Thomas Tooke

The Fall in applications for discount of mercantile bills post Feb 1819

In United Kingdom Bank restriction from February 27th 1797 to May 1st 1821 on October 10, 2012 at 1:13 am

Thomas Tooke in his letter to Lord Grenville wrote:

” From the fall in the market rate of interest, and the little inducement to speculation, the applications for discount of mercantile bills fell off rapidly: these stood at about eight to ten millions in Feb. 1819, and it is probable that they were reduced to half that amount by the end of the year; not from any disinclination on the part of the Bank to grant the accommodation, but from the want of inducement on the part of the merchants to give five per cent, when they could readily obtain discount through private channels at on or two percent less. As as Government, from the improved state of the finances, required no further advances from the Bank, (supposing that the latter had been disposed to grant them,) there remained no medium for maintaining the circulation of Bank notes but the purchase of bullion, and possibly a reduction of the Government balances. It is owing to these two channels for the issue of notes by the Bank, that the circulation was not more reduced*.

* It may be urged that the Bank might and ought to have reduced its rate of interest on mercantile bills, in order to keep up the amount of its issues through that channel, or to have bought Exchequer Bills in the market at a premium. How far it might have been expedient to adopt either or both of these modes, It will not now stop to discuss; to have done either would, at any rate, have involved a departure from their ordinary rules, and it would have been difficult for so unwieldy a body to abandon suddenly its established habits, without the risk that its efforts might be too great in the opposite direction. The event proves that they might have ventured upon a considerable effort for enlarging their issues; and Mr. Ricardo was entitled to contend that they ought to have made this effort, and that if they had, the alteration in the value of the currency would not have been so great as it proved to be. My own opinion is, that the Directors were right, under the circumstances, in not deviating from their regular course till after they had actually resumed cash payments. And I am not at all sure that any evil consequences did arise from their having adhered to their ordinary rules. If, at the close of 1819, they had forcibly, that is, by a departure from their ordinary rules, extended their issues, they would have hastened the fall in the rate of interest, and would so far only have hastened the inducement to Government to diminish its unfunded debt, and consequently to repay the Bank, as it eventually did. ”

COMMENT:

A few critical points mentioned back in the first half of the XIX century by Ricardo and others which are still relevant today. First we see the impact of  the Government repaying its debts during a revulsion of credit which would create a contraction. This is not viewed from a Keynesian perspective of diminished spending (austerity) but in terms of reduction of collateral to issuance of  Bank notes, so the circulation would contract . We have to remember that during this period we are not in a redeemable monetary regime (Gold or bimettallic standard) we are under a compulsory regime which is irredeemable (fiat if you will). Under a redeemable monetary regime there is little a central bank do to avert a contraction/ revulsion of credit. The flip side of the price stability is steep and absolute busts.

So to continue the commentary, it is mentioned that if the BoE wanted to avert the negative consequences of a contraction, it could have bought exchequer´s bills (the equivalent of today´s QEs), or it could have lowered its discount rate on commercial bills (it seems that we are repeating the same old recipe). This was not considered for fear of negative unintended consequences of going to far in the other direction (not new either!). In summary, the QEs and  the lower discount rates are same old recipes to a contraction under a non-redeemable monetary system (fiat). The discount mechanism of the BoE was blunt, 5% always, if the market rate is lower nothing goes to get discounted at the central bank but goes in the market, if there is over excitement of trade, the BoE provides discounting at a fixed rate. Eichengreen might be right, it is a bit pro-cyclical….

Now another important lesson is that the investor should always have an eye on what is going on with money markets versus Fed Funds rates.

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