened by the freezing of their assets, forgot or ignored the old banking tradition of meeting an abnormal demand for cash with the utmost readiness to pay it out in whatever form the public wished, and met the demands of their customers wholly or partly in Bank of England notes. This they were quite entitled to do, since Bank of England notes are legal tender, but since these notes were for sums of not less than five pounds they were an obviously inconvenient form of currency for holiday makers and there was consequently a crowd of applicants at the Bank of England wanting to change notes into gold.

One effect of the crisis which marked the beginning of the war was thus to cause a heavy drain on the Bank of England both for notes and gold, with the result that in the two weeks from July 24 to Aug. 7 the reserve of its banking department was reduced by nearly 20 millions and was brought down below ro millions, though for many years previously 20 millions had been regarded as its danger-point. During the same period the Bank's stock of bullion in both departments was reduced by 122 millions. At the same time demands upon it for advances and discounts were on a very large scale and its holding of other securities rose by nearly 32 millions. It was thus evident that special measures had to be taken for suspending the usual restrictions on the Bank's power to do business, and preparations were made for a suspension of the Bank Act, because it limited the amount of notes which the Bank was empowered to issue against securities. According to precedent this suspension could only be granted if Bank rate were raised to 10%, and consequently the public, whose nerves on the subject of finance were already sufficiently on edge, were startled by a rocket advance from 3 to 8 in Bank rate on Friday, July 31, and a further advance to 10% on Saturday, Aug. 1. This development was the more terrifying because movements in Bank rate on any other day but Thursday, or of more than r % at a time, are quite exceptional. At the same time the belief that the Bank of England would always meet a crisis by lending freely was disproved by its action in refusing to lend money to bill-brokers who were being pressed by the banks to repay the loans and advances on which they relied as part of their working resources, though this refusal on the part of the Bank of England to provide emergency credit was only maintained for a very short time.

These chaotic conditions clearly had to be met with stronger measures than a mere suspension of the Bank Act. It has already been shown that five-pound notes are of very little use for ordinary currency purposes and that paper money of a smaller denomination was required in order to check the demand for gold. The measures taken included the prolonging of the August Bank Holiday for four days, during which, by reassuring statements from leading politicians of both parties, the publics' nerves, which had been unnecessarily shattered by too much respect for precedent, were soothed into composure. The Currency and Bank Notes Act of 1914 was passed, which suspended the Bank Act of 1844 by empowering the Bank of England and other banks of issue to issue notes " in excess of any limits fixed by law " so far as temporarily authorized by the Treasury and subject to any conditions attached to that authority. According to its published weekly returns the Bank of England never took advantage of this authority, its fiduciary issue being never shown above the £18,450,000 authorized under the terms of the Bank Act (1844). But it was stated by Mr. Asquith in Parliament in Nov. 1915 that there had been an excess issue of £3,043,000 above the legal limit during the crisis. The most important provision of the 1914 Act, however, was that which allowed an issue of £1 and ios. currency notes by the Treasury which were to be legal tender in the United Kingdom for the payment of any amount. They were also convertible on demand during office hours at the Bank of England into " gold coin, which is for the time being legal tender in the United Kingdom." At the same time postal orders were made temporarily legal tender and similarly convertible at the Bank of England into any legal-tender coin. By the terms of the Act, currency notes were to be issued to such persons and in such manner as the Treasury directed, but the amount of the notes issued was to be a floating charge in priority to all other charges on the assets of the recipient.

This provision was based on the belief that the Treasury notes would be issued by way of loan to bankers. An explanatory memorandum by the Treasury stated that " Currency notes are issued through the Bank of England to bankers as and when required up to a maximum limit not exceeding, in the case of any bank, zo % of its liabilities on deposit and current accounts. The amount of notes issued to each bank is treated as an advance by the Treasury to that bank, bearing interest from day to day at the current Bank rate. The bank is permitted to repay the whole or any part of the advance at any time." But in fact many of the banks never took out currency notes as a loan, but paid for them from the beginning with a draft on their balance at the Bank of England; and this soon became the usual and general way by which the notes went into circulation.

At the same time a general moratorium for postponement of payments was made by proclamation on Aug. 6, which provided that any payments due before that date or on any day before Sept. 4, in respect of any cheques or bills payable on demand drawn before the beginning of the 4th day of August, or in respect of any negotiable instrument, not being a bill of exchange, dated before that time, or in respect of any contract made before that time, should be deemed to be due and payable on a day one calendar month after the day on which the payment originally became due and payable, or on Sept. 4 1914, whichever was the later date. The proclamation did not apply to wages or salaries or to liabilities of less than L5 or to dividends or interest on stocks, funds or securities or to the liability of banks of issue in respect of bank-notes issued by them. This last-named provision is important as showing that the moratorium did not affect the convertibility of the Bank of England note. Any payments to be made by a Government department were also exempted from the moratorium. This general moratorium was afterwards continued for two more months. By its terms all danger of a continued run on the banks was stopped because the banks were enabled to exercise their own discretion as to meeting cheques drawn upon them in respect of money paid in before Aug. 4. Already, however, the public nervousness concerning the banking position had been allayed and it is an open question whether it was really necessary to give the banks the protection of a moratorium of which most of them made little or no use. On Aug. 7 Bank rate was reduced from 10 to 5%.

By these measures - the provision of new currency which the banks were empowered to take by way of loan from the Treasury to a much greater extent than they actually required and the suspension of payments - the situation between the banks and the public was effectively regulated. The more difficult and technical position arising from the position of the accepting houses, the banks as large acceptors of bills and the discount market, owing to the break-down of the machinery of exchange and the consequent inability of foreigners to make remittance, had been already met by a proclamation of Sunday, Aug. 2, for postponing the payment of bills of exchange by reacceptance for a month. On Aug. 13 a notice was published stating that the Government had agreed to guarantee the Bank of England against any loss incurred in discounting bills of exchange, " home or foreign, bank or trade, accepted prior to August 4, 1914," and that the Bank of England was prepared to discount " approved " bills accepted before Aug. 4 without recourse against the holders. By this measure all holders of such bills were able to dispose of them to the Bank of England and be quit of any liability in respect of them as is usually carried by all who endorse a bill. It was also stated that the Bank of England would be prepared " for this purpose to approve such bills of exchange as are customarily discounted by them and also good trade bills and the acceptances of such foreign and colonial firms and bank agencies as are established in Great Britain." It was found, however, that these measures did not sufficiently meet the position by restoring the machinery of acceptance and exchange and on Sept. 5 a fresh step was announced and the Bank of England, instead of merely buying bills accepted before the moratorium, lent money to acceptors to meet them with, so relieving not only the holders of the bills but also previous endorsers from liability. Moreover, the assets of the acceptors were to be subject to a first charge in favour of any bills drawn since the moratorium, and this provision naturally encouraged the creation of new bills by making pre-moratorium bills, the liability for which the Government had accepted, a second charge on the assets of the acceptors. The acceptors were not to be asked to repay these advances made to meet their pre-moratorium bills for a period " of one year after the close of the war," but in the meantime the acceptors were to be under obligation " to collect from their clients all the funds due to them as soon as possible, and to apply those funds to the repayment of advances made by the Bank of England." Interest was charged at 2% above the ruling Bank rate.

Such were the measures taken for dealing with the monetary crisis that preceded and accompanied the beginning of the war. It was then the general belief that the war could not last long, and that the business organization should be encouraged to proceed as far as possible as usual so that British trade should

continue to be financed on the old lines with the ordinary machinery of exchange, acceptance and the discounting of commercial bills in Lombard Street. As the war went on, however, the money market became more and more a controlled establishment. As Government purchases of munitions, food, wool, etc., expanded, the credits drawn for their financing were naturally taken out of the hands of private enterprise and were created for the Government by means of Treasury bills, Ways and Means advances, and occasionally by bills drawn on and accepted by Government departments. Moreover, as the war went on and its cost increased, the Government found it necessary to prohibit new capital issues at home except such as were permitted by a Treasury Committee appointed to consider whether they were desirable from the point of view of the country's war efficiency and also to forbid the export of capital. All these measures and tendencies made a profound difference to the nature of the business done by the London money market. The diminished supply of what used to be called " bank " and " trade " bills, that is to say, bills drawn on banks, accepting houses, merchants and traders, was very much more than replaced by the enormous total of Treasury bills, of hich there were 15 millions outstanding when the war began, 1,148 millions in Dec. 1916, and 1,124 millions at the date of the Armistice. The system had also been introduced by which the Treasury bills, instead of being offered occasionally for public tender, were on offer from day to day at rates fixed by the Treasury. Thus the discount market, instead of having to compete for bills, fluctuating in number according to the trade and financial demands of Great Britain and her foreign customers, and having to exercise judgment and experience in discriminating concerning the quality of the bills and the degree of favour with which they would be regarded by the banks and other buyers to whom it hoped in due course to sell most of them, had its business enormously simplified by the supply " on tap," in unlimited amounts, of Treasury bills with the credit of the Government behind them. The rate at which Treasury bills were offered became the dominant factor in the discount market. At the same time a new market for Treasury bills came into being, and a large part of the new supply was bought by contractors, shipowners and others who acquired big cash balances during the war. The following table shows the extent to which Treasury bills and Ways and Means advances were created during and after the war.

Dec. 31


Treasury Bills


Ways and Means



1913 .




1914 .




1915 .




1916 .




1917 .




1918 .




1919 .




1920 .




A still more profound change, and one which had much more important effects upon the general public and upon the whole course of British war finance, was the enormous extent to which the Government found it necessary to apply to the Bank of England Floating Debt Outstanding (million f) and to the other banks for assistance in providing the necessary funds. It has been shown above, in the analysis given of the prewar working of our monetary system, that advances made by banks nearly always mean a corresponding addition in banking deposits and consequently an increase in the amount of money that the public can spend in the shape of the cheques that can be drawn against these deposits and are normally taken in payment for goods and services ( see Inflation). It is important to note that in so far as the Government got funds from the Bank of England on Ways and Means advances or Treasury bills or any other security on which the Bank lent to it, the credit basis on which all the other banks worked was thereby increased; because the money, as it was paid out to contractors and others to whom the Government owed it, was paid in by them to their own accounts with the outside banks, which thus received an increase in their cash at the Bank of England, which they could either hold as such or convert into currency notes; and so an advance was caused in the proportion between their cash and liabilities which encouraged them to expand the credit based on their increased cash holding. In the same way when the outside banks bought Treasury bills or Exchequer bonds or any other form of Government security issued, the result was an increase among their assets in their Government securities or bills discounted (if they included Treasury bills in this item), and a corresponding increase in the aggregate of banking deposits or potential money in the hands of the public, which was thus enabled to draw more cheques; because the money paid by banks for Treasury bills was paid first to the Government and by them paid out to the public, who were able to draw against it. It should also be noted that the outside banks were enabled by the increase in their cash at the Bank of England, caused by the new credits created by it for the Government, to take out currency notes and add them to their cash reserves, paying for them by transferring to the Government cash at the Bank of England.

By this process the whole principle on which the money market worked was radically altered in practice, though in theory the old checks and restrictions were still operative, and London remained throughout the war, on paper, a free market in gold with a banking system working on a convertible currency. It has already been stated that, though the Currency and Bank Notes Act of 1914 suspended the restrictions of the Bank Act of 1844, the Bank of England only availed itself of this suspension for a few hours and in all its published weekly returns showed a gold backing for every note issued above the legal limit of f 18,450,000 on the fiduciary issue. Its notes were still convertible on demand, as were also the new currency notes, which were poured out in an almost steadily increasing volume through the process described above. There was during the war period no legal prohibition of gold exports, and so in theory anyone abroad who had a monetary claim on England could still turn his claim into legal-tender cash, turn the latter into gold and take the gold away. In fact, however, he would have found considerable difficulty in doing so, because the British public and banks had had impressed upon them the need for conserving the gold resources of the country for the purpose of financing abroad the war requirements of England and her Allies. The public had been effectively persuaded to pay in its gold holdings into its banks, and the banks and other professional financiers were restrained by patriotic and other considerations from applying to the Bank of England for gold in order to oblige a foreign customer or earn a profit in exchange; moreover, the possibility of profit in exchange was largely extinguished by Admiral Tirpitz and the submarine campaign, which did much - through the cost of freight and insurance - to maintain the convertibility of British currency during the war (see Exchanges, Foreign). The convertibility of British currency thus became a pious fiction, and its amount, in the form of legal-tender notes, was limited only by the extent to which the Bank of England created new credit for the Government and others; and, in the shape of cheques, by the extent to which the public drew on the everincreasing deposits which the other banks created on the basis of the new cash and credit provided by the Treasury and the Bank of England. There was thus a constant tendency to increasing abundance of money of one kind or another, as will be seen from the appended tables.

Last Return of





£ 38,478,000


£ 21,535,000

1915 .




1916 .




1917 .




1918 .




1919 .




1920 .








(to June 30)

End of

Bank of












1913 .





1914 .










1916 .










1918 .










1920 .





Currency Notes Circulation Bank-Note Circulation The growing flood of new currency and credit tended to produce a low level of rates in the money market, which, if unchecked, would have cheapened the raising of the sinews of war, but would also have produced an adverse effect on the foreign exchanges by encouraging Britain's foreign creditors to take their balances home instead of employing them in London. From the point of view of British financial prestige, which was of the highest possible importance for the war, it was necessary to make every effort to keep the foreign exchanges favourable. For the purpose of financing the war cheaply at home there was much to be said for a policy of low rates in the money market. As has already been shown, the Government was practically the only borrower, since no other party could offer issues except with the permission of a Treasury Committee and the export of capital was forbidden. Thus, if the tendency towards ease had been allowed to take its course, the Government could apparently have secured for itself at low rates all the investment money that was available, especially if it had made use of the hint of compulsion so effectively employed by Mr. Bonar Law when he achieved the greatest borrowing success of the war at the beginning of 1917. This consideration, however, gave way, perhaps rightly, to the need for maintaining our prestige abroad as expressed by the foreign exchanges; rates in the money market, as will be shown, were artificially propped up, and it was not until the last year of the war that a system was adopted of differential rates for home and foreign money. In consequence of this system of considering the effect upon foreign exchanges as more important than the price that the Government had to pay for the funds that it needed, and a belief of bankers that, even at a time of war crisis, when no other borrowers were in the market, the only way to induce the public or professional financiers to subscribe for war securities was by offering them continually higher rates for their money, this crescendo movement continued until the autumn of 1916, when 6% was offered on an issue of Exchequer Bonds.

Such were the most important changes that affected the working of the money market during the course of the war, and it now remains to sketch the history of these developments as they evolved. The effect of the measures taken for meeting the crisis of Aug. 1914 was to leave the market very amply supplied with funds created by the Bank of England for the assistance of the accepting houses for discounting pre-moratorium bills and for financing the Government. The " other deposits " at the Bank of England, which stood at 42 millions in the middle of July, had risen to 168 millions by the beginning of Dec., though they declined to 128 millions at the end of the year. Bank rate had been hastily reduced, from the 10% to which it had been raised on the eve of war, to 5% when business was reopened after the prolonged Bank Holiday of Aug. 1914, and remained at this point until July 1916. The market rate of discount for 3months' bills had risen to 51% at the end of July 1914 and first emerged into a quotable condition on Aug. 24 at 5%, rapidly descending to 3% by the middle of Sept. and ending the year 1914 at a shade over 22%. A £350,000,000 War Loan at 31% issued in Nov. of this year drew very little response from the public and a large part of it was taken by the Bank of England and was subsequently repaid to it out of the proceeds of the War Loan of 1915. By far the greater part of the advances under which the Treasury notes had been originally issued to the banks had been very promptly repaid and henceforward Treasury notes were almost entirely issued under the system already described in exchange for credit at the Bank of England. There were a considerable number of issues which raised their total outstanding to 117 millions. Ways and Means advances, of which 1 million were outstanding when the war began, had reached 58 millions on Dec. 31 1914.

In 1915 extreme ease and weakness of discount rates at first again prevailed. The market rate for 3 months was below 18% in Feb. although Bank rate remained at 5% throughout the year. In April, however, the market was steadied by the beginning of the system under which Treasury bills were offered at fixed rates which were at first 21% for 3 months, 31% for 6 months, 34% for 9 months. On May 8 12-months' Treasury bills were also put on continuous offer at 31 per cent. Towards the end of June the complexion of the market was altered by the appearance of the great 42% War Loan offered by Mr.

McKenna, who had become Chancellor of the Exchequer in May in succession to Mr. Lloyd George, who had taken charge of the newly created Ministry of Munitions. This loan, including conversions of 31% War Loan, Consols, etc., produced total applications for 900 millions, the actual cash receipts being 585 millions. During the second half of 1915 the market rate for 3-months' bills was close up to Bank rate and rose above it in the middle of Nov., remaining so until the end of the year. By this movement the market was merely following the official fixed rate for Treasury bills on offer, which was raised to 42 for all dates in Aug. and to 5% in November. An important new departure was instituted during this autumn by which the Bank of England took money from the other banks at a fixed rate. When the system began the terms were 42% for a month, but the period was soon shortened to three days. By this means the rate for short money was effectively screwed up, since the banks naturally did not lend below the rate that they could get from the Bank of England; but its chief object was to get money direct for the Government at cheaper rates than on Treasury bills.

Total Deposits

Total Securities

End of Year



End of Year




£ 71.343,555

£ 71,343,555

£ 45,492,483

£ 65,336,8c7

£ 65,336,807

£ 38,212,049



180, 54 8,003







2 73 ,176,698


144,915, 726





178,84 3 ,038

132,587 ,088





166,170, 777

268,7 3 2,015


1 53, 1 9 1, 740


1 3 7,216,026




152,1 75 ,628







I 11,612,495






191 ,14 9 ,003


1 93 ,8 93 ,040




-- of

1913 1914 1915 1916 1917 1918 1919 1920









Capital and Reserves









Undivided Profit









Deposits .




1 ,444,4 2 7


1,9 88 ,347

2 ,35 6, 2 7 1


Acceptances. .. .









Notes, Drafts, etc.. .. .

























Cash in hand and Money at Call .









Investments. ... .









Discounts and Advances.









Premises and Cover for Acceptances

















In 1916, with Treasury bills still " on tap " for all dates at 5%, the market rate remained steady slightly above that level until March, when the Treasury rates of discount were reduced to 41% for 3 months, 41% for 6 and 9 months and 5% for 12 months. On this the market rate for 3 months promptly dipped to a shade above 42%, and remained so until the middle of June, when it jumped to 5% again when the official rate for all dates was raised to 5. The first half of this year was notable for the beginning on Feb. 21 of the issue of War Savings Certificates for 15s. 6d., to be repaid at the end of five years at L1 or to be convertible into cash with interest accrued at any time after they had been held for a year. Since then the privilege of holding these certificates has been continued for another five years, at the end of which they will be repaid at Li 6s. By the issue of this ingenious and attractive security the savings of the poorest were brought to bear on the problem of war finance and an enormous increase has been secured in the number of citizens who have a stake in the country by being holders of Government obligations (see Savings Movement). A campaign for the purpose of bringing home to all the need for saving during the war had been organized by the Parliamentary War Savings Committee in 1915 Bank of England Aggregate Balance-Sheet Of Banks Of The United Kingdom (Excluding Bank of England) (000's omitted) LT .Abilities Assets at the time of the issue of Mr. McKenna's 42% War Loan, but had made little headway owing to the lack of a security in which the working classes could invest with a certainty of being able to get their money back in full at any time. This campaign was now taken up with much greater ener

Copyright Statement
These files are public domain.

Bibliography Information
Chisholm, Hugh, General Editor. Entry for 'Money Market'. 1911 Encyclopedia Britanica. 1910.

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