Wk. 8 Walter Bagehot, Lombard Street: A Description of the Money Market (1873)

Question 1

Walter Bagehot, Lombard Street: A Description of the Money Market (1873)

Answer 1

In the second half of the nineteenth century, the world’s economy reached an unprecedented level of globalization financed by London banks, which Walter Bagehot describes below. Bagehot (1826-1877) pronounced “Badge-it,” was a journalist and writer who specialized in explaining complex subjects in simple language.

How did he think London banks differed from banks elsewhere in the world?

• The ability to borrow money is greatest in England.“how much greater the ready balance the floating loan-fund which can be lent to anyone or for any purpose is in England than it is anywhere else in the world. A very few figures will show how large the London loan-fund is, and how much greater it is than any other.”

What were the effects of the banking system on the domestic and global economy?

Why did he say it was more profitable to trade on borrowed money?

• The French kept their money stored away, scattered throughout the country, not being used or loaned, thus it was not “borrowable” or generating wealth.“Nothing but their immense misfortunes, nothing but a vast loan in their own securities, could have extracted the hoards of France from the custody of the French people. The offer of no other securities would have tempted them, for they had confidence in no other securities. For all other purposes the money hoarded was useless and might as well not have been hoarded.”
• The English keep their cash in banks which makes it available to be loaned and so it facilitates the growth of business and innovation even as it earns for the banks and it’s owners.“But the English money is “borrowable” money. Our people are bolder in dealing with their money than any continental nation, and even if they were not bolder, the mere fact that their money is deposited in a bank makes it far more obtainable.”
• Cash that is in the hands of consumers or kept in homes does not propel the economy. That only happens when banks can borrow and lend based on deposits kept at the bank by companies and the people. It consolidates the nation’s money for lending, something not available elsewhere.“A million in the hands of a single banker is a great power; he can at once lend it where he will, and borrowers can come to him, because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all: no one knows where to find it or whom to ask for it.”
• Simply having the money available to land is a way to produce vast wealth. Through lending (investing), the money works for you, bringing in interest.“Concentration of money in banks, though not the sole cause, is the principal cause which has made the Money Market of England so exceedingly rich, so much beyond that of other countries.”
• Depending on the risk of that country being able to pay back the money determines the cost that that country has to pay in order to borrow. “It is sometimes said that any foreign country can borrow in Lombard Street at a price: some countries can borrow much cheaper than others; but all, it is said, can have some money if they choose to pay enough for it.” There is a cost of money which is the interest paid on the loan.
• English banks lend it to foreign banks who intern lend to their government or a company in that country.“English bankers are not themselves very great lenders to foreign states. But they are great lenders to those who lend.”
• So there is a limit to the countries to which they will lend. Only “civilized” countries can borrow. Others are too big of a risk for nonpayment.“Perhaps this is an exaggeration; but confined, as of course it was meant to be, to civilized Governments, it is not much of an exaggeration. There are very few civilized Governments that could not borrow considerable sums of us if they choose”
• So global investment projects have the English banks to think perhaps even the entirety of the industrial revolution has English banks to think for the capital necessary to make these things work, something that was not available anywhere else in the world at the time.“And it is in this way that vast works are achieved with English aid which but for that aid would never have been planned.”
• “Margin” is a concept we’re only part of the money needed was put down. The rest could be borrowed in order to leverage your financial position.“They advance on foreign stocks, as the phrase is, with “a margin;” that is, they find eighty percent of the money, and the nominal lender finds the rest.”
• Because some projects are so massive and require so much initial capital in order to follow through, borrowing is the only way that such projects can get done. Since sovereign infrastructure projects tend to be of this sort, It is because of this borrowing that these projects are able to unfold. “He would have thought that it was of no use inventing railways (if he could have understood what a railway meant), for you would not have been able to collect the capital with which to make them. At this moment, in colonies and all rude countries, there is no large sum of transferable money; there is no fund from which you can borrow, and out of which you can make immense works.” Before the English banking system, large projects could not be done because there was not a sufficient fund from which to borrow.
• Differentiates England from other countries, again as the first and the greatest.“A place like Lombard Street, wherein all but the rarest times money can be always obtained upon good security or upon decent prospects of probable gain, is a luxury which no country has ever enjoyed with even comparable equality before.”
• This is an example of how margin works – – using borrowed money to make more money and leverage the cash you already have, Making you greater returns on your money because you can control more than your personal cash would otherwise allow.“English trade is carried on upon borrowed capital to an extent of which few foreigners have an idea, and none of our ancestors could have conceived. In every district small traders have arisen, who “discount their bills” largely, and with the capital so borrowed, harass and press upon, if they do not eradicate, the old capitalist. The new trader has obviously an immense advantage in the struggle of trade. If a merchant have £50,000 all his own, to gain 10% on it he must make £5,000 a year, and must charge for his goods accordingly; but if another has only £10,000, and borrows £40,000 by discounts (no extreme instance in our modem trade), he has the same capital of £50,000 to use, and can sell much cheaper. If the rate at which he borrows be 5%, he will have to pay £2,000 a year [in interest]; and if, like the old trader, he make £5,000 a year, he will still, after paying his interest, obtain £3,000 a year, or 30%, on his own £10,000. As most merchants are content with much less than 30%, he will be able, if he wishes, to forego some of that profit, lower the price of the commodity, and drive the oldfashioned trader – the man who trades on his own capital – out of the market.” This is why big companies will still borrow despite having tons of cash. It allows them to facilitate their business on a much larger scale and produce a much greater return then if they used only the cash available.
• Leveraging gives power to the little people. “On the one hand, it prevents the long duration of great families of merchant princes, such as those of Venice and Genoa, who inherited nice cultivation as well as great wealth, and who, to some extent, combined the tastes of an aristocracy with the insight and verve of men of business. These are pushed out, so to say, by the dirty crowd of little men.”
• Referring to the “old guard“ of merchant princes who rely on their own wealth rather than leveraging to drive their business. The old guard will suffer because they do not use leverage. This gives an advantage to the common person who smartly uses leverage and makes gains in wealth and power on the old guard, eventually replacing them. “Upon their immense capital they can only obtain low profits, and these they do not think enough to compensate them for the rough companions and rude manners they must meet in business.”
• Differentiate England as not “sleepy“ and “prompts to seize” New advantages. “No country of great hereditary trade, no European country at least, was ever so little “sleepy,” to use the only fit word, as England; no other was ever so prompt at once to seize new advantages.”
• Old school countries become stagnant and at a disadvantage to those countries who is common people are empowered by leverage. “A country dependent mainly on great “merchant princes” will never be so prompt; their commerce perpetually slips more and more into a commerce of routine.”
• Common people are empowered by leverage. “But a new man, who has his way to make in the world, knows that such changes are his opportunities; he is always on the look-out for them, and always heeds them when he finds them. The rough and vulgar structure of English commerce is the secret of its life; for it contains “the propensity to variation,” which, in the social as in the animal kingdom, is the principle of progress.”
• England stands out among countries as “advantage with respect to credit”.“This efficient and instantly-ready organization gives us an enormous advantage in competition with less advanced countries – less advanced, that is, in this particular respect of credit.”
• England banking is a driver of innovation. “English capital is instantly at the disposal of persons capable of understanding the new opportunities and of making good use of them. In countries where there is little money to lend, and where that little is lent tardily and reluctantly, enterprising traders are long kept back, because they cannot at once borrow the capital, without which skill and knowledge are useless.”
• The Suez Canal is an example of the great things that can happen only with great borrowing. “The Suez Canal is a curious case of this. All predicted that the canal would undo what the discovery of the passage to India round the Cape effected. Before that all Oriental trade went to ports in the South of Europe, and was thence diffused through Europe. That London and Liverpool should be centers of East Indian commerce is a geographical anomaly, which the Suez Canal, it was said, would rectify. “The Greeks,” said M. de Tocqueville, “the Styrians, the Italians, the Dalmatians, and the Sicilians, are the people who will use the Canal if any use it.” But, on the contrary, the main use of the Canal has been by the English. None of the nations named by Tocqueville had the capital, or a tithe of it, ready to build the large screw steamers which alone can use the Canal profitably.” In the English have become not only the funders of the Suez Canal but they also became the largest private users of the canal. End it is because of the unequaled fund of floating money in England.