Promise to Pay

by Robert McNair Wilson

  The banker did not pursue the subject. He assured himself that, in any case, his loans had had the effect of developing the town and all its industries. They had acted like a stream of water in a desert.

  ‘‘You’ll admit that we’ve got a move on. Look at the expansion. The progress!’’

  ‘‘And the misery.’’

  The methods adopted by the banker were, naturally, adopted very soon by other keepers of strong-rooms in other parts of the country and, indeed, throughout the world, with the result that there was witnessed a sudden and violent expansion of production and then an equally sudden and violent contraction. This alternating boom and slump became a permanent feature of the whole world’s trade and was called ‘‘The Trade Cycle’’, or ‘‘The Credit Cycle’’. What was not generally realised about this ‘‘credit cycle’’ was that the bankers were making profits both ways, by compelling buyers to pay them tribute during the booms and by compelling sellers to pay them tribute during the slumps - and all this by means of their loans or promises-to-pay what none of them possessed. Our banker delivered an address to his fellow townsmen on ‘‘The Credit Cycle’’.

  ‘‘This movement of prices up and down,’’ he declared, ‘‘is inherent in human nature. It belongs, too, to the nature of things as well as to the nature of men. Look at the seasons. Out of winter darkness emerges the sunlight of spring. That is transformed soon into the glory and happiness of summer. But all too soon the days begin to draw in. Comes the fall of the leaf and then, once more, winter darkness. Believe me, my friends, in the pessimism which now infects our spirits we see only a reflection of Nature herself. But let us lift up our hearts:

  ‘If winter comes can spring be far behind?’’’ The good man pointed to the skies.

  ‘‘What is it,’’ he asked, ‘‘which causes a revival in trade? Surely it is confidence. Confidence in ourselves. Confidence in our fellows.

  Confidence in the future. Because we feel confidence returning to our spirits we begin to plan, to look ahead, to devise new means of production. Such a change of heart, believe me, cannot be produced artificially by any banker. Can a banker, by some act of financial wizardry, induce farmers to expect harvests at seed time? There is a time to sow and there is a time to reap. How can a banker lend when no man wishes to borrow? How can he refuse to lend when substantial and credit-worthy borrowers approach him? Never forget that a banker’s first duty is towards his clients, the honest and frugal folk who have entrusted to him the savings of their lifetime. Would you have him risk these savings in loans that no man desires? Would you have him make use of your savings to attempt to change the laws of Nature, to try to sow in the time of reaping? Again, would you hold him back from affording you the chance to help yourself and all your fellows by granting aid to the masters of the harvest when their fields are white and their trees heavy with fruit? It is confidence which begins a boom, my friends; and it is lack of confidence which brings it to an end. There is no financial conjuring trick, believe me, which can change by an iota that law of nature, that economic law, that inexorable economic law.’’

  ‘‘A banker, indeed, can only follow where wisdom and prudence lead. If he does not expand his loans when there is a genuine need of them, he will be failing in his trust: if he does not contract his loans when confidence has begun to ebb away he will be wanting in common sense.’’

  In private, however, the banker was less happy than he had been. A cloud of a most unlooked-for kind had begun to darken his horizon. This cloud was in the form of another banker, living in the capital city of the country, who had developed the business of lending his IOUs to the merchants engaged in trade with foreign countries. The International Banker was concerned, above everything else, to see that the volume of foreign trade was well maintained, that is to say that a brisk demand for his loans continued to exist. He had noticed that when booms occurred in the home market the volume of foreign trade tended to diminish because people were able to buy their own goods and did not wish to export them. He was anxious, therefore, to prevent the Home Bankers from lending too much in the home markets.

  When Our Banker understood what was afoot he became very angry and declared that he would tolerate no interference with the conduct of his business. He would lend his IOUs when and to whom he chose and he would withdraw them only at such times as seemed good to him. He defied the International Banker to do his worst.

  But he was uneasy, nevertheless. For in his heart of hearts he knew that the promises-to-pay in which he dealt were promises he could not possibly fulfil if any large number of his clients asked for their money at the same time. He decided that, in future, he must be more careful than ever before to ‘‘keep his position liquid’’, that is to say to invent smaller quantities of his IOUs and to lend them only to borrowers of the most trustworthy substantial kind.

  The International Banker, however, had another plan to propose. Why not, he suggested, bury the hatchet and co-operate instead of quarrelling?

  ‘‘I am in need, often’’, he said ‘‘of sums of money to lend to shippers and merchants. I am prepared to borrow for short periods of time, a night or a weekend even, so that your money will always be within your reach if you want it. Why not lend me the IOUs for which, at the moment, you cannot find good borrowers in your own town?’’

  The banker thought over this proposition; and the more he thought about it the better he liked it. It was true he often had difficulty in making a new loan immediately. Good, sound borrowers were none too easy to find, especially in times of slump. Consequently he was often in the position of having IOUs to lend and not being able to lend them - a most distressing state of affairs seeing that his unlent promises were earning no interest.

  The International Banker offered him what was, evidently, a way out of his difficulty. He could hand over to the International Banker all his unlent IOUs with the comfortable assurance that the loans were for very short periods of time. It would be a matter of hours only to call up any of these loans, so that if a good borrower came along he could always accommodate him by withdrawing IOUs from the International Banker.

  He accepted the offer therefore and began to re-organise his system of lending. He was still in possession of gold and silver to the amount of £10,000. But in future he would not lend the whole of these promises in his own town. He would divide his loans into short loans and long ones. He would lend, say, £20,000 to the International Banker and £80,000 to his fellow townsmen. When business was very bad in the town he might even lend £40,000 or £50,000 to the International Banker and only £50,000 or £60,000 to the town. In booms, on the contrary, his loans to the town would be increased and his loans to the International Banker diminished. In that way all his IOUs would be kept at work earning interest and he would be in a position to shorten sail overnight if need be. He would be holding a substantial part of his IOUs in a very ‘‘liquid’’ state.

  The plan worked exceedingly well and the banker found his income Increased by it. When he thought that conditions in the town were ripe for a new boom - when the old stocks of goods had been sold off at rubbish prices and the bankrupt businesses disposed of to fresh owners - he withdrew some of his IOUs from the International Banker and put them, cautiously, into circulation at home. Prices at home then began to rise. People saw a chance of profit and production was speeded up. More and more of his IOUs were now withdrawn from the International Banker - who only paid about 2 per cent - and entrusted to fellow townsmen who paid 5 or 6 per cent. Then, when the new goods which the boom had created began to come on the markets he took in sail again by calling up some of his loans to his fellow townsmen and returning these IOUs to the International Banker until such time as the slump had developed and so prepared the way for another boom.

  Since rates of interest rose while he was withdrawing his loans from the town and did not fall again until the slump had touched bottom he obtained an income from his own clients which varied very little. In addition, he got an
other, smaller, income from the International Banker. The International Banker, on his side, obtained IOUs over and above those which he was able to create for himself, just when he had most need of them - that is to say during the periods of slump when manufacturers, who could not sell their wares at home, were shipping them out of the country into foreign markets and so were in need of the International Banker’s services.

  ‘‘What I do,’’ the International Banker explained, ‘‘is to lend IOUs to merchants who have cargoes to export or import. I take the cargoes as security for my loans. The merchants, of course, pay me interest.’’

  Our banker understood very well what this meant. The International Banker, like himself, was engaged in inventing promises-to-pay. He was lending these at interest and thus obtaining tribute from his clients for nothing. The danger he had to fear was that his clients might demand the fulfilment of the promises - might demand that is to say gold or silver in exchange for the IOUs.

  This demand for gold was likely to occur when outgoing cargoes did not balance, and so pay for, incoming cargoes, because, in that case the difference would have to be paid in gold. Bills of exchange, in other words, which are the IOUs of international trade, would no longer serve as the means of payment. The International Banker would be forced to honour his signature his signature upon these bills by giving gold for them. As he, too, was lending promises-to-pay ten times the amount of gold in his possession he could not do this to any great extent.

  Our banker realised all the dangers involved in such a system. But he was growing accustomed to dangers. He fixed his thoughts on his own business and began to interest himself in the development of railways. He lent considerable sums of his IOUs for the building of lines to his home town. A boom in consequence developed and very soon the whole of his available IOUs were in the hands of home borrowers.

  As a consequence of this flooding of the home market with money, large numbers of people became possessed of buying power. More goods, therefore, were sold at home and the export trade began to languish. Very soon there were not enough exports to balance, and so pay for, imports.

  What had been foreseen now occurred. The International Banker found himself faced by demands that he should fulfil his promises to pay gold, and became panic-stricken lest the demands should exceed his holding of that metal. When the drain of gold had continued for some days he lost his nerve. What was he to do? The answer seemed to be that he must shut his doors. He stopped lending abruptly and tried to call up as many of his loans as possible. Foreign trade, in consequence, came to a standstill.

  The effect was to throw goods designed for export on to the home market and so to cause prices at home to break. At the first sign of this danger all the Home Bankers also began to call up their loans. The boom had been violent; the slump was equally violent. Our banker gazed at his ledger with terrified eyes. Hundreds of accounts had been opened with him. Would he be able to call up his loans before the panic which was spreading over the whole country brought his clients to his door? People who owned gold were hoarding it. He demanded his IOUs from every borrower and so compelled borrowers in their turn to put pressure on their debtors. But day by day, in spite of these drastic methods, his holding of gold leaked away. He began to sell the houses and shops of borrowers who could not repay their loans. The slump was so widespread that neither houses nor shops fetched even moderately good prices. They had to be sold at a ruinous sacrifice. He watched his counter. All his clients who had credit balances seemed to want gold. Everybody wanted gold. His shelves were growing emptier and emptier and still there were thousands of claims, thousands of his promises-to-pay, outstanding against him.

  In his despair he rushed off to the capital city. Would the great National Bank help him? He would pay anything, anything at all, for some gold and silver to tide him over the crisis. The National Bank, when he reached it, was besieged by a crowd of Home Bankers all of whom were as frantic as himself. He was told that there was no gold to be had. The public was hoarding it.

  He had to return home. He proceeded to sell everything that he possessed, all the wealth that had come to him in other days, his horses, his country house, his plate - for within the limits of the system he was an honest man. Thanks to these extreme sacrifices he was able for another week, to keep his doors open. But at the end of that time his vault was empty and the demands for gold had not ceased. He made up his mind, as he lay abed, that he would not open his doors on the morrow.

  He did not sleep. His morning letters were brought to him. One of them announced the declaration by the Government of a Moratorium for debt and the issue, by the National Bank, of notes to replace the vanished gold. He need not pay out another gold or silver coin. He was saved.

  IV The Balance Of Trade

  He explained to his clients next morning that the crisis was over.

  ‘‘What has happened,’’ he said, ‘‘is that a gold famine was produced by the inconsiderate action of a few selfish hoarders. Though we possessed claims on gold we could not obtain the metal. And so the Government has stepped in and said that, till things right themselves, the notes it is about to issue through the National Bank will be counted as gold. They will be the same as gold. They will be legal tender. I hope to have a supply of these notes today when I shall begin at once to pay them out to those who feel doubtful about the value of my IOUs.’’

  As soon as people knew that the Government was standing in behind the banks they ceased to feel frightened. Within a few weeks our banker had his gold back again on his shelves and had begun, once more, to build up his fortune. He had not done so badly. If he had sold many of his assets at a heavy loss, he had many more assets in his hands for which he could count on getting reasonable prices. His losses, moreover, were losses not of money but of promises to pay it. These promises had cost him nothing. Now that he had the gold back on his shelves he could begin to invent more of them. The boom was over; the town wallowed in the succeeding slump. People with credit balances on his books, therefore, would have to withdraw them in order to pay their debts and since many of these debts were owed to borrowers from himself he would soon be able to cancel a substantial number of his IOUs.

  He set his house in order and then lent the IOUs he did not wish to use at home to the International Banker, who had also, thanks to the fall in prices, got out of his difficulties. The goods which could no longer be sold at a profit at home were being rushed into foreign markets. Exports were rising high enough to balance and pay for imports. The demands for gold to be sent abroad were no longer being made.

  But the International Banker, nevertheless, was very much shaken. He and his colleagues called a meeting of the Home Bankers in the Capital City.

  ‘‘Gentlemen,’’ said the International Banker, ‘‘you must now see that this state of affairs cannot be allowed to continue. Look what has happened. There was a chance of making big profits in railway construction. What did you all do? You rushed in, headlong, with your IOUs and lent everything you could lend in the hope of getting high rates of interest. Up soared prices in consequence; up went wages. There was so much buying power in the home market that nobody had any wish to export - even supposing that it had been possible, in view of the high wages and therefore of the high costs of production, to sell anything outside of the country.

  ‘‘What was the result? Not enough exports to balance and pay for imports. A demand by foreigners with claims against this country for payments in gold. Like yourselves we, the International Bankers, lend our IOUs to the extent of ten times our holding of gold. The demands upon us were far greater than our means of meeting these demands. We had to stop lending. We had to call up every available loan. Foreign trade came to a standstill. That reacted back on you because it threw onto the home market the goods which could no longer be shipped abroad. Home prices also fell. You know the rest.’’

  The speaker paused for a moment. When he saw that he had produced the effect he wanted, he added:

  ‘
‘Those of us who have weathered the storm were saved by the action of the Government in declaring the moratorium and giving leave to issue notes. But the Government is profoundly uneasy and the public is panic-stricken. If this sort of thing happens again it is as likely as not that the Government will take the banking system our of our hands. We will be turned into mere agents, forbidden to create private promises-to-pay and compelled to handle instead the Government’s promises. There will be small profit for any of us in that arrangement. So it follows, evidently, that we must add safeguards to our system, such safeguards as will make it impossible for any boom in the country to reach such dimensions as to interfere seriously with the export trade. I have to propose... ’’

  Here the International Banker assumed almost a threatening expression.

  ‘‘I have to propose that, in future, when a golden coin leaves this country a National Bank note to the value of that coin shall be removed from circulation - in other words that buying power to the amount of the departing gold shall be taken from the home market. Such a withdrawal of buying power as you know, will at once produce a fall in prices and bring the boom to an end before it has become a danger to all of us.’’

  Our banker rose and glanced about him uneasily.

  ‘‘You are asking us,’’ he said, ‘‘to consent to an arrangement which places us wholly in the hands of yourself and your colleagues - of International Finance. And not us only. Our clients as well. The whole nation.’’

  ‘‘No, sir.’’

  ‘‘Yes, sir. Because it comes to this: if you, the International Bankers, choose to make large loans of your IOUs to foreigners, and if, in consequence, gold leaves this country... ’’