Promise to Pay
Page 10
Cash and Deposits at the Central Bank £10 Deposits:
Loans to Money Market £10
Advances £50
Securities (Government and other) £30
Total Deposits £100
PRICE LEVEL
If the price level falls all debts become more burdensome because it takes more goods to pay them off. If a farmer can pay his rent with two sheep he is obviously better off than when it requires four sheep to pay the same rent.
A rise in the price level reduces the burden of debt by reducing the quantity of goods needed to pay off debts.
FOREIGN EXCHANGE MARKET
The market where promises to pay, e.g. pounds, are sold for promises to pay, e.g. dollars, francs and so on. The value of every such promise-to-pay is determined by the demand for it. If there is a big demand for promises to pay pounds by holders of promises to pay dollars, the dollar will fall in relation to the pound. In other words more dollars will be needed to buy a pound than formerly. This is what happens when exchanges are ‘‘unpegged’’.
Pegging a currency means that it is prevented from falling by an export of gold. If owners of promises to pay dollars, for example, are able to change their promises into gold, they will do so if dollars look like losing their value; for gold, having a fixed price everywhere, cannot lose its value. If, for example, the owner of a promise to pay five dollars can no longer get a pound for his promises to pay he will change his promises into gold by demanding their fulfilment. The gold he obtains from the banker making the promises will buy rather more than a pound. Gold as a result of this transaction will leave America to come to England. When it leaves America a corresponding quantity of dollar notes will be withdrawn from circulation and American prices, therefore, will be made to fall.
When the gold reaches England a corresponding quantity of pound notes will be put into circulation and English prices, therefore, will be made to rise. Thus America will be better able to export goods than England and so the demand for dollars (to pay for the exported goods) will increase and the demand for pounds will fall. Dollar and pound will now once more be level with one another and the bankers issuing promises to pay dollars will no longer be asked to redeem these promises.
DISCOUNT MARKET
Market where promises-to-pay of various bankers are borrowed on short terms by Government (on security of Treasury bills), by international bankers (on security of finance bills) and by traders and merchants (on security of commercial bills).
The Discount Market and the Foreign Exchange Market are necessarily closely related. Thus bill brokers, bullion brokers, discount houses, acceptance houses, private banks and the Central Bank itself have a common meeting ground in what is generally called The Money Market.
Examples of Central Banks are the Bank of England, the Banque de France, the Reichsbank, and the Federal Reserve System. These are often called ‘‘bankers’ banks’’. Practice varies from country to country but the bed-rock principles do not vary.