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§ 3. Fluctuations in the rate of interest arise from variations either in the demand for loans, or in the supply. The supply is liable to variation, though less so than the demand. The willingness to lend is greater than usual at the commencement of a period of speculation, and much less than usual during the revulsion which follows. In speculative times, money-lenders as well as other people are inclined to extend their business by stretching their credit; they lend more than usual (just as other classes of dealers and producers employ more than usual) of capital which does not belong to them. Accordingly, these are the times when the rate of interest is low; though for this too (as we shall immediately see) there are other causes. During the revulsion, on the contrary, interest always rises inordinately, because, while there is a most pressing need on the part of many persons to borrow, there is a general disinclination to lend. This disinclination, when at its extreme point, is called a panic. It occurs when a succession of unexpected failures has created in the mercantile, and sometimes also in the non-mercantile public, a general distrust in each other's solvency; disposing every one not only to refuse fresh credit, except on very onerous terms, but to call in, if possible, all credit which he has already given. Deposits are withdrawn from banks; notes are returned on the issuers in exchange for specie; bankers raise their rate of discount, and withhold their customary advances; merchants refuse to renew mercantile bills. At such times the most calamitous consequences were formerly experienced from the attempt of the law to prevent more than a certain limited rate of interest from being given or taken. Persons who could not borrow at five per cent, had to pay, not six or seven, but ten or fifteen per cent, to compensate the lender for risking the penalties of the law; or had to sell securities or goods for ready money at a still greater sacrifice.

Except at such periods, the amount of capital disposable on loan is subject to little other variation than that which arises from the gradual process of accumulation; which process, however, in the great commercial countries, is sufficiently rapid to account for the almost periodical recurrence of these fits of speculation; since, when a few years have elapsed without a crisis, and no new and tempting channel for investment has been opened in the meantime, there is always found to have occurred in those few years so large an increase of capital seeking investment, as to have lowered considerably the rate of interest, whether indicated by the prices of securities or by the rate of discount on bills; and this diminution of interest tempts the possessors to incur hazards in hopes of a more considerable return. The demand for loans varies much more largely than the supply, and embraces longer cycles of years in its aberrations. A time of war, for example, is a period of unusual drafts on the loan market. The Government, at such times, generally incurs new loans, and as these usually succeed each other rapidly as long as the war lasts, the general rate of interest is kept higher in war than in peace, without reference to the rate of profit, and productive industry is stinted of its usual supplies. During part of the last French war, the government could not borrow under six per cent, and of course all other borrowers had to pay at least as much. Nor does the influence of these loans altogether cease when the government ceases to contract others; for those already contracted continue to afford an investment for a greatly increased amount of the disposable capital of the country, which, if the national debt were paid off, would be added to the mass of capital seeking investment, and (independently of temporary disturbance) could not but, to some extent, permanently lower the rate of interest. The same effect on interest which is produced by government loans for war expenditure, is produced by the sudden opening of any new and generally attractive mode of permanent investment. The only instance of the kind in recent history on a scale comparable to that of the war vol. II.-53

loans, is the absorption of capital in the construction of railways. This capital must have been principally drawn from the deposits in banks, or from savings which would have gone into deposit, and which were destined to be ultimately employed in buying securities from persons who would have employed the purchase money in discounts or other loans at interest: in either case, it was a draft on the general loan fund. It is, in fact, evident, that unless savings were made expressly to be employed in railway adventure, the amount thus employed must have been derived either from the actual capital of persons in business, or from capital which would have been lent to persons in business. In the first case, the subtraction, by crippling their means, obliges them to be larger borrowers; in the second, it leaves less for them to borrow ; in either case it equally tends to raise the rate of interest.

§ 4. From the preceding considerations it would be seen, even if it were not otherwise evident, how great an error it is to imagine that the rate of interest bears any necessary relation to the quantity or value of the money in circulation. An increase of the currency has in itself no effect, and is incapable of having any effect, on the rate of interest. A paper currency issued by government in the payment of its ordinary expenses, in however great excess it may be issued, affects the rate of interest in no manner whatever. It diminishes indeed the power of money to buy commodities, but not the power of money to buy money. If a hundred pounds will buy a perpetual annuity of four pounds a year, a depreciation which makes the hundred pounds worth only half as much as before, has precisely the same effect on the four pounds, and therefore cannot alter the relation between the two. Unless, indeed, it is known and reckoned upon that the depreciation will only be temporary; for people certainly might be willing to lend the depreciated currency on cheaper terms if they expected to be repaid in money of full value.

It is perfectly true that in England, and in most other commercial countries, an addition to the currency almost always seems to have the effect of lowering the rate of interest; because it is almost always accompanied by something which really has that tendency. The currency in common use, being a currency provided by bankers, is all issued in the way of loans, except such part as happens to be employed in the purchase of gold and silver. The same operation, therefore, which adds to the currency, also adds to the loans, or to the capital seeking investment on loan; properly, indeed, the currency is only increased in order that the loans may be increased. Now, though as currency these issues have not an affect on interest, as loans they have. Inasmuch therefore as an expansion or contraction of paper currency, when that currency consists of bank notes, is always also an expansion or contraction of credit; the distinction is seldom properly drawn between the effects which belong to it in the former and in the latter character. The confusion is thickened by the unfortunate misapplication of language, which designates the rate of interest by a phrase (“the value of money”) which properly expresses the purchasing power of the circulating medium. Not only, therefore, are bank notes supposed to produce effects as currency, which they only produce as loans, but attention is habitually diverted from effects similar in kind and much greater in degree, when produced by an action on loans which does not happen to be accompanied by any action on the currency.

For example, in considering the effect produced by the proceedings of banks in encouraging the excesses of speculation, an immense effect is usually attributed to their issues of notes, but until of late hardly any attention was paid to the management of their deposits, though nothing is more certain than that their imprudent extensions of credit take place more frequently by means of their deposits than of their issues. “There is no doubt,” says Mr. Tooke,” “that banks, whether private or joint stock, may, if imprudently conducted, minister to an undue extension of credit for the purpose of speculations, whether in commodities, or in overtrading in exports or imports, or in building or mining operations, and that they have so ministered not unfrequently, and in some cases to an extent ruinous to themselves, and without ultimate benefit to the parties to whose views their resources were made subservient.” But, “Supposing all the deposits received by a banker to be in coin, is he not, just as much as the issuing banker, exposed to the importunity of customers, whom it may be impolitic to refuse, for loans or discounts, or to be tempted by a high interest? and may he not be induced to encroach so much upon his deposits as to leave him, under not improbable circumstances, unable to meet the demands of his depositors In what respect, indeed, would the case of a banker in a perfectly metallic circulation, differ from that of a London banker at the present day ? IIe is not a creator of money, he cannot avail himself of his privilege as an issuer in aid of his other business, and yet there have been lamentable instances of London bankers issuing money in excess.” In the discussions, too, which have been for so many years carried on respecting the operations of the Bank of England, and the effects produced by those operations on the state of credit, though for nearly half a century there never has been a commercial crisis which the Bank has not been strenuously accused either of producing or of aggravating, it has been almost universally assumed that the influence of its acts was felt only through the amount of its notes in circulation, and that if it could be prevented from exercising any discretion as to that one feature in its position, it would no longer have any power liable to abuse. This at least is an error which, after the experience of the year 1847, we may hope has been committed for the last time. During that year the hands of the bank were absolutely tied, in its character of a bank of issue; but through

* Inquiry into the Currency Principle, chap. xiv.

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