readily withdrawable by cheque. It constitutes purchasing power and at any one moment represents what is available to the public, the Government and the banks for spending. Apart from the action of a bank, the public in practice are powerless to increase or diminish permanently the total of money except by destroying their notes or sending them out of the country. They may buy or sell, borrow or lend, spend or save; the quantity of money in the country will be unchanged. Should they draw out notes from their banks they do no more than convert a bank balance into currency in circulation. Should they pay in notes to the credit of their accounts they increase bank deposits to the exact amount by which currency in circulation is diminished. By spending or saving they may make money circulate faster or slower; only by a change of habit which led them to carry more or less currency in their pockets could they of their own initiative affect the total of money. Not even by dealing in foreign exchange nor by borrowing or lending abroad is it possible for the public to alter the volume of money, although by so doing they may raise or depress the external value of sterling. It is a common practice to talk of foreign money coming here or English money going abroad, but the language, though convenient, is inaccurate, for the implication that the total amount of money in the country is affected by these operations is false. It is not the money that moves, but the title to the money. The ownership of sterling may pass into foreign hands or we may acquire the ownership of foreign money, but, with the unimportant exception already named of notes being sent abroad, the money itself is rooted in the country of its origin.

The Government, independently of action by the Bank of England, are no less passive than the public as regards the volume of money. It is conceivable indeed that they might issue currency notes for the purpose of putting themselves in funds, in which case the total of money would be increased. But in fact this is not done. Notes are issued only when required as currency, and when after use they come back through the banks to the Bank of England they are immediately cancelled. All currency, whether notes or coin, comes into circulation only when bought by the public, whose purchasing power as expressed in bank deposits is correspondingly reduced.

It appears then that fluctuations in the quantity of money cannot under present conditions be accounted for by anything done independently either by the public or the Government. We must, therefore, look to action by the banks, and particularly the Bank of England as the central institution, for the cause of these movements. Here we are at once forced back upon the familiar proposition that every new loan or purchase by a bank creates an equivalent deposit, thus increasing the quantity of money, while every repayment to or sale by a bank destroys a deposit and correspondingly diminishes the quantity of money. Since whatever the banks pay out comes back to one or other of them as a new deposit, the layman might naturally expect that they would not weary in the profitable business of making loans and buying bills and investments. In practice, however, strict limits are set to their activities in this direction. Lending and buying, with the exception of a purchase of gold, increase deposits but add nothing to the total of cash reserves. All banks insist on maintaining a fairly regular proportion between their cash and deposits, and unless cash is increased a material rise in deposits will not be permitted. The proportion may not be the same in different banks, and one bank may gain while another loses deposits, but it is true to say that without an alteration in the total of bank cash, deposits as a whole will vary but little. If, then, we are to discover the real causes of fluctuation in the quantity of money we must look for them in whatever produces variation in the total of bank cash.

VARIATION IN BANK CASH.

It may not be out of place to recall that in the language of the clearing banks cash means currency together with balances at the Bank of England. Banks hold coin and notes in their tills to meet their customers' immediate requirements, additional notes in their vaults as a currency reserve, and balances at the Bank of England which are drawn upon according to the needs of their business. These together constitute bank cash, and as the amount rises or falls so the banks buy or sell, lend or don't lend, in order to maintain their customary proportions between bank cash and deposits.

The total of bank cash may vary from three causes. First, the public may on balance pay into the banks some of the currency previously in circulation, or on the other hand may draw off additional currency. Secondly, the banks may in theory buy gold; but as such transactions do not at present take place on any substantial scale, they call for no further mention. Finally, there may be fluctuations in the total of bank balances at the Bank of England quite apart from either of the preceding causes.

As regards the first possibility, variations in the quantity of currency in circulation, the short-term fluctuations may be fairly accurately foreseen and depend upon regularly recurrent needs. Wages, which create a large demand for currency, are almost always paid on Friday, with the result that the banks usually hold less cash at the close of that day's business than on any other day of the week. But the currency passes through the hands of shopkeepers, rent collectors and others back to the banks, and comparing one week with another the total of bank cash does not vary much on this account. Again, at Christmas, Easter, Whitsuntide and August Bank Holiday the public call for more currency, and the result is a temporary reduction in bank cash. These are events of regular occurrence and short duration. The conventional proportion of cash to deposits is slightly lowered in the first stage of such demands for additional currency, but the decline does not usually give rise to any protective measures by the banks in the way of restricting loans or selling securities in order to restore their normal cash proportions. As regards long-term variations, these are only gradual and arise from changes in national habit, which are necessarily slow in making themselves felt and which therefore do not demand consideration at this point.

The third and far the most important cause of fluctuation in the total of bank cash takes the form of variations in bank balances at the Bank of England which may be attributed to causes other than public demands for currency. Herein lies the kernel of the matter. It is not generally recognized that the principal cause of any but the most transient movements in these balances is not something done by the banks, but something done by the Bank of England. If the Bank of England makes a loan, or discounts bills, or buys gold or securities, the amount paid becomes bank cash. Conversely, when a loan by the Bank of England is repaid, or discounted bills are met at maturity, or gold or securities are sold, bank cash is correspondingly diminished. The only other possible cause of fluctuation is the payment of currency into or out of the Bank of England according as the public require less or more for circulation, and, as I have already shown, such movements are in the main purely temporary and of no very serious extent.

BANK OF ENGLAND CONTROL OF MONEY SUPPLIES.

We have now reached two vital conclusions: first, that variations in the quantity of money are due to variations in the total of bank cash; and second, that the total of bank cash is determined, except to an immaterial extent,

solely by the action of the Bank of England. Indirectly, therefore, the Bank of England is in practice the controller of the volume of money. Thus we see that the gold standard is by no means the automatic mechanism it is commonly alleged to be, since the Bank, merely by buying or selling, lending or calling in loans, can within limits prompt an expansion or contraction of credit regardless of movements of gold. This power, however, cannot be exercised without restraint. The Bank is itself governed by the terms of its constitution, and even such freedom for the exercise of policy as it might possess is in considerable measure limited by the rigidity of its system. This is the point on which I wish to lay emphasis to-day. The Bank has justly earned a worldwide reputation for integrity and the large spirit in which it conducts its business, and we are apt to ascribe this reputation to the merits of the institution itself. The honour, however, is not due to the system, but to the skill with which it has been worked. That this is so will appear from an examination of some of the Bank's functions.

The Bank of England is required to buy at a fixed price all gold tendered to it and to sell gold on request at a slightly higher price. It discounts approved bills for its customers at rates determined by reference to the Bank rate, which may be regarded as the minimum charge for discounting. In addition it makes temporary loans to the Government in anticipation of revenue. These particular operations are conducted as a matter of course, without regard to any preconceived policy. But open market dealings in bills or purchases or sales of securities or the making of loans to customers other than the Government are matters in the discretion of the Bank, and action upon these lines may depend upon the view taken as to the desirability of increasing or diminishing trade credit. This is the sphere of policy, the scope of which in determining the quantity of money is still sufficiently wide to give it great importance, even though the main operations of the Bank are conducted in accordance with well-established rules.

It is not surprising, therefore, in view of the conditions of our trade in recent years, that Bank of England policy has for some time been a matter of controversy. All parties acknowledge the principle that the governing factor in the exercise of monetary powers should be the needs of healthy and legitimate trade, but they do not agree as to the practicability or the method of securing this result. Indeed, neither the critics nor the defenders of the present monetary system are all in agreement among themselves. If we were to label one party deflationist and the other inflationist we should do great injustice to many of the more sober disputants on both sides. It is true that some people seek by a slow but steady reduction in the quantity of money, regardless of other consequences, to bring us back to what they describe as pre-war normality, though they never explain why the conditions of 1913 should be regarded as normal any more than those of 1927 or 1827 or any other date. It is no less true that another group of people firmly believe in the possibility of an indefinite extension of production and trade on a solid and prosperous basis by means of nothing more than a continuous increase in the quantity of money. These two sets of men are rightly called deflationists and inflationists, and I have not yet made up my mind which of the two if they had their way would do more injury to our national welfare.

INFLATION AND DEFLATION.

The arguments against both inflation and deflation are sufficiently clear to make it evident that our proper course is to have nothing to do with either, But it is not always easy to know when we are in fact inflating or deflating. Let me illustrate what I mean by turning to the United States, where, as I

have mentioned already, the volume of money has expanded enormously in recent years.* On the face of it this might appear to be a case of inflation, but if we examine statistics of production over the same period we shall see that a very large increase has taken place in industrial output. As a result there has been no rise in prices and no inflation.† I will not trouble you with details of the figures, either of production or prices, for these are readily available in official publications. Such are the facts, and Americans rightly claim that the additional money has been needed to carry the greater volume of trade. The creation of additional money was indeed an essential condition of trade expansion, and if the Federal Reserve Board had allowed themselves to discover an inflationary taint in the growth of bank deposits, as the deflationists in England would certainly have done, the trade prosperity which has grown up and flourished in the United States would have been strangled at its birth.

Here we have an example of very considerable expansion of credit without inflation. Now let me take another case, drawn from our own experience, in which without any actual restriction of credit the basic circumstances are such as to make our condition one of continuous deflation.

For close upon seven years we have had an army of unemployed in this country, never less than a million, at one time over two millions, and at present nearly a million and a half. Every year the normal growth of population

* For statistics of bank deposits see a previous page. Figures relating to currency in circulation are as follows:

Average for 12 months to November 1922

$ millions.

4,433

Applicants for employment registered at employment exchanges in Great Britain only, according to last weekly return in each half-y

-Federal Reserve Bulletin.

-year :

• Coal stoppage in progress.

The corresponding figure for January 10, 1927, was 1,432,000.

18th Abstract of Labour Statistics of the U.K. and Returns issued by Ministry of Labour.

adds roughly two hundred thousand to the number of our people capable of productive labour of one kind or another. In order fully to occupy our people an immediate increase of banking credit, that is of money, is indispensable for carrying the larger volume of commodities which the unemployed and the new recruits to labour will produce. To check the growth of credit when the population is steadily increasing and vast numbers of men and women are out of employment is obviously to cut off all hope of trade expansion unless prices are continuously lowered. But we all know what falling prices mean to trade in these conditions. They spell stagnation, from which the sole means of recovery is a reduction in wages. It may be true that with falling prices the reduction would be in nominal more than in real wages, but I think our experience has taught us sufficiently the difficulty of effecting any reduction at all, and that what actually ensues when the volume of money decreases is long-continued trade depression. Stationary or even insufficiently expanding money supplies, with a growing population struggling to find employment, represent in truth a condition of deflation.

MONETARY POLICY AND TRADE CONDITIONS.

In order to avoid misunderstanding it is necessary for me to remind you that my present endeavour is to describe how the machinery of credit works and its influence upon trade. I am not discussing the merits of Bank of England policy. Deflation, even rigorous deflation, was a harsh necessity in 1920 and 1921. Its continuance in varying degrees of intensity through the following three years, after the United States had abandoned the process, was based on the desire to effect an early return to the gold standard. It will long remain a matter of opinion whether the rise in sterling was unduly forced and whether the final result could not have been attained with a less stifling influence on British production. But to-day such questions as these have only historic significance. We have been working on the gold standard for nearly two years, and except for the rigidity of the Bank of England system, there is now nothing to prevent the same response being given to growing trade demands in this country as has been given in America.

It may be argued that if the Bank of England were to buy or lend more freely, thus increasing bank cash and enabling the banks to grant additional accommodation to industry, we should have no absolute assurance that this step would as a fact be followed by greater production. If it were not, then the expansion would be in the nature of pure inflation. I admit the risk. But what reason is there for supposing that production would not be stimulated here as it was in the United States in the autumn of 1921 and at intervals since that time, when exactly this policy was pursued? We make no such assumption when the increase in bank credit is due to certain purely fortuitous circumstances which have nothing to do with the requirements of British trade. For example, when the Bank of England buys more gold as a result of a decline in the Indian or German demand, the increase in bank cash, and consequently in the volume of credit, gives rise to no alarm. It is accepted as an axiom that an influx of gold into the Bank of England stimulates trade here. The stimulus, however, is not due to the Bank having more or less bullion buried in its vaults, but to the additional bank cash which the purchase of gold creates. The effect on the total of bank cash is precisely the same whether the Bank buys gold or bills or War Loan or bricks and mortar, whether it lends to the Government, the Bank of France or any other of its private customers. The Bank may buy from policy, with a steadfast eye on the needs of British trade, just as readily as it buys under compulsion when gold is tendered to it. But if gold does not