A full, detailed study of the credit system and the tools it creates for itself, such as credit money, falls outside our plan here. Only a few points need bringing out — the ones necessary to describe the capitalist mode of production in general. We are dealing here only with commercial credit and bank credit. How their development connects to the development of public credit is left aside.
I showed earlier (Volume One, Chapter 3, Section 3b) how, out of plain commodity circulation, money comes to function as a means of payment — and with that a relationship of creditor and debtor forms among the people who produce and deal in commodities. As trade develops, and with it a capitalist mode of production that produces only with an eye to circulation, this natural, spontaneously grown basis of the credit system gets expanded, generalized, worked out further.
By and large, money here functions only as a means of payment: a commodity is sold not for money, but for a written promise to pay at a set date. For short, we can lump all these promises to pay together under the name bills of exchange. Until they fall due, such bills themselves keep circulating as a means of payment — they form the real commercial money. To the extent that they end up cancelling each other out, one claim balancing one debt, they function absolutely as money: no final conversion into money takes place.
These mutual advances that producers and merchants extend to one another are the real basis of credit. In the same way, the instrument they circulate in — the bill of exchange — is the basis of credit money proper: banknotes and the like. None of this rests on the circulation of money, whether metal coin or government paper. It rests on the circulation of bills.
W. Leatham, a banker in Yorkshire, writes in his Letters on the Currency (2nd edition, London, 1840):
He finds that the total of all bills for the whole of 1839 came to £528,493,842 (he reckons foreign bills at about a seventh of that total), and that the amount of bills running at any one time that year was £132,123,460. Bills of exchange, he says, are one component of the currency bigger than everything else put together. This enormous superstructure of bills rests (!) on the foundation formed by the stock of banknotes and gold; and if events narrow that foundation too far, the whole thing's solidity, even its very existence, is put at risk. Reckoning the whole currency — he means the banknotes — together with the amount of the banks' obligations payable in cash on demand, he finds a sum of 153 million that the law lets people demand be converted into gold, against only 14 million in gold to meet that demand. Bills of exchange, he says, cannot be brought under any control except by preventing the glut of money and the low rates of interest or discount that create part of them and encourage this large, dangerous expansion. It is impossible to say how much of it arises from real, bona fide business — actual buying and selling — and how much is artificially made (fictitious), consisting only of accommodation bills: that is, where one bill is drawn just to take up another falling due, manufacturing mere circulating paper and so creating fictitious capital. In times of plentiful, cheap money, he knows this reaches an enormous scale.
J. W. Bosanquet writes in Metallic, Paper, and Credit Currency (London, 1842):
He finds that the average amount settled each business day at the Clearing House — where London's bankers exchange among themselves the cheques paid in and the bills falling due — comes to more than £3 million, while the amount of actual money needed for this each day is little more than £200,000. (By 1889, the Clearing House's total turnover for the year had reached £7,618 3/4 million, which works out, over roughly 300 business days, to about £25 1/2 million a day.) Bills of exchange, he says, undoubtedly act as currency independent of money, in that they transfer property from hand to hand by endorsement. On average, he assumes, every bill in circulation carries two endorsements, so on average every bill settles two payments before it falls due. On that assumption, it would appear that endorsement alone transferred property worth twice 528 million — £1,056,000,000 — more than £3 million a day, over the course of 1839. So it is certain, he concludes, that bills of exchange and deposits together perform money's functions, transferring property from hand to hand with no help from money at all, to a daily amount of at least £18 million.
This is what Tooke has to say about credit in general:
Tooke defines credit, in its simplest expression, as the trust — well founded or not — that leads one person to entrust another with a certain amount of capital, whether in money or in goods valued at an agreed sum of money, always repayable once a fixed term has passed. Where the capital is lent in money — say, as banknotes, or a cash credit, or an order on a correspondent — an addition of so much per cent is made to the sum to be repaid, for the use of the capital. Where it is goods, whose money value the parties have agreed and whose transfer counts as a sale, the fixed sum to be repaid already includes a charge for the use of the capital and for the risk carried until the term expires. Written promises to pay by a fixed date are mostly given for credit of this kind, and it is these transferable promises that let the lenders — whenever they themselves want to use their capital, in money or in goods, before their own bills fall due — usually borrow or buy more cheaply, because their own credit is reinforced by the other name now on the bill.
Ch. Coquelin, "Du Crédit et des Banques dans l'Industrie," Revue des deux Mondes, 1842, volume 31:
In every country, he says, most credit business happens within the circle of industry's own dealings. The producer of the raw material advances it to the manufacturer who processes it, and gets back from him a promise to pay by a fixed date. Once the manufacturer has done his share of the work, he in turn advances his product, on similar terms, to another manufacturer who has to process it further — and so credit stretches on, from one to the next, all the way to the consumer. The wholesaler advances goods to the retailer, while getting the same kind of advance himself from the manufacturer or the agent. Everyone borrows with one hand and lends with the other — sometimes money, but far more often goods. So, within industry's own dealings, there runs an unbroken exchange of advances, combining and crossing each other in every direction. The growth of credit is exactly this: the multiplication and growth of these mutual advances — and that is where its power truly lives.
The other side of the credit system grows directly out of the money trade, which under capitalist production naturally keeps pace with the growth of trade in commodities. We saw earlier (Chapter 19) how looking after businessmen's reserve funds, the mechanics of taking in and paying out money, handling payments abroad, and so the trade in bullion too, all became concentrated in the hands of money-dealers.
Building on that money trade, this other side of the credit system now develops: managing interest-bearing capital, or money capital, becomes a special function of the money-dealers. Borrowing and lending money becomes their own particular business. They step in as go-betweens between the real lender and the real borrower of money capital.
Put generally, this side of banking consists in concentrating loanable money capital, in large masses, in the banker's own hands, so that instead of facing individual money-lenders one by one, industrial and commercial capitalists now face bankers who act as representatives of all the lenders together. Bankers become the general administrators of money capital. On the other side, facing all the lenders, they concentrate the borrowers too, by borrowing on behalf of the whole world of trade. So a bank represents, on one side, the centralizing of money capital -- of the lenders -- and, on the other, the centralizing of the borrowers. Its profit consists, in general, in borrowing at a lower rate of interest than the rate at which it lends.
The capital banks have available to lend flows to them in several ways. First, because banks act as cashiers for industrial capitalists, the money capital that every producer and merchant holds as a reserve fund, or that comes in to him as payment, becomes concentrated in the bank's hands. These funds are thereby turned into loanable money capital. Because the reserve fund of the whole business world is now held in common, it is cut down to the necessary minimum, and part of the money capital that would otherwise lie idle as a reserve fund gets lent out instead, functioning as interest-bearing capital.
Second, the bank's loanable capital is made up of the deposits of money capitalists, who hand over to the bank the job of lending it out. As the banking system develops, and especially once banks start paying interest on deposits, the savings and momentarily unused money of people of every class get deposited with them too. Small sums, each too small on its own to function as money capital, get combined into large masses and so form a monetary power. This gathering-together of small amounts must be kept distinct, as a separate effect of the banking system, from the bank's role as go-between connecting the real money capitalists and the borrowers.
Finally, revenues meant to be spent only gradually are also deposited with the banks.
Lending -- here we are dealing only with commercial credit proper -- happens by discounting bills, that is, turning them into money before they fall due, and by advances of various kinds: direct advances on personal credit, advances against interest-bearing paper, government securities, or shares of every sort, and, in particular, advances against bills of lading, dock warrants and other certified titles to goods, as well as by letting customers overdraw their deposits, and so on.
The credit a banker gives can take various forms: bills drawn on other banks, say, or cheques on them, or credit facilities of the same kind, and finally, for banks that issue notes, the bank's own banknotes. A banknote is nothing but a bill on the banker, payable to the bearer at any time, which the banker gives in place of private bills.
This last form of credit strikes the layman as especially remarkable and important -- first, because this kind of credit money passes out of mere commercial circulation into general circulation and functions there as money; also because in most countries the main note-issuing banks are, in effect, a peculiar mixture of national bank and private bank, and in fact they have the nation's credit behind them and their notes are more or less legal tender; and because here it becomes visible that what the banker deals in is credit itself, since the banknote is only a circulating token of credit.
But the banker deals in credit in all its other forms too, even when he advances money that was deposited with him in cash. In fact the banknote is only the small change of wholesale trade, and it is always the deposit that counts as the main thing at a bank. The best proof of this is the Scottish banks.
The special credit institutions, like the particular forms banks themselves take, need not be looked at further for our purposes here.
Tooke says the bankers' business divides into two branches. One is to collect capital from those who have no immediate use for it, and to distribute and hand it on to others who can use it; the other is to receive deposits of income from their customers and pay out the sums as those customers need them for their own spending. The first, he says, is a circulation of capital, the second a circulation of money -- of currency.
Put another way, he says: one branch is the concentration of capital on one side and its distribution on the other; the other branch is administering the circulation for the local needs of the district.
We shall come back to this passage in Chapter 28.
In the 1840s, when a bill was discounted in London, banks in countless cases handed over not banknotes but a twenty-one-day bill drawn by one bank on another. That is what a country banker named Pease testified. And according to the same report, whenever money grew tight, bankers made a habit of paying their customers in these bills instead of notes. If the customer wanted actual banknotes, he had to get the bill discounted all over again. For the banks, this amounted to a privilege of coining money. Jones Loyd and Co. had paid their customers this way for as long as anyone could remember, whenever money was scarce and the interest rate above 5 per cent. Customers were glad to take these bankers' bills, since a bill from Jones Loyd and Co. was easier to get discounted than one of their own; such bills often passed through twenty or thirty hands.
All these forms exist for one purpose: to make a claim to payment something that can be passed on to someone else.
Fullarton says there is scarcely any shape credit can be put into in which it will not at times be called on to do money's job; banknote, bill of exchange or cheque, the process is essentially the same and the result is essentially the same. And his other line: banknotes are the small change of credit.
What follows comes from J. W. Gilbart's book on the history and principles of banking, published in London in 1834.
In Gilbart's account a bank's capital falls into two parts, the capital it has invested and its banking capital, which it has borrowed. This borrowed banking capital is raised in three ways: by taking in deposits, by issuing its own banknotes, and by drawing bills. If someone lends me £100 for nothing, and I lend that £100 to someone else at 4 per cent, I make £4 over the year on the deal. In the same way, if someone takes my written promise to pay (that is the usual wording printed on an English banknote) and brings it back to me at the end of the year, paying me 4 per cent for it just as if I had lent him 100 sovereigns, I make £4 on that deal too. And again, if someone in a country town hands me £100 on condition that I pay the same sum to a third person in London twenty-one days later, then whatever interest I can make on the money in the meantime is my profit. This is a fair account of how a bank operates, and of how a banking capital gets raised out of deposits, banknotes, and bills. A banker's profits generally run in proportion to the size of his borrowed, or banking, capital. To find a bank's real profit, you subtract the interest on the invested capital from the gross profit; what is left is the banking profit. A banker's advances to his customers are made with other people's money. It is precisely the bankers who issue no banknotes who build up a banking capital by discounting bills. They use their discounting to grow their deposits. London bankers will only discount for houses that keep a deposit account with them. A firm that has had bills discounted at its bank, and paid interest on the full amount, has to leave at least part of that amount sitting with the bank, earning no interest. This way the banker earns more than the going rate of interest on the money he has advanced, and builds up a banking capital out of the balance left in his hands.
Economizing on reserve funds, deposits, cheques.
Deposit banks economize on the use of actual money by transferring balances between accounts, settling large sums of business with only a small amount of real money. The money this frees up is used by the banker for advances to his customers, by discount or otherwise. So the transfer of balances makes the deposit system that much more effective. It makes no difference whether the two parties dealing with each other bank with the same house or with different ones, since bankers exchange cheques among themselves at the clearing house. In this way the deposit system could, through transfers, be extended so far that it drove out the use of metal money altogether. If everyone kept a deposit account and made all payments by cheque, cheques would become the sole circulating medium. But this would only work if it could be assumed the bankers actually held the money — otherwise the cheques would be worth nothing.
Local business is centralized in the hands of the banks in two ways: first, through branches — country banks have branch offices in the smaller towns of their district, London banks in the different parts of London; second, through agencies.
Every country bank keeps an agent in London, to pay its notes or bills there and to receive money paid in by London residents on behalf of people living in the country. Each banker collects up the other's notes and does not put them back into circulation. In every larger town, bankers meet once or twice a week and exchange notes; the balance is settled by a draft on London. The purpose of banking is to make business easier, and whatever makes business easier also makes speculation easier. Business and speculation are, in many cases, so closely tied together that it is hard to say where business stops and speculation begins... Wherever there are banks, capital is easier and cheaper to get. Cheap capital gives speculation a boost, in just the same way that cheap meat and beer give gluttony and drunkenness a boost. Since banks that issue their own banknotes always pay out in those notes, it might seem that their discounting business is carried on entirely with capital made by those very notes — but that is not so. A banker may perfectly well pay out his own notes for every bill he discounts, and yet nine-tenths of the bills he holds may still represent real capital. For although he himself gave nothing but his own paper for those bills, that paper need not stay in circulation until the bills fall due. The bills may run for three months; the notes may come back to him in three days. A customer overdrawing his account is a regular piece of business — it is, in fact, the very purpose a cash credit is granted for... Cash credits are secured not only by personal guarantees but also by depositing securities. Capital advanced against a pledge of goods has the same effect as capital advanced by discounting a bill. If someone borrows £100 against the security of his goods, it is the same as if he had sold the goods for a £100 bill and had the bank discount it. But the advance lets him hold his goods back for a better market, and avoid sacrifices he would otherwise have had to make to raise money for pressing needs.
From The Currency Theory Reviewed, pages 62 and 63.
It is beyond dispute, the pamphlet says, that the £1,000 deposited with A today may be paid out again tomorrow and become a deposit with B. The day after, paid out again by B, it may become a deposit with C, and so on without end. So the same £1,000 in money can, through a chain of transfers, multiply itself into an absolutely indeterminable sum of deposits. It is therefore possible that nine-tenths of all the deposits in England have no existence at all beyond the entries in the bankers' own books, each banker answering for his own share... As in Scotland, where the money in circulation — on top of which almost all of it is paper — never exceeds £3 million, while the deposits run to £27 million. Now so long as there is no general, sudden demand to withdraw deposits all at once — a run on the banks — that same £1,000, travelling back the other way, can cancel out an equally indeterminable sum with the very same ease. Since the same £1,000 with which I settle my debt to a merchant today can settle his debt to another merchant tomorrow, and that merchant's settlement with the bank the day after, and so on without end, the same £1,000 can pass from hand to hand and bank to bank and cancel out any sum of deposits you care to name.
We have already seen that Gilbart knew this back in 1834:
Gilbart's maxim was that anything that makes trade easier also makes speculation easier. The two are so closely tangled together in many cases that you cannot say where trade stops and speculation begins.
The easier it is to get an advance of money on goods not yet sold, the more such advances get drawn, and the greater the temptation to manufacture goods, or to ship goods already made off to distant markets, purely to get a money advance on them. English trade between 1845 and 1847 is a striking example of how a whole country's business world can be swept up in this kind of swindling, and of where it ends. Here we see what credit can do. Just a few brief remarks first, by way of setting up the examples that follow.
At the end of 1842 the pressure that had lain on English industry almost without a break since 1837 began to lift. Over the next two years foreign demand for English manufactures grew still further; 1845 and 1846 were the years of the greatest prosperity. In 1843 the Opium War had opened China to English trade. This new market gave a fresh excuse for an expansion that was already running at full tilt, especially in the cotton industry. "How could we ever produce too much? We have three hundred million people to clothe," a Manchester manufacturer told the present writer at the time. But all the new factory buildings, steam engines, spinning machines and looms were not enough to absorb the surplus-value pouring in from Lancashire. With the same appetite that drove up production, people threw themselves into building railways; here the manufacturers' and merchants' hunger for speculation found its first outlet, and had done so since the summer of 1844 already. Shares were subscribed as far as the money would stretch to cover the first instalments - the rest would take care of itself! Then when the further instalments fell due - according to Question 1059 of the 1848 Committee on Commercial Distress, the capital sunk in railways in 1846 and 1847 came to about £75 million - credit had to be called on, and the firm's own proper business usually had to bleed for it as well.
And this proper business was in most cases already overstretched. The tempting high profits had led firms into operations far more extensive than their available ready funds could justify. But credit was there for the taking, easy to get and cheap on top of it. Bank discount stood low: 1 3/4 to 2 3/4 per cent in 1844, under three per cent through October 1845, then rising briefly to five per cent (February 1846), then falling back to 3 1/4 per cent by December 1846. The Bank held a gold reserve in its vaults of an unheard-of size. Every domestic share price stood higher than ever before. So why let such a fine opportunity slip by, why not get straight into harness? Why not send every good you could manufacture out to foreign markets starving for English wares? And why should the manufacturer himself not pocket the double profit that came from selling his yarn and cloth out east and then selling the return cargo he got for them back in England?
That is how the system of mass consignments to India and China against advances arose - a system that very soon developed further into consignments made purely for the sake of the advance, as is described in detail in the notes that follow, and which had to end, necessarily, in markets glutted on a massive scale and in a crash.
This crash broke out as a consequence of the bad harvest of 1846. England, and Ireland especially, needed huge imports of food, above all corn and potatoes. But the countries supplying them could be paid in English manufactures only to the smallest degree; precious metal had to be handed over instead - gold worth at least £9 million went abroad. A full £7 1/2 million of this came out of the Bank of England's own reserve, which badly crippled its freedom of movement on the money market. The other banks, whose reserves sit with the Bank of England and are in practice identical with its own reserve, now had to restrict their money accommodation as well. The rapid, easy flow of payments began to stall, first here and there, then generally. Bank discount, still three to three and a half per cent in January 1847, rose in April, when the first panic broke, to seven per cent; then in summer came a brief small easing again (6 1/2, 6 per cent), but once the new harvest also failed, panic broke out afresh, and worse. The Bank's official minimum discount rose to seven per cent in October and to ten per cent in November - meaning the great majority of bills could only be discounted, if at all, at colossal, usurious rates of interest. The general stoppage of payments bankrupted a string of leading houses and very many middling and small ones; the Bank itself was in danger of failing, because of the restrictions the cunning Bank Act of 1844 had placed on it - at which point the government, under general pressure, suspended the Bank Act on the 25th of October and so removed the absurd legal fetters that had been placed on it. Now it could put its stock of notes into circulation unhindered; and since the credit of these banknotes was in fact guaranteed by the credit of the nation, and so unshaken, this at once brought the decisive easing of the money squeeze. Of course a good many large and small firms still went under, ones hopelessly overcommitted beyond rescue, but the peak of the crisis had been passed, and Bank discount fell again in December to five per cent; and already in the course of 1848 that renewed business activity was taking shape which blunted the edge of the Continent's revolutionary movements in 1849, and which in the eighteen-fifties first brought about an industrial prosperity never before known - and then, in due course, the crash of 1857. - F. E.
A report the House of Lords published in 1848 lays out just how much government bonds and shares collapsed in the crisis of 1847. It shows the fall in their value by 23 October of that year, compared with where they stood back in February:
Then there is the swindling in the East India trade. Normally a bill got drawn because goods had been bought. Here it ran backwards: people bought goods so that they could draw bills that could be discounted and turned into cash. The Manchester Guardian described it this way on 24 November 1847:
Say A in London gets B to buy goods from the manufacturer C in Manchester, to be shipped out to D in East India. B pays C with a six-month bill, drawn by C on B. B then covers himself the same way, with a six-month bill on A. As soon as the goods are shipped, A draws a six-month bill on D, against the bill of lading that has been sent to him.
So, the newspaper explained, buyer and shipper both had cash in hand many months before they had actually paid for the goods. Usually, when a bill fell due, it simply got renewed, on the excuse that trade over such distances needed more time for the money to come back.
But losses in this trade did not shrink it — they made it grow. The poorer a firm got, the more it needed to buy, just to make up, through new advances, for the capital it had lost in earlier ventures. Purchases stopped being governed by supply and demand and became instead the main way a struggling firm managed its finances.
And that was only one side of it. The same thing happening with exports from Manchester was happening with buying and shipping goods at the other end. Houses in India with enough credit to get their bills discounted bought sugar, indigo, silk, or cotton — not because the prices looked likely to bring a profit against London's, but because earlier bills drawn on the London house were about to fall due and had to be covered. What could be simpler than buying a cargo of sugar, paying for it with a ten-month bill on the London house, and sending the shipping papers by the overland mail? Within two months, the goods — barely shipped — were already pledged in Lombard Street, and the London house had its cash eight months before the bills drawn against those goods even fell due. And all of this ran smoothly, without a hitch, for as long as the discount houses had plenty of money to advance against shipping papers and warehouse warrants, and would discount, without limit, the bills of Indian houses drawn on the 'fine' firms of Mincing Lane.
This swindle kept working as long as goods bound to and from India had to sail round the Cape. Once they started going through the Suez Canal, and in steamships at that, this way of manufacturing fictitious capital lost the very thing it depended on — the long time goods spent in transit. And once the telegraph let an English merchant learn the state of the Indian market, and an Indian dealer the state of the English market, on the very same day, the method became completely impossible.
Here is a passage from the report on Commercial Distress, 1847-8, already mentioned:
In the last week of April 1847, the Bank of England told the Royal Bank of Liverpool it would from then on cut its discount business with that bank by half. This hit especially hard, because payments coming into Liverpool had lately been made much more in bills than in cash — merchants who used to bring the Bank plenty of cash to pay their acceptances could now bring only bills they had taken in for their cotton and other goods, and that had grown fast as the difficulties mounted. The acceptances the Bank had to pay on the merchants' behalf were mostly drawn on them from abroad, and up to now these had usually been covered by whatever payment came in for the goods. The bills the merchants now brought instead of cash were of different terms and kinds — quite a few were bankers' bills at three months, but the bulk were cotton bills. Where they were bankers' bills, London bankers had accepted them; otherwise, merchants of every kind — Brazilian, American, Canadian, West Indian, and so on. The merchants were not drawing on each other; rather, buyers inland who had bought goods from the merchants settled up with bills on London bankers, or on other London houses, or on more or less anyone. The Bank of England's announcement led to shorter terms on bills drawn against sales of foreign goods, terms that had often run to more than three months before.
The years of prosperity from 1844 to 1847 in England, as described earlier, went hand in hand with the first great railway swindle. Here is what the same report says about its effect on business in general:
By April 1847, almost every trading house had started starving its own business, more or less, by putting part of its trading capital into railways. Loans were also being raised at a high rate of interest — say, 8 per cent — on railway shares, from private individuals, bankers, and insurance companies. These heavy advances that such trading houses made to the railways then pushed them, in turn, to take on too much capital from the banks through bill discounting, just to keep their own business going.
Asked whether payments on railway shares had added much to the pressure on the money market in April and October 1847, the witness answered that they had hardly added anything to the pressure in April — if anything, up to April, and perhaps into the summer, they had strengthened the banks rather than weakened them, since the money was not actually spent nearly as fast as it was called in, so most banks held a fairly large amount of railway money at the start of the year — something many statements by bankers in the Commercial Distress report of 1848-57 confirm. That gradually melted away over the summer, and by 31 December was much smaller. One cause of the pressure in October was this gradual draining away of railway money from the banks' hands — between 22 April and 31 December their railway balances fell by a third. Railway calls had this effect across the whole country: little by little, they drained the banks' deposits.
Samuel Gurney — head of the notorious firm Overend, Gurney & Co. — said much the same:
In 1846 there was a considerably greater demand for capital, for building railways, but it did not raise the value of money. Small sums condensed into large masses, and those large masses got used in our market — so that, on the whole, the effect was to put more money into the City's money market rather than take it out.
A. Hodgson, a director of the Liverpool Joint Stock Bank, shows just how much a bank's reserves can consist of bills of exchange:
It was our habit to keep at least nine-tenths of all our deposits, and all the money we held for other people, in our bill case, in bills falling due day by day — so much so that during the crisis, the bills falling due each day were almost equal to the demands being made on us that same day.
Speculative bills.
Question 5092: who generally accepted the bills drawn against sold cotton? Answer, from R. Gardner, the cotton manufacturer mentioned several times already: produce brokers — someone buys cotton, hands it to a broker, draws a bill on that broker, and gets the bill discounted.
Question: and these bills go to the Liverpool banks and get discounted there? Answer: yes, and elsewhere too. If that kind of accommodation had not existed — mostly granted by the Liverpool banks — I believe cotton would never have gone as high last year as it did, by a penny and a half or twopence a pound.
Question: you have said a vast number of bills were put into circulation, drawn by speculators on cotton brokers in Liverpool — does the same hold for your advances on bills against other colonial produce besides cotton? Answer, from A. Hodgson, a Liverpool banker: it applies to all kinds of colonial produce, but especially to cotton.
Question: as a banker, do you try to keep this kind of bill at arm's length? Answer: not at all — we consider it a perfectly legitimate kind of bill, when kept within reason. This kind of bill is often renewed.
Swindling in the East India and China market, 1847. Charles Turner, head of one of the leading East India firms in Liverpool:
We all know what has happened with the trade to Mauritius and similar trades. Brokers were used to advancing money on goods once they had arrived, to cover the bills drawn against them — which is perfectly proper — and on bills of lading too. But they have also advanced money on produce before it was even shipped, and in some cases before it was made. Take my own case: I once bought bills in Calcutta worth six or seven thousand pounds; the proceeds went to Mauritius, to help grow sugar; the bills came to England, and more than half of them were protested — because by the time the sugar shipments finally arrived, the sugar meant to pay for those bills had already been pledged to other people before it was shipped, in fact almost before it had been boiled.
Goods for the East India market now have to be paid for in cash to the manufacturer — though that does not mean much, because if the buyer has any credit in London, he draws on a London house and gets the bill discounted there, where discount rates are currently low, and pays the manufacturer with the money he gets that way. It takes at least twelve months for someone shipping goods to India to get his returns back from there. A man with ten or fifteen thousand pounds going into the Indian trade would open a fairly large credit with a London house, paying it one per cent, and draw on it — on the understanding that the proceeds of the goods sent out would be returned to that London house — while both sides quietly understood that the London house was never really expected to pay out cash: the bills would simply be renewed until the returns came in. These bills were discounted in Liverpool, Manchester, London — some of them sit in Scottish banks.
Then there was a house that failed in London recently; going through its books, this came out. There was a firm in Manchester, and another in Calcutta. They opened a credit account with a London house for £200,000 — meaning the Manchester firm's business friends, who consigned goods to the Calcutta house from Glasgow and Manchester, could draw on the London house up to £200,000. At the same time, it was understood that the Calcutta house would also draw on the London house for £200,000; those bills were sold in Calcutta, the proceeds used to buy other bills, which were sent to London so the London house could pay off the first bills drawn from Glasgow and Manchester. So this one piece of business put £600,000 worth of bills into the world.
And now: if a house in Calcutta buys a cargo for England and pays for it with its own bills on its London correspondent, and sends the bills of lading over here, those bills of lading immediately become usable for raising advances in Lombard Street — so they get the use of the money for eight months before their correspondents are even called on to pay.
IV. In 1848 a secret committee of the House of Lords sat to look into what had caused the crisis of 1847. But the evidence given to it was not published until 1857. One of the witnesses was Mr Lister, a director of the Union Bank of Liverpool. Among other things, he said the following.
Question 2444. In the spring of 1847, Lister said, credit had been stretched too far. The reason was that businessmen had moved their capital out of their ordinary trade and into railway shares, while still trying to keep trading at the same scale as before. Each of them probably thought at first that he could sell the railway shares at a profit and put the money back into the business. Perhaps he then found that it would not work, and he started buying and selling on credit in his business where he used to pay cash. That is how the extension of credit began.
Question 2500. Asked whether the bills the banks lost money on were mainly bills against corn or against cotton, Lister said they were bills against produce of every kind - corn, cotton, sugar, foreign produce in general. Almost nothing had held its price at the time, except perhaps oil.
Question 2506. Asked about a broker who accepts a bill, he said the broker never accepts one without being covered well enough, even against a fall in the price of the goods put up as security.
Question 2512. Lister explained that two kinds of bill get drawn against produce. The first kind is the original bill drawn abroad on the importer. Bills of this kind often fall due before the produce itself has even arrived. So when the goods do arrive, if the merchant does not have enough capital of his own, he has to pledge them with the broker until he can sell them. At that point a bill of the second kind is drawn straight away - by the Liverpool merchant on the broker, with the pledged goods as security. It then falls to the banker to check with the broker that he really holds the goods, and how much he has advanced against them. The banker has to make sure the broker has enough cover to protect himself if the deal turns out at a loss.
Question 2516. We also receive bills from abroad, Lister said. Someone buys a bill on England over there and sends it to a house here; and we cannot tell, just by looking at the bill, whether it was drawn sensibly or not - whether it stands for real produce or for nothing at all.
Question 2533. Asked whether foreign produce of almost every kind had been sold at a heavy loss because of reckless speculation in it, Lister said no: it came from a very large quantity being imported while there was no matching demand to take it off the market. Consumption, by every sign, had fallen off a great deal. Question 2534. By October, he added, produce was almost impossible to sell.
On how, at the height of a crash, a general every-man-for-himself takes hold, an expert of the first rank speaks in the same report - the worthy, wily Quaker Samuel Gurney, of Overend, Gurney and Co.
Question 1262. When a panic is on, Gurney said, a businessman does not stop to ask how much he can raise on his banknotes, or whether he will lose one or two per cent selling his exchequer bills or his three-per-cents. Once fear has taken hold of him, profit and loss no longer matter to him at all - he gets himself to safety, and lets the rest of the world do as it pleases.
V. Next in the witness chair is Alexander, a merchant in the East India trade, giving evidence to the House of Commons committee that looked into the 1857 Bank Act. His subject: two markets flooding each other at once.
Question 4330. Right now, Alexander said, if I lay out 6 shillings in Manchester, I get back 5 shillings in India; and if I lay out 6 shillings in India, I get back 5 shillings in London.
So the Indian market had been glutted by England, and the English market just as much by India. And this was happening in the summer of 1857 - barely ten years after the bitter experience of 1847.
A full, detailed study of the credit system and the tools it creates for itself, such as credit money, falls outside our plan here. Only a few points need bringing out — the ones necessary to describe the capitalist mode of production in general. We are dealing here only with commercial credit and bank credit. How their development connects to the development of public credit is left aside.
I showed earlier (Volume One, Chapter 3, Section 3b) how, out of plain commodity circulation, money comes to function as a means of payment — and with that a relationship of creditor and debtor forms among the people who produce and deal in commodities. As trade develops, and with it a capitalist mode of production that produces only with an eye to circulation, this natural, spontaneously grown basis of the credit system gets expanded, generalized, worked out further.
By and large, money here functions only as a means of payment: a commodity is sold not for money, but for a written promise to pay at a set date. For short, we can lump all these promises to pay together under the name bills of exchange. Until they fall due, such bills themselves keep circulating as a means of payment — they form the real commercial money. To the extent that they end up cancelling each other out, one claim balancing one debt, they function absolutely as money: no final conversion into money takes place.
These mutual advances that producers and merchants extend to one another are the real basis of credit. In the same way, the instrument they circulate in — the bill of exchange — is the basis of credit money proper: banknotes and the like. None of this rests on the circulation of money, whether metal coin or government paper. It rests on the circulation of bills.
W. Leatham, a banker in Yorkshire, writes in his Letters on the Currency (2nd edition, London, 1840):
He finds that the total of all bills for the whole of 1839 came to £528,493,842 (he reckons foreign bills at about a seventh of that total), and that the amount of bills running at any one time that year was £132,123,460. Bills of exchange, he says, are one component of the currency bigger than everything else put together. This enormous superstructure of bills rests (!) on the foundation formed by the stock of banknotes and gold; and if events narrow that foundation too far, the whole thing's solidity, even its very existence, is put at risk. Reckoning the whole currency — he means the banknotes — together with the amount of the banks' obligations payable in cash on demand, he finds a sum of 153 million that the law lets people demand be converted into gold, against only 14 million in gold to meet that demand. Bills of exchange, he says, cannot be brought under any control except by preventing the glut of money and the low rates of interest or discount that create part of them and encourage this large, dangerous expansion. It is impossible to say how much of it arises from real, bona fide business — actual buying and selling — and how much is artificially made (fictitious), consisting only of accommodation bills: that is, where one bill is drawn just to take up another falling due, manufacturing mere circulating paper and so creating fictitious capital. In times of plentiful, cheap money, he knows this reaches an enormous scale.
J. W. Bosanquet writes in Metallic, Paper, and Credit Currency (London, 1842):
He finds that the average amount settled each business day at the Clearing House — where London's bankers exchange among themselves the cheques paid in and the bills falling due — comes to more than £3 million, while the amount of actual money needed for this each day is little more than £200,000. (By 1889, the Clearing House's total turnover for the year had reached £7,618 3/4 million, which works out, over roughly 300 business days, to about £25 1/2 million a day.) Bills of exchange, he says, undoubtedly act as currency independent of money, in that they transfer property from hand to hand by endorsement. On average, he assumes, every bill in circulation carries two endorsements, so on average every bill settles two payments before it falls due. On that assumption, it would appear that endorsement alone transferred property worth twice 528 million — £1,056,000,000 — more than £3 million a day, over the course of 1839. So it is certain, he concludes, that bills of exchange and deposits together perform money's functions, transferring property from hand to hand with no help from money at all, to a daily amount of at least £18 million.
This is what Tooke has to say about credit in general:
Tooke defines credit, in its simplest expression, as the trust — well founded or not — that leads one person to entrust another with a certain amount of capital, whether in money or in goods valued at an agreed sum of money, always repayable once a fixed term has passed. Where the capital is lent in money — say, as banknotes, or a cash credit, or an order on a correspondent — an addition of so much per cent is made to the sum to be repaid, for the use of the capital. Where it is goods, whose money value the parties have agreed and whose transfer counts as a sale, the fixed sum to be repaid already includes a charge for the use of the capital and for the risk carried until the term expires. Written promises to pay by a fixed date are mostly given for credit of this kind, and it is these transferable promises that let the lenders — whenever they themselves want to use their capital, in money or in goods, before their own bills fall due — usually borrow or buy more cheaply, because their own credit is reinforced by the other name now on the bill.
Ch. Coquelin, "Du Crédit et des Banques dans l'Industrie," Revue des deux Mondes, 1842, volume 31:
In every country, he says, most credit business happens within the circle of industry's own dealings. The producer of the raw material advances it to the manufacturer who processes it, and gets back from him a promise to pay by a fixed date. Once the manufacturer has done his share of the work, he in turn advances his product, on similar terms, to another manufacturer who has to process it further — and so credit stretches on, from one to the next, all the way to the consumer. The wholesaler advances goods to the retailer, while getting the same kind of advance himself from the manufacturer or the agent. Everyone borrows with one hand and lends with the other — sometimes money, but far more often goods. So, within industry's own dealings, there runs an unbroken exchange of advances, combining and crossing each other in every direction. The growth of credit is exactly this: the multiplication and growth of these mutual advances — and that is where its power truly lives.
The other side of the credit system grows directly out of the money trade, which under capitalist production naturally keeps pace with the growth of trade in commodities. We saw earlier (Chapter 19) how looking after businessmen's reserve funds, the mechanics of taking in and paying out money, handling payments abroad, and so the trade in bullion too, all became concentrated in the hands of money-dealers.
Building on that money trade, this other side of the credit system now develops: managing interest-bearing capital, or money capital, becomes a special function of the money-dealers. Borrowing and lending money becomes their own particular business. They step in as go-betweens between the real lender and the real borrower of money capital.
Put generally, this side of banking consists in concentrating loanable money capital, in large masses, in the banker's own hands, so that instead of facing individual money-lenders one by one, industrial and commercial capitalists now face bankers who act as representatives of all the lenders together. Bankers become the general administrators of money capital. On the other side, facing all the lenders, they concentrate the borrowers too, by borrowing on behalf of the whole world of trade. So a bank represents, on one side, the centralizing of money capital -- of the lenders -- and, on the other, the centralizing of the borrowers. Its profit consists, in general, in borrowing at a lower rate of interest than the rate at which it lends.
The capital banks have available to lend flows to them in several ways. First, because banks act as cashiers for industrial capitalists, the money capital that every producer and merchant holds as a reserve fund, or that comes in to him as payment, becomes concentrated in the bank's hands. These funds are thereby turned into loanable money capital. Because the reserve fund of the whole business world is now held in common, it is cut down to the necessary minimum, and part of the money capital that would otherwise lie idle as a reserve fund gets lent out instead, functioning as interest-bearing capital.
Second, the bank's loanable capital is made up of the deposits of money capitalists, who hand over to the bank the job of lending it out. As the banking system develops, and especially once banks start paying interest on deposits, the savings and momentarily unused money of people of every class get deposited with them too. Small sums, each too small on its own to function as money capital, get combined into large masses and so form a monetary power. This gathering-together of small amounts must be kept distinct, as a separate effect of the banking system, from the bank's role as go-between connecting the real money capitalists and the borrowers.
Finally, revenues meant to be spent only gradually are also deposited with the banks.
Lending -- here we are dealing only with commercial credit proper -- happens by discounting bills, that is, turning them into money before they fall due, and by advances of various kinds: direct advances on personal credit, advances against interest-bearing paper, government securities, or shares of every sort, and, in particular, advances against bills of lading, dock warrants and other certified titles to goods, as well as by letting customers overdraw their deposits, and so on.
The credit a banker gives can take various forms: bills drawn on other banks, say, or cheques on them, or credit facilities of the same kind, and finally, for banks that issue notes, the bank's own banknotes. A banknote is nothing but a bill on the banker, payable to the bearer at any time, which the banker gives in place of private bills.
This last form of credit strikes the layman as especially remarkable and important -- first, because this kind of credit money passes out of mere commercial circulation into general circulation and functions there as money; also because in most countries the main note-issuing banks are, in effect, a peculiar mixture of national bank and private bank, and in fact they have the nation's credit behind them and their notes are more or less legal tender; and because here it becomes visible that what the banker deals in is credit itself, since the banknote is only a circulating token of credit.
But the banker deals in credit in all its other forms too, even when he advances money that was deposited with him in cash. In fact the banknote is only the small change of wholesale trade, and it is always the deposit that counts as the main thing at a bank. The best proof of this is the Scottish banks.
The special credit institutions, like the particular forms banks themselves take, need not be looked at further for our purposes here.
Tooke says the bankers' business divides into two branches. One is to collect capital from those who have no immediate use for it, and to distribute and hand it on to others who can use it; the other is to receive deposits of income from their customers and pay out the sums as those customers need them for their own spending. The first, he says, is a circulation of capital, the second a circulation of money -- of currency.
Put another way, he says: one branch is the concentration of capital on one side and its distribution on the other; the other branch is administering the circulation for the local needs of the district.
We shall come back to this passage in Chapter 28.
In the 1840s, when a bill was discounted in London, banks in countless cases handed over not banknotes but a twenty-one-day bill drawn by one bank on another. That is what a country banker named Pease testified. And according to the same report, whenever money grew tight, bankers made a habit of paying their customers in these bills instead of notes. If the customer wanted actual banknotes, he had to get the bill discounted all over again. For the banks, this amounted to a privilege of coining money. Jones Loyd and Co. had paid their customers this way for as long as anyone could remember, whenever money was scarce and the interest rate above 5 per cent. Customers were glad to take these bankers' bills, since a bill from Jones Loyd and Co. was easier to get discounted than one of their own; such bills often passed through twenty or thirty hands.
All these forms exist for one purpose: to make a claim to payment something that can be passed on to someone else.
Fullarton says there is scarcely any shape credit can be put into in which it will not at times be called on to do money's job; banknote, bill of exchange or cheque, the process is essentially the same and the result is essentially the same. And his other line: banknotes are the small change of credit.
What follows comes from J. W. Gilbart's book on the history and principles of banking, published in London in 1834.
In Gilbart's account a bank's capital falls into two parts, the capital it has invested and its banking capital, which it has borrowed. This borrowed banking capital is raised in three ways: by taking in deposits, by issuing its own banknotes, and by drawing bills. If someone lends me £100 for nothing, and I lend that £100 to someone else at 4 per cent, I make £4 over the year on the deal. In the same way, if someone takes my written promise to pay (that is the usual wording printed on an English banknote) and brings it back to me at the end of the year, paying me 4 per cent for it just as if I had lent him 100 sovereigns, I make £4 on that deal too. And again, if someone in a country town hands me £100 on condition that I pay the same sum to a third person in London twenty-one days later, then whatever interest I can make on the money in the meantime is my profit. This is a fair account of how a bank operates, and of how a banking capital gets raised out of deposits, banknotes, and bills. A banker's profits generally run in proportion to the size of his borrowed, or banking, capital. To find a bank's real profit, you subtract the interest on the invested capital from the gross profit; what is left is the banking profit. A banker's advances to his customers are made with other people's money. It is precisely the bankers who issue no banknotes who build up a banking capital by discounting bills. They use their discounting to grow their deposits. London bankers will only discount for houses that keep a deposit account with them. A firm that has had bills discounted at its bank, and paid interest on the full amount, has to leave at least part of that amount sitting with the bank, earning no interest. This way the banker earns more than the going rate of interest on the money he has advanced, and builds up a banking capital out of the balance left in his hands.
Economizing on reserve funds, deposits, cheques.
Deposit banks economize on the use of actual money by transferring balances between accounts, settling large sums of business with only a small amount of real money. The money this frees up is used by the banker for advances to his customers, by discount or otherwise. So the transfer of balances makes the deposit system that much more effective. It makes no difference whether the two parties dealing with each other bank with the same house or with different ones, since bankers exchange cheques among themselves at the clearing house. In this way the deposit system could, through transfers, be extended so far that it drove out the use of metal money altogether. If everyone kept a deposit account and made all payments by cheque, cheques would become the sole circulating medium. But this would only work if it could be assumed the bankers actually held the money — otherwise the cheques would be worth nothing.
Local business is centralized in the hands of the banks in two ways: first, through branches — country banks have branch offices in the smaller towns of their district, London banks in the different parts of London; second, through agencies.
Every country bank keeps an agent in London, to pay its notes or bills there and to receive money paid in by London residents on behalf of people living in the country. Each banker collects up the other's notes and does not put them back into circulation. In every larger town, bankers meet once or twice a week and exchange notes; the balance is settled by a draft on London. The purpose of banking is to make business easier, and whatever makes business easier also makes speculation easier. Business and speculation are, in many cases, so closely tied together that it is hard to say where business stops and speculation begins... Wherever there are banks, capital is easier and cheaper to get. Cheap capital gives speculation a boost, in just the same way that cheap meat and beer give gluttony and drunkenness a boost. Since banks that issue their own banknotes always pay out in those notes, it might seem that their discounting business is carried on entirely with capital made by those very notes — but that is not so. A banker may perfectly well pay out his own notes for every bill he discounts, and yet nine-tenths of the bills he holds may still represent real capital. For although he himself gave nothing but his own paper for those bills, that paper need not stay in circulation until the bills fall due. The bills may run for three months; the notes may come back to him in three days. A customer overdrawing his account is a regular piece of business — it is, in fact, the very purpose a cash credit is granted for... Cash credits are secured not only by personal guarantees but also by depositing securities. Capital advanced against a pledge of goods has the same effect as capital advanced by discounting a bill. If someone borrows £100 against the security of his goods, it is the same as if he had sold the goods for a £100 bill and had the bank discount it. But the advance lets him hold his goods back for a better market, and avoid sacrifices he would otherwise have had to make to raise money for pressing needs.
From The Currency Theory Reviewed, pages 62 and 63.
It is beyond dispute, the pamphlet says, that the £1,000 deposited with A today may be paid out again tomorrow and become a deposit with B. The day after, paid out again by B, it may become a deposit with C, and so on without end. So the same £1,000 in money can, through a chain of transfers, multiply itself into an absolutely indeterminable sum of deposits. It is therefore possible that nine-tenths of all the deposits in England have no existence at all beyond the entries in the bankers' own books, each banker answering for his own share... As in Scotland, where the money in circulation — on top of which almost all of it is paper — never exceeds £3 million, while the deposits run to £27 million. Now so long as there is no general, sudden demand to withdraw deposits all at once — a run on the banks — that same £1,000, travelling back the other way, can cancel out an equally indeterminable sum with the very same ease. Since the same £1,000 with which I settle my debt to a merchant today can settle his debt to another merchant tomorrow, and that merchant's settlement with the bank the day after, and so on without end, the same £1,000 can pass from hand to hand and bank to bank and cancel out any sum of deposits you care to name.
We have already seen that Gilbart knew this back in 1834:
Gilbart's maxim was that anything that makes trade easier also makes speculation easier. The two are so closely tangled together in many cases that you cannot say where trade stops and speculation begins.
The easier it is to get an advance of money on goods not yet sold, the more such advances get drawn, and the greater the temptation to manufacture goods, or to ship goods already made off to distant markets, purely to get a money advance on them. English trade between 1845 and 1847 is a striking example of how a whole country's business world can be swept up in this kind of swindling, and of where it ends. Here we see what credit can do. Just a few brief remarks first, by way of setting up the examples that follow.
At the end of 1842 the pressure that had lain on English industry almost without a break since 1837 began to lift. Over the next two years foreign demand for English manufactures grew still further; 1845 and 1846 were the years of the greatest prosperity. In 1843 the Opium War had opened China to English trade. This new market gave a fresh excuse for an expansion that was already running at full tilt, especially in the cotton industry. "How could we ever produce too much? We have three hundred million people to clothe," a Manchester manufacturer told the present writer at the time. But all the new factory buildings, steam engines, spinning machines and looms were not enough to absorb the surplus-value pouring in from Lancashire. With the same appetite that drove up production, people threw themselves into building railways; here the manufacturers' and merchants' hunger for speculation found its first outlet, and had done so since the summer of 1844 already. Shares were subscribed as far as the money would stretch to cover the first instalments - the rest would take care of itself! Then when the further instalments fell due - according to Question 1059 of the 1848 Committee on Commercial Distress, the capital sunk in railways in 1846 and 1847 came to about £75 million - credit had to be called on, and the firm's own proper business usually had to bleed for it as well.
And this proper business was in most cases already overstretched. The tempting high profits had led firms into operations far more extensive than their available ready funds could justify. But credit was there for the taking, easy to get and cheap on top of it. Bank discount stood low: 1 3/4 to 2 3/4 per cent in 1844, under three per cent through October 1845, then rising briefly to five per cent (February 1846), then falling back to 3 1/4 per cent by December 1846. The Bank held a gold reserve in its vaults of an unheard-of size. Every domestic share price stood higher than ever before. So why let such a fine opportunity slip by, why not get straight into harness? Why not send every good you could manufacture out to foreign markets starving for English wares? And why should the manufacturer himself not pocket the double profit that came from selling his yarn and cloth out east and then selling the return cargo he got for them back in England?
That is how the system of mass consignments to India and China against advances arose - a system that very soon developed further into consignments made purely for the sake of the advance, as is described in detail in the notes that follow, and which had to end, necessarily, in markets glutted on a massive scale and in a crash.
This crash broke out as a consequence of the bad harvest of 1846. England, and Ireland especially, needed huge imports of food, above all corn and potatoes. But the countries supplying them could be paid in English manufactures only to the smallest degree; precious metal had to be handed over instead - gold worth at least £9 million went abroad. A full £7 1/2 million of this came out of the Bank of England's own reserve, which badly crippled its freedom of movement on the money market. The other banks, whose reserves sit with the Bank of England and are in practice identical with its own reserve, now had to restrict their money accommodation as well. The rapid, easy flow of payments began to stall, first here and there, then generally. Bank discount, still three to three and a half per cent in January 1847, rose in April, when the first panic broke, to seven per cent; then in summer came a brief small easing again (6 1/2, 6 per cent), but once the new harvest also failed, panic broke out afresh, and worse. The Bank's official minimum discount rose to seven per cent in October and to ten per cent in November - meaning the great majority of bills could only be discounted, if at all, at colossal, usurious rates of interest. The general stoppage of payments bankrupted a string of leading houses and very many middling and small ones; the Bank itself was in danger of failing, because of the restrictions the cunning Bank Act of 1844 had placed on it - at which point the government, under general pressure, suspended the Bank Act on the 25th of October and so removed the absurd legal fetters that had been placed on it. Now it could put its stock of notes into circulation unhindered; and since the credit of these banknotes was in fact guaranteed by the credit of the nation, and so unshaken, this at once brought the decisive easing of the money squeeze. Of course a good many large and small firms still went under, ones hopelessly overcommitted beyond rescue, but the peak of the crisis had been passed, and Bank discount fell again in December to five per cent; and already in the course of 1848 that renewed business activity was taking shape which blunted the edge of the Continent's revolutionary movements in 1849, and which in the eighteen-fifties first brought about an industrial prosperity never before known - and then, in due course, the crash of 1857. - F. E.
A report the House of Lords published in 1848 lays out just how much government bonds and shares collapsed in the crisis of 1847. It shows the fall in their value by 23 October of that year, compared with where they stood back in February:
Then there is the swindling in the East India trade. Normally a bill got drawn because goods had been bought. Here it ran backwards: people bought goods so that they could draw bills that could be discounted and turned into cash. The Manchester Guardian described it this way on 24 November 1847:
Say A in London gets B to buy goods from the manufacturer C in Manchester, to be shipped out to D in East India. B pays C with a six-month bill, drawn by C on B. B then covers himself the same way, with a six-month bill on A. As soon as the goods are shipped, A draws a six-month bill on D, against the bill of lading that has been sent to him.
So, the newspaper explained, buyer and shipper both had cash in hand many months before they had actually paid for the goods. Usually, when a bill fell due, it simply got renewed, on the excuse that trade over such distances needed more time for the money to come back.
But losses in this trade did not shrink it — they made it grow. The poorer a firm got, the more it needed to buy, just to make up, through new advances, for the capital it had lost in earlier ventures. Purchases stopped being governed by supply and demand and became instead the main way a struggling firm managed its finances.
And that was only one side of it. The same thing happening with exports from Manchester was happening with buying and shipping goods at the other end. Houses in India with enough credit to get their bills discounted bought sugar, indigo, silk, or cotton — not because the prices looked likely to bring a profit against London's, but because earlier bills drawn on the London house were about to fall due and had to be covered. What could be simpler than buying a cargo of sugar, paying for it with a ten-month bill on the London house, and sending the shipping papers by the overland mail? Within two months, the goods — barely shipped — were already pledged in Lombard Street, and the London house had its cash eight months before the bills drawn against those goods even fell due. And all of this ran smoothly, without a hitch, for as long as the discount houses had plenty of money to advance against shipping papers and warehouse warrants, and would discount, without limit, the bills of Indian houses drawn on the 'fine' firms of Mincing Lane.
This swindle kept working as long as goods bound to and from India had to sail round the Cape. Once they started going through the Suez Canal, and in steamships at that, this way of manufacturing fictitious capital lost the very thing it depended on — the long time goods spent in transit. And once the telegraph let an English merchant learn the state of the Indian market, and an Indian dealer the state of the English market, on the very same day, the method became completely impossible.
Here is a passage from the report on Commercial Distress, 1847-8, already mentioned:
In the last week of April 1847, the Bank of England told the Royal Bank of Liverpool it would from then on cut its discount business with that bank by half. This hit especially hard, because payments coming into Liverpool had lately been made much more in bills than in cash — merchants who used to bring the Bank plenty of cash to pay their acceptances could now bring only bills they had taken in for their cotton and other goods, and that had grown fast as the difficulties mounted. The acceptances the Bank had to pay on the merchants' behalf were mostly drawn on them from abroad, and up to now these had usually been covered by whatever payment came in for the goods. The bills the merchants now brought instead of cash were of different terms and kinds — quite a few were bankers' bills at three months, but the bulk were cotton bills. Where they were bankers' bills, London bankers had accepted them; otherwise, merchants of every kind — Brazilian, American, Canadian, West Indian, and so on. The merchants were not drawing on each other; rather, buyers inland who had bought goods from the merchants settled up with bills on London bankers, or on other London houses, or on more or less anyone. The Bank of England's announcement led to shorter terms on bills drawn against sales of foreign goods, terms that had often run to more than three months before.
The years of prosperity from 1844 to 1847 in England, as described earlier, went hand in hand with the first great railway swindle. Here is what the same report says about its effect on business in general:
By April 1847, almost every trading house had started starving its own business, more or less, by putting part of its trading capital into railways. Loans were also being raised at a high rate of interest — say, 8 per cent — on railway shares, from private individuals, bankers, and insurance companies. These heavy advances that such trading houses made to the railways then pushed them, in turn, to take on too much capital from the banks through bill discounting, just to keep their own business going.
Asked whether payments on railway shares had added much to the pressure on the money market in April and October 1847, the witness answered that they had hardly added anything to the pressure in April — if anything, up to April, and perhaps into the summer, they had strengthened the banks rather than weakened them, since the money was not actually spent nearly as fast as it was called in, so most banks held a fairly large amount of railway money at the start of the year — something many statements by bankers in the Commercial Distress report of 1848-57 confirm. That gradually melted away over the summer, and by 31 December was much smaller. One cause of the pressure in October was this gradual draining away of railway money from the banks' hands — between 22 April and 31 December their railway balances fell by a third. Railway calls had this effect across the whole country: little by little, they drained the banks' deposits.
Samuel Gurney — head of the notorious firm Overend, Gurney & Co. — said much the same:
In 1846 there was a considerably greater demand for capital, for building railways, but it did not raise the value of money. Small sums condensed into large masses, and those large masses got used in our market — so that, on the whole, the effect was to put more money into the City's money market rather than take it out.
A. Hodgson, a director of the Liverpool Joint Stock Bank, shows just how much a bank's reserves can consist of bills of exchange:
It was our habit to keep at least nine-tenths of all our deposits, and all the money we held for other people, in our bill case, in bills falling due day by day — so much so that during the crisis, the bills falling due each day were almost equal to the demands being made on us that same day.
Speculative bills.
Question 5092: who generally accepted the bills drawn against sold cotton? Answer, from R. Gardner, the cotton manufacturer mentioned several times already: produce brokers — someone buys cotton, hands it to a broker, draws a bill on that broker, and gets the bill discounted.
Question: and these bills go to the Liverpool banks and get discounted there? Answer: yes, and elsewhere too. If that kind of accommodation had not existed — mostly granted by the Liverpool banks — I believe cotton would never have gone as high last year as it did, by a penny and a half or twopence a pound.
Question: you have said a vast number of bills were put into circulation, drawn by speculators on cotton brokers in Liverpool — does the same hold for your advances on bills against other colonial produce besides cotton? Answer, from A. Hodgson, a Liverpool banker: it applies to all kinds of colonial produce, but especially to cotton.
Question: as a banker, do you try to keep this kind of bill at arm's length? Answer: not at all — we consider it a perfectly legitimate kind of bill, when kept within reason. This kind of bill is often renewed.
Swindling in the East India and China market, 1847. Charles Turner, head of one of the leading East India firms in Liverpool:
We all know what has happened with the trade to Mauritius and similar trades. Brokers were used to advancing money on goods once they had arrived, to cover the bills drawn against them — which is perfectly proper — and on bills of lading too. But they have also advanced money on produce before it was even shipped, and in some cases before it was made. Take my own case: I once bought bills in Calcutta worth six or seven thousand pounds; the proceeds went to Mauritius, to help grow sugar; the bills came to England, and more than half of them were protested — because by the time the sugar shipments finally arrived, the sugar meant to pay for those bills had already been pledged to other people before it was shipped, in fact almost before it had been boiled.
Goods for the East India market now have to be paid for in cash to the manufacturer — though that does not mean much, because if the buyer has any credit in London, he draws on a London house and gets the bill discounted there, where discount rates are currently low, and pays the manufacturer with the money he gets that way. It takes at least twelve months for someone shipping goods to India to get his returns back from there. A man with ten or fifteen thousand pounds going into the Indian trade would open a fairly large credit with a London house, paying it one per cent, and draw on it — on the understanding that the proceeds of the goods sent out would be returned to that London house — while both sides quietly understood that the London house was never really expected to pay out cash: the bills would simply be renewed until the returns came in. These bills were discounted in Liverpool, Manchester, London — some of them sit in Scottish banks.
Then there was a house that failed in London recently; going through its books, this came out. There was a firm in Manchester, and another in Calcutta. They opened a credit account with a London house for £200,000 — meaning the Manchester firm's business friends, who consigned goods to the Calcutta house from Glasgow and Manchester, could draw on the London house up to £200,000. At the same time, it was understood that the Calcutta house would also draw on the London house for £200,000; those bills were sold in Calcutta, the proceeds used to buy other bills, which were sent to London so the London house could pay off the first bills drawn from Glasgow and Manchester. So this one piece of business put £600,000 worth of bills into the world.
And now: if a house in Calcutta buys a cargo for England and pays for it with its own bills on its London correspondent, and sends the bills of lading over here, those bills of lading immediately become usable for raising advances in Lombard Street — so they get the use of the money for eight months before their correspondents are even called on to pay.
IV. In 1848 a secret committee of the House of Lords sat to look into what had caused the crisis of 1847. But the evidence given to it was not published until 1857. One of the witnesses was Mr Lister, a director of the Union Bank of Liverpool. Among other things, he said the following.
Question 2444. In the spring of 1847, Lister said, credit had been stretched too far. The reason was that businessmen had moved their capital out of their ordinary trade and into railway shares, while still trying to keep trading at the same scale as before. Each of them probably thought at first that he could sell the railway shares at a profit and put the money back into the business. Perhaps he then found that it would not work, and he started buying and selling on credit in his business where he used to pay cash. That is how the extension of credit began.
Question 2500. Asked whether the bills the banks lost money on were mainly bills against corn or against cotton, Lister said they were bills against produce of every kind - corn, cotton, sugar, foreign produce in general. Almost nothing had held its price at the time, except perhaps oil.
Question 2506. Asked about a broker who accepts a bill, he said the broker never accepts one without being covered well enough, even against a fall in the price of the goods put up as security.
Question 2512. Lister explained that two kinds of bill get drawn against produce. The first kind is the original bill drawn abroad on the importer. Bills of this kind often fall due before the produce itself has even arrived. So when the goods do arrive, if the merchant does not have enough capital of his own, he has to pledge them with the broker until he can sell them. At that point a bill of the second kind is drawn straight away - by the Liverpool merchant on the broker, with the pledged goods as security. It then falls to the banker to check with the broker that he really holds the goods, and how much he has advanced against them. The banker has to make sure the broker has enough cover to protect himself if the deal turns out at a loss.
Question 2516. We also receive bills from abroad, Lister said. Someone buys a bill on England over there and sends it to a house here; and we cannot tell, just by looking at the bill, whether it was drawn sensibly or not - whether it stands for real produce or for nothing at all.
Question 2533. Asked whether foreign produce of almost every kind had been sold at a heavy loss because of reckless speculation in it, Lister said no: it came from a very large quantity being imported while there was no matching demand to take it off the market. Consumption, by every sign, had fallen off a great deal. Question 2534. By October, he added, produce was almost impossible to sell.
On how, at the height of a crash, a general every-man-for-himself takes hold, an expert of the first rank speaks in the same report - the worthy, wily Quaker Samuel Gurney, of Overend, Gurney and Co.
Question 1262. When a panic is on, Gurney said, a businessman does not stop to ask how much he can raise on his banknotes, or whether he will lose one or two per cent selling his exchequer bills or his three-per-cents. Once fear has taken hold of him, profit and loss no longer matter to him at all - he gets himself to safety, and lets the rest of the world do as it pleases.
V. Next in the witness chair is Alexander, a merchant in the East India trade, giving evidence to the House of Commons committee that looked into the 1857 Bank Act. His subject: two markets flooding each other at once.
Question 4330. Right now, Alexander said, if I lay out 6 shillings in Manchester, I get back 5 shillings in India; and if I lay out 6 shillings in India, I get back 5 shillings in London.
So the Indian market had been glutted by England, and the English market just as much by India. And this was happening in the summer of 1857 - barely ten years after the bitter experience of 1847.