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We are continuing our look at the Bank of England during the period
1844-1913. In 1844, the Bank fell under a new regulation and
reorganization, in which it was separated into two entities, the
Issue Department and the Banking Department. The Issue Department
was solely responsible for paper banknotes, and operated a system
very similar to the "Making Change" or currency-board type system we
looked at earlier.
April
14, 2013: The Bank of England, 1844-1913
The Issue Department did not hold deposits. The only assets were
gold bullion and bonds, either government bonds or "other
securities," most likely high-quality corporate bonds or gold-based
bonds of other governments.
Here's the liabilities side of the Banking Department's balance
sheet. "Capital" is the original shareholders' investment. "Rest"
amounts to retained earnings. "Capital" and "Rest" together
constitute what we would call today shareholders' equity or book
value.
"Public Deposits" are demand deposits of government entities.
"Other Deposits" are demand deposits of nongovernment entities,
mostly other banks.
Today, we recognize deposits at the central bank as a type of base
money. Today, central banks hold both "public deposits" and "other
deposits," so we can combine them into aggregate deposits. Base
money today consists of banknotes in circulation+public
deposits+other deposits.
The Asset side of the balance sheet of the Banking Department looked
like this. There was a little gold bullion, but not much. Government
securities are of course government bonds, and we see that, unlike
the Issue Department, they vary quite a lot.
I will have to look up the definitions of the other asset classes to
be sure of what they mean. "Other securities" probably means
corporate bonds. "Notes" probably means loans (promissory notes).
Here's what it looks like when we combine the Issue Department and
Banking Department. Banking Department deposits gradually became a
larger and larger component of base money.
This was actually quite common at the time. In the United States as
well, deposits at the central bank ("bank reserves") were a large
portion of base money, until just recently.
United States deposit/base money ratio
March
...
13, 2011: Bank Reserves 2: Reserves Out the Wazoo
Taking into account banknotes in circulation alone, the gold bullion
reserve ratio was about 60%. However, when including the deposit
portion of base money, the bullion reserve ratio was quite stable
around 30%.
As a percentage of aboveground bullion, the Bank of England did not
hold very much. It was around 1.50% during this seventy-year period.
You can run the world's premier reserve currency without holding a
lot of gold bullion.
The liabilities of the Bank of England, both Departments combined,
basically amounted to base money. On the asset side, this is what it
looks like when we aggregate both the Issue and Banking Departments,
mirroring central banks today.
Unlike the Issue Department, which ran an automatic currency-board
like mechanism, the Banking Department had discretion as to how much
it would expand or contract deposits. It did this by buying and
selling government and other securities, and also adjusting the
amount of loans ("notes") it would make via changes in the Discount
Rate (i.e. lending rate). If the Bank's discount rate was generally
above the prevailing market rate, people would pay back their loans
to the Bank and the Bank would not make new loans, so lending (and
thus base money) would contract. In practice, it appears that,
toward the end of the 19th century, the Banking Department often
managed aggregate base money by watching market exchange rates
between the British Pound and other gold-based currencies worldwide
such as the U.S. dollar. If the pound was sinking in value vs. the
dollar, the Banking Department would sell government bonds. The
money paid to the Banking Department for its bonds would most likely
take the form of a deposit at the Bank. Thus, deposits would
contract, shrinking the overall base money supply. Likewise, if the
pound was a little strong on the forex market, the Banking
Department would buy government bonds, thus increasing the amount of
base money and lowering the value of the pound. The Banking
Department could also buy or sell "other securities," or let them
mature without rolling them over, or adjust is lending via the
Discount Rate or other means.
In practice, the Banking Department found that, toward the end of
the 19th century, the effectiveness of discount rate adjustments,
leading to adjustments in lending and thus base money, were becoming
less effective due to the Banking Department's shrinking market
share of the short-term lending business. Thus, the Banking
Department gradually moved toward open-market operations in
government bonds and other bonds as a means of adjusting the
monetary base. However, both techniques could be used together. This
took place while the Issue Department also ran its own,
currency-board-like automatic adjustment of banknotes in
circulation, which also adjusted the monetary base.
Banknotes and deposits could be easily transferred one to the other.
For example, if a bank wanted to "withdraw" its deposits in the form
of banknotes, it could request the Banking Department to do so. The
Banking Department would send gold bullion to the Issue Department
and the Issue Department would send banknotes back. Or, the Banking
Department could just buy bullion on the open market, and send it to
the Issue Department, and thus not have to deplete its own (rather
small) reserves. Likewise, if people had more banknotes than they
wanted and preferred deposits, they could bring their banknotes to
the Banking Department and get a deposit. If the Banking Department
had too many banknotes, it would send the banknotes to the Issue
Department, get gold bullion in return, and then either keep that or
perhaps sell it on the world market. In other words, deposits and
banknotes, two different forms of base money, were easily fungible.
target="_blank" January
...
29, 2012: Gold Standard Technical Operating Discussions 3:
Automaticity Vs. Discretion
target="_blank" January
15,
2012:
...
Gold Standard Technical Operating Discussions 2: More Variations
January
8,
...
2012: Some Gold Standand Technical Operating Discussions
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