War-Time Financial Problems Part 6

It thus happened that we find in primitive communities one particular commodity of general use being selected for the purpose of what is now called currency. It is very likely that this process arose quite unconsciously; the hatter who did not want bread may very likely have observed that the baker had something, such as a hit of leather, which was more durable than bread, and which the hatter could be quite certain that either he himself would want at some time, or that somebody else would want, and he would therefore always be able to exchange it for something that he wanted. All that is needed for currency in a primitive or any other kind of people is that it should be, in the first place, durable, in the second place in universal demand, and, in the third place, more or less portable. If it also possessed the quality of being easily able to be sub-divided without impairing its value, and was such that the various pieces into which it was sub-divided could be relied on not to vary in desirability, then it came near to perfection from the point of view of currency.

All these qualities were possessed in an eminent degree by the precious metals. It is an amusing commentary on the commonly a.s.sumed material outlook of the average man that the article which has won its way to supremacy as currency by its universal desirability, should be the precious metals which are practically useless except for purposes of ornamentation. For inlaying armour and so adorning the person of a semi-barbarous chief, for making into ornaments for his wives, and for the embellishment of the temples of his G.o.ds, the precious metals had eminent advantages, so eminent that the practical common sense of mankind discovered that they could always be relied upon as being acceptable on the part of anybody who had anything to sell. In the matter of durability, their power to resist wear and tear was obviously much greater than that of the hides and tobacco and other commodities then fulfilling the functions of currency in primitive communities. They could also be carried about much more conveniently than the cattle which have been believed to have fulfilled the functions of currency in certain places, and they were capable of sub-division without any impairing of their value, that is to say, of their acceptability. Merely as currency, precious metals thus have advantages over any other commodity that can be thought of for this purpose.

So far, however, we have only considered the needs of man for currency; that is to say, for a medium of exchange for the time being. It is obvious, however, that any commodity which fulfils this function, that is to say, is normally taken in payment in the exchange of commodities and services, also necessarily acquires a still more important duty, that is, it becomes a standard of value, and it is on the alleged failure of gold to meet the requirements of the standard of value that the present attack upon it is based. On this point the defenders of the gold standard will find a good deal of difficulty in discovering anything but a negative defence. The ideal standard of value is one which does not vary, and it cannot be contended that gold from this point of view has shown any approach to perfection in fulfilling this function. It could only do so if the supply of it available as currency could by some miracle be kept in constant relation with, the supply of all other commodities and services that are being produced by mankind. That it should be constant with each one of them is, of course, obviously impossible, since the rate at which, for example, wheat and pig-iron are being produced necessarily varies from time to time as compared with one another. Variations in the price of wheat and pig-iron are thus inevitable, but it can at least be claimed by idealists in currency matters that some form of currency might possibly be devised, the amount of which might always be in agreement with the amount of the total output of saleable goods, in the widest sense of the word, that is being created for man's use.

It need not be said that this desirability of a constant agreement between the volume of currency and the volume of goods coming forward for exchange is based on what is called the quant.i.tative theory of money. This theory is still occasionally called in question, but is on the whole accepted by most economists of to-day, and seems to me to be a mere arithmetical truism if we only make the meaning of the word "currency" wide enough; that is to say, if we define it as including all kinds of commodities, including pieces of paper and credit instruments, which are normally accepted in payment for goods and services. This addition of credit instruments, however, is a complication which has considerably confused the problem of gold as the best means of ultimate payment. Taken simply by itself the quant.i.tative theory of money merely says that if money of all kinds is increased more rapidly than goods, then the buying power of money will decline, and the prices of goods will go up and vice versa. This seems to be an obvious truism if we make due allowance for what is called the velocity of circulation. If more money is being produced, but the larger amount is not turned over as rapidly as the currency which was in existence before, then the effect of the increase will inevitably be diminished, and perhaps altogether nullified. But other things being equal, more money will mean higher prices, and less money will mean lower prices.

But, as has been said, the question is very greatly complicated by the addition of credit instruments to the volume of money, and this complication has been made still more complicated by the fact that many economists have refused to regard as money anything except actual metal, or at least such credit instruments as are legal tender, that is to say, have to be taken in payment for commodities, whether the seller wishes to do so or not. For example, many people who are interested in currency questions would regard at the present moment in this country gold, Bank of England notes, Treasury notes, and silver and copper up to their legal limits as money, but would deny this t.i.tle to cheques. It seems to me, however, that the fact that the cheque is not and cannot be legal tender does not in practice affect or in any way impair the effectiveness of its use as money. As a matter of fact cheques drawn by a good customer of a good bank are received all over the country day by day in payment for an enormous volume of goods. In so far as they are so received, their effect upon prices is exactly the same as that of legal tender currency. This fact is now so generally recognised that the Committee on National Expenditure has called attention to the financing of the war by bank credits as one of the reasons for the inflation of prices which has done so much to raise the cost of the war. It is, in fact, being generally recognised that the power of the bankers to give their customers credits enabling them to draw cheques amounts in fact to an increase in the currency just as much as the power of the Bank of England to print legal tender notes, and the power of the Government to print Treasury notes.

Thus it has happened that by the evolution of the banking system the use of the precious metals as currency has been reinforced and expanded by the printing of an enormous ma.s.s of pieces of paper, whether in the form of notes, or in the form of cheques, which economise the use of gold, but have hitherto always been based on the fact that they are convertible into gold on demand, and in fact have only been accepted because of this important proviso. Gold as currency was so convenient and perfect that its perfection has been improved upon by this ingenious device, which prevented its actually pa.s.sing from hand to hand as currency, and subst.i.tuted for it an enormous ma.s.s of pieces of paper which were promises to pay it, if ever the holders of the paper chose to exercise their power to demand it. By this method gold has been enabled to circulate in the form of paper subst.i.tutes to an extent which its actual amount would have made altogether impossible if it had had to do its circulation, so to speak, in its own person. From the application of this great economy to gold two consequences have followed; the first is that the effectiveness of gold as a standard of value has been weakened because this power that banks have given to it of circulating by subst.i.tute has obviously depreciated its value by enormously multiplying the effective supply of it. Depreciation in the buying power of money, and a consequent rise in prices, has consequently been a factor which has been almost constantly at work for centuries with occasional reactions, during which the process went the other way. Another consequence has been that people, seeing the ease with which pieces of paper can be multiplied, representing a right to gold which is only in exceptional cases exercised, have proceeded to ask whether there is really any necessity to have gold behind the paper at all, and whether it would not be possible to evolve some ideal form of super-paper which could take the place of gold as the basis of the ordinary paper which is created by the machinery of credit, which would be made exchangeable into it on demand instead of into gold.

It is difficult to say how far the events of the war have contributed to the agitation for the subst.i.tution for gold of some other form of international currency. It would seem at first sight that the position of gold at the centre of the credit system has been shaken owing to the fact that in Sweden and some other neutral countries the obligation to receive gold in payment for goods has been for the time being abrogated. The critics of the gold standard are thus enabled to say, "See what has happened to your theory of the universal acceptability of gold. Here are countries which refuse to accept any more gold in payment for goods. They say, 'We do not want your gold any more. We want something that we can eat or make into clothes to put on our backs.'" This is certainly an extremely curious development that is one of the by-products of war's economic lessons. But I do not feel quite sure that it has really taught us anything new. All that has ever been claimed for gold is that it is universally acceptable when men are buying and selling together under more or less normal circ.u.mstances. It has always been recognised that a shipwrecked crew on a desert island would be unlikely to exchange the coco-nuts or fish or any other commodities likely to sustain life which they could find, for any gold which happened to be in the possession of any of them, except with a view to their being possibly picked up by a pa.s.sing ship, and returning to conditions under which gold would rea.s.sume its old privilege of acceptability.

During the war the shipping conditions have been such that many countries have been hard put to it, especially if they were contiguous to nations with which the Entente is at present at war, to get the commodities which they needed for their subsistence. The Entente, with its command of the sea, has found it necessary to ration them so that they should have no available surplus to hand on to the enemy. They have very naturally endeavoured to resist these measures, and in order to do so have made use of the power that they exercise by their being in possession of commodities which the Entente desires. They have shown a tendency to say that they would not part with these commodities unless the Entente allowed them to have a larger proportion of things needed for subsistence than the Entente thought necessary for them, and it was as part of this battle for larger imports of necessaries that gold has been to some extent looked upon askance as means of payment, the preference being given to things to eat and wear rather than to the metal. These wholly abnormal circ.u.mstances, however, do not seem to me to be any proof that gold will after the war be any less acceptable as a means of payment than before. The Germans are usually credited with considerable sagacity in money matters, with rather more, in fact, I am inclined to think, than they actually possess; they, at any rate, show a very eager desire to collect together and hold on to the largest possible store of gold, obviously with a view to making use of it when the war is over in payment for raw materials, and other commodities of which they are likely to find themselves extremely short. America also has shown a strong tendency to maintain as far as possible within its borders the enormous amount of gold which the early years of the war poured into its hands. While such is the conduct of the chief foreign nations, it is also interesting to note that one comes across a good many people who, in spite of all the admonitions of the Government to all good citizens to pay their gold into the banks, still hold on to a small store of sovereigns in the fear of some chain of circ.u.mstances arising in which only gold would be taken in payment for commodities. On the whole, I am inclined to think that the power of gold as a desirable commodity merely because it is believed to be always acceptable has not been appreciably shaken by the events of the war.

This does not alter the fact that, as has been shown above, gold, complicated by the paper which has been based upon it, cannot claim to have risen to full perfection as a standard of value. In primitive times the question of the standard of value hardly arises.

Transactions are for the most part carried out and concluded at once, and any seller who takes a piece of metal in payment for his goods does so with the rough knowledge of what that piece of metal will buy for him at the moment, and that is the only point which concerns him. The standard of value only becomes important when under settled conditions of society long-term contracts bulk large in economic transactions. A man who makes an investment which ent.i.tles him to 5 per cent. interest, and repayment in 30 years' time, begins to be very seriously interested in the question of what command over commodities his annual income of 5 per cent. will give him, and whether the repayment of his money at the end of 30 years will represent the repayment of anything like the same amount of buying power as his money now possesses. It is here, of course, that gold has failed because, as we have seen, the process has been a fairly steady one of depreciation in the buying power of the alleged standard and a rise in the prices of other commodities. This means to say that the investor who has accepted repayment at the end of 30 years of the amount that he lent, be it 100 or 10,000, has found that the money repaid to him had by no means the same buying power as the money which he originally invested.

Within limits this tendency of the standard of value towards depreciation has possessed considerable advantages, probably much greater advantages than would have followed from the contrary process if it had been the other way round. If we can imagine that the currency history of the world had been such that a constantly diminished quant.i.ty of currency in relation to the output of other commodities had caused a steady fall in prices, it is obvious that there might have been a very considerable check to the enthusiasm of industry. It has indeed been contended that the scarcity of precious metals which, with the absence of an organised credit system, produced this result during the later Roman Empire was a very important cause of the decay into which that Empire fell. I do not feel at all convinced that this effect would necessarily have followed the cause.

It seems to me that the ingenuity of enterprising man is such that the producer might, and probably would, have found means for facing the probability of depreciation in price. But it is always an empty pastime to try to imagine what would have happened "if things had been otherwise." What we do know is that a period of rising prices, especially if the rise does not go too fast, stimulates the enterprise of producers, and sets business going actively, and consequently it may at least be claimed that the failure of the gold standard to maintain that steadiness of value which is an obvious attribute of the ideal standard has at least been a failure on the right side, by tending to depreciation of the value of currency, and so to a rise of the prices of other commodities. Obviously, people will tuck up their sleeves more readily to the business of production and manufacture if the course of the market in the product which they hope to sell some day is likely to be in their favour rather than against them.

And when all is admitted concerning the failure of the existing standard of value, the question is, what subst.i.tute can we find which will carry with it all the advantages that gold has been shown to possess, and at the same time maintain that steadiness of value which gold has certainly lacked? We hear airy talk of an international currency based on the credit of the nations leagued together to promote economic peace. It is certainly very obvious that the diplomatic relations of the world require complete reform, and the system by which the nations at present settle disputes between themselves has been found by the experience of the last four years to be so disgusting, so barbarous and so ridiculous that all the most civilised nations of the world are determined to go on with it until it is stopped for ever. Nevertheless, obvious as it is that some kind of a League of Nations is essential as a form of international police if civilisation is to be rescued from destruction, it is very doubtful whether such an organisation could, at least during the first half-century or so of its existence, be called upon to tackle so difficult a question as that of the creation of an international currency based on international credit. In the first place, what will be required more than anything else after the war in economic matters will be the elimination of all possible reasons for uncertainty; so much uncertainty and difficulty will be inevitable that it seems to me to be almost criminal to add to those uncertainties by an outburst of eloquence on the part of currency reformers if there were any danger of their recommendations being accepted. It will be difficult enough to know where the producers of the world are to get raw material, find efficient labour, and then find a market for their products, without at the same time upsetting their minds with doubts concerning some kind of new-fangled currency that is to be created, and in which they are to be made to accept payment, with the possibilities of changes in the system which may have to be effected owing to some quite unforeseen results happening from its adoption. The gold standard, with all its failures, we do know; we also know that something may be done some day to remedy them if mankind can produce a set of rulers capable of approaching the question with all the knowledge and experience required; but to subst.i.tute this system at a time of great uncertainty for one which might or might not work would seem to be tempting Providence in an entirely unnecessary manner at a time when it is above all necessary to get the economic ship as far as possible on an even keel.

If the proposed subst.i.tute is to succeed it will have to be at least as acceptable as gold, and at the same time its quant.i.ty must be so regulated as to be at all times constant in relation to the output of commodities. Can we pretend that the economic enlightenment of mankind has yet reached a point at which such a currency could be produced and regulated by the Governments of the world and be accepted by their citizens?

XI

BONUS SHARES

_July_, 1918

A Deluge of Bonus Shares--The Effect on the Market--A Problem in Financial Psychology--The Capitalisation of Reserves--The Stock Exchange View--The Issue of Bonus-carrying Shares--The Case of the A.B.C.--A Wiser Variation from Canada--Bonus Shares on Flotation--An American Device--Midwife or Doctor?--The Good and Bad Points of Both Systems.

Of the many kinds of Bonus shares, the one which has lately been most prominent in the public eye is that which is produced by the capitalisation of a reserve fund. There has lately been a perfect epidemic of this kind of Bonus share, which is almost as plentiful as the caterpillars in the oak trees and the green fly on the allotments.

The reason for this outburst is apparently the anxiety which the directors of many prosperous industrial companies feel lest the high dividends which good management and sound finance in the past have enabled them to pay should lay them open to misunderstanding and attack by well-meaning people who think that it is a crime for a company to earn more than a certain percentage on its capital.

This explanation was very frankly given by the directors of Brunner, Mond and Company, when they lately capitalised part of their reserves.

The company, they stated, has for many years paid a dividend on its Ordinary shares of 27-1/2 per cent., and "the directors feel that there is a widespread impression that this is the rate of profit earned on the total of the capital invested, and consequently that the company is making an unfair profit out of its customers and the labour it employs. This is by no means the case." It is a lamentable proof of the backward state of the economic education of this country that it should be necessary for well-financed and prosperous concerns to take steps to make it quite clear to the public that they are not earning more than they appear to be. In a well-educated community it would be perceived at once that it is the well-financed and prosperous companies which improve production in the interests of their shareholders, their workmen, and the public; that the price which the public pays for a commodity is ultimately the price at which the worst financed and worst managed companies can just manage to keep alive; that the higher profits earned by the better companies are not wrung out of the pockets of the community, or their workmen, but are the result of good management and good finance; and that the more the good companies are encouraged to go ahead and drive the bad ones out of existence, the better will the community be served, and the better will be the chance of the workmen to get good wages. These plat.i.tudes are of course, only true in a state of free compet.i.tion. If there is anything like monopoly the public and the workers are fully justified in being suspicious and examining the source from which high dividends are produced.

Such being the reason why this outburst of capitalisation of reserves first began--since in these days all capitalists and those who have to manage capital feel that they are working under criticism, which is not only jealous and suspicious (as it should be), but is also too often both ignorant and prejudiced--it is interesting to note that the movement which was so started has been stimulated by its very exhilarating effect on the market in the shares of the companies concerned. Why this should be so it is difficult at first sight to say. What happens is merely this--that a company, let us suppose, for the sake of simplicity, with a capital consisting wholly of 3,000,000 Ordinary shares, has acc.u.mulated out of past profits, or out of premiums on new issues of shares, a reserve fund of 1,000,000. Its net profit has lately averaged 400,000, and it has, year by year, distributed 300,000 in the shape of a 10 per cent. dividend to its shareholders, and put 100,000 into its reserve fund, which is represented on the other side of the balance-sheet by buildings and plant and a certain amount of first-cla.s.s investments. If the directors now decide to capitalise that 1,000,000 of reserve fund, the only effect is that each shareholder will be given one new share for every three which he holds in the existing capital, the reserve fund will be wiped out, and the ordinary capital will be increased from 3,000,000 to 4,000,000. None of the shareholders will be in actual fact better off to the extent of one halfpenny, because all will be in the same position with regard to one another; their relative shares in the enterprise will not have been altered. If we imagine, by way of simplifying the problem, that all the Ordinary shares were in one hand, that one holder would have had in his Ordinary shares a claim to the total a.s.sets of the company, that is to say, to its earning power as long as it is a going concern, and to whatever its a.s.sets realise if it went into liquidation; the fact that 1,000,000 worth of the a.s.sets had been bought out of past profits or premiums paid on new issues of shares would have already added to the value of the claim that he had on the property of the company, and no addition would be made to that value by turning the reserve fund into shares.

In other words, the reserve fund is already the property of the shareholders, and to convert it from reserve fund into capital, making them a present of new shares, which merely represent their claim to the a.s.sets held against the reserve fund, is as empty a gift as presenting a man with a piece of paper informing him that he is the owner of his own hat. All this remains equally true if, besides the ordinary capital, there is a considerable amount outstanding of Preference shares and Debenture debt. In any case, the Ordinary shareholders possess a claim to the earning power of the company when prior charges have been satisfied, and to whatever surplus may remain on liquidation after first charges have been paid off in full. Whether that interest of theirs is represented by a larger or smaller number of shares, or by shares of a larger or smaller denomination, or by a reserve fund upon which they have a claim when all other claims have been settled makes no difference whatever as a matter of academic fact. Apart from the sentiment of the matter, there is no reason why ordinary capital should have any nominal value.

As to the earning power of the company, that, of course, is not affected one whit by the process. The earning power of the company is all in the a.s.sets--the plant, machinery and other property--plus the elusive qualities which are bound up in the word "goodwill,"

representing the selling power, organisation, and the expectation of future profits. The capitalisation of the reserve simply affects the manner in which the liabilities of the company are arranged, and the existence of a reserve fund merely means that the Ordinary shareholders have a claim to a larger amount than their nominal holding in case of liquidation. It does not matter in the least whether this larger claim is handed to them in the shape of a certificate, since the nominal amount of their claim has nothing whatever to do with the amount that their claim realises to them annually in the shape of dividends, or in the event of liquidation, from the realisation of the company's a.s.sets.

In fact, the capitalisation of reserves is sometimes criticised by economic purists as a retrograde step because it seems likely to encourage the directors to be extravagant in the matter of dividends.

In the example which we supposed above of the company with a capital of three millions and reserve fund of one million, if the reserve fund is turned into Ordinary shares and the earning power of the company remains the same there may obviously be a temptation to the directors to modify the prudent policy under which they had hitherto placed one hundred thousand a year to reserve, because if they continued it the shareholders would discover they were really no better off and that they simply got a lower rate of dividend on the larger amount of shares, and that their actual receipts from the company were exactly the same as before. And if the earning power of the company remained the same and the directors left off placing the one hundred thousand a year to reserve, and paid away the whole of the net profit in dividend, it is clear that the progressive expansion of the company's business would be to that extent checked. On the other hand, there is a contrary argument that as long as the company has a large reserve fund there is a possibility that dissatisfied shareholders may agitate for a realisation of sufficient a.s.sets to enable that reserve fund to be distributed, especially if it has been wholly acquired out of past profits. In this case the capitalisation of the reserve fund puts this temptation out of their reach since, when once the reserve fund has been capitalised, it can only be got at by greedy shareholders through the process of liquidation. Since, however, the shareholder in these times is not quite so short-sighted as he used to be, there is not perhaps really very much advantage in this point.

But since, as has been shown, capitalisation of reserves has no effect upon the earning power and a.s.sets of the company, it is interesting to try and discover why the rumour and announcement of such an intention on the part of the board of directors is nearly always accompanied by a rise in the shares of the company affected. If the shareholder is merely to be given a larger nominal claim, which does not in the least affect the value of the a.s.sets which that claim concerns, and if the relative amount of his claim is exactly the same with regard to the other shareholders, it is clear that the rise in the value of the shares is based entirely either on a psychological mistake on the part of the public and its financial advisers, or on the fact that the transaction called attention to the value of the shares which have hitherto been undervalued in the market. Probably the movement arises from both these causes. A large number of people think they are better off if they have a larger nominal share, without considering that all the other shareholders are at the same time having their claim increased, that the a.s.sets to which they all have a claim are not being increased, and that, consequently, if a sharing-out process were to take place they would all be exactly as they would have been if no such capitalisation of reserves had been carried out. And if a sufficient number of people think that a share or any other commodity is more valuable, it thereby becomes more valuable, because value is nothing else than the amount, whether in money or other commodities, at which a commodity can be disposed of.

But it is also true that there are, at all times, a very large number of securities, especially in the industrial market, which would stand higher if their earning power and position were more closely scrutinised. This is very clearly seen to be the case from the apparently extravagant prices at which insurance companies, for example, sometimes buy the businesses of one another. They give a price which is considerably above the market value of the concern as represented by the price of its shares. Critics say that the terms are extravagant, and yet the deal is found to be highly profitable to the buying company. The profit of the deal, of course, may be increased by the advantages of amalgamation, but quite apart from that it is clear that the market price of securities very often undervalues, as it also, perhaps, still oftener overvalues, the real position of the companies on whose earning powers they represent claims. In any case, there is the fact that these capitalisations of reserve funds, which make no real difference to the actual position of the company, are universally regarded, in the language of the Stock Exchange, as "bull points." It is a.s.sumed, of course, that the directors would not carry out such an operation unless they saw their way to a higher earning power in the future as a justification for the larger capital. In this expectation the directors might be right or wrong, and, even if they are right, that prospect of higher earning power, if market prices could be relied upon to express the true position of a company, would have been "in the price."

There is another kind of Bonus share, which is not exactly a Bonus share, but carries a bonus with it. This comes into being when the directors of a company sell new shares to existing shareholders at a price below the terms which they might have obtained if they made a new issue to the general public. The cla.s.sical example of this system is the Aerated Bread Company, that concern to which City clerks and journalists and others owe so much as pioneers of cheap and simple catering. It will be remembered that in the palmy days of this company, before it had been severely cut into by compet.i.tion, its 1 shares used to stand in the neighbourhood of 15. The directors used then to make issues of new shares to existing shareholders at their face value, that is to say, at 1 per share, although it was obvious that if they had made a public issue inviting all and sundry to subscribe they could have sold their new issues at or above 14 per share. This system put an enormous bonus in the pockets of the existing shareholders at the expense of the company and its future prospects. The directors practically gave to the existing shareholders a present of 130,000 if they sold them 10,000 new shares for 10,000, which they and the public would have readily subscribed for at 140,000. There was nothing wicked about the process, but it was extremely short-sighted. If the company had retained the monopoly which its pioneer work as a cheap caterer for a long time secured it, it might have kept its prosperity unimpaired even by this short-sighted finance. As it was, attracted several compet.i.tors, some of which were extremely well managed and financed, and although it still does a most useful work for the community, its earning power has suffered considerably. But this is only an extreme example of a system which is reasonable enough if it is not carried too far. The Canadian Pacific Railway, for instance, has for many years adopted a very moderate use of this system, making new issues to its shareholders on terms rather cheaper than it could have obtained by a public issue, but not giving away enough to impair its future seriously in order to make presents to the existing stockholders by this means. By the continued making of small presents to their const.i.tuents the directors of the company have obtained the support of a very loyal body of stockholders, who feel that they are being well treated but not pampered. This system of granting a small bonus to existing shareholders on occasions when the company has to issue new capital is one which is quite un.o.bjectionable as long as it is not abused. If, owing to the use of it, the directors are encouraged to finance themselves badly, that is to say, to pay out of new capital for improvements and extensions which a more prudent policy would have financed out of earnings, just because they find that these issues carrying a small bonus makes them popular with the stockholders, then the system is being abused. Otherwise there seems no reason to object to a measure which keeps the shareholders happy and does not do any harm to the concern so long as it is worked in moderation.

Finally, there is a Bonus share or stock which does not represent acc.u.mulation out of vast profits or issues of new shares at a premium, and does not involve a bonus by the sale to existing shareholders at a price below the terms which could be got in the market, but is at first sight pure water, representing merely possibilities, perhapses, and potentialities. This kind of Bonus share is chiefly known on the other side of the Atlantic, and is usually d.a.m.ned with bell, book and candle by purists among English financial critics. We say on this side of the water that every pound of an English well-financed company represents a pound which has actually been spent and put into tangible a.s.sets which help the company to earn profits. This boast is by no means true, since nearly all industrial companies come into being with something paid for in the shape of goodwill, which is of enormous importance, but can hardly be called a tangible a.s.set; and even in the case of our railway companies, many millions of original capital went into Parliamentary and legal expenses, which have been, in one sense, dead capital ever since, though without this expenditure the railways could never have got to work. The American system of Common shares, representing what appears to be water, is only a modification of what every company has to do, in one form or another, on this side or anywhere in the world. Wherever an existing business is bought out something has to be given over and above the old iron value of the concern for the value of the connection and other intangible a.s.sets.

Wherever an entirely new industry is started it has to meet certain initial expenses. It has to placate, to use the unpleasant American word, various interests in order to get to work, or it has to lay out money, in building up a concern by advertising or otherwise. It is impossible that every penny which is put into it will go into actual buildings, plant, machinery, and stock-in-trade.

In America the system has been preferred by which the actual tangible a.s.sets of a new concern are financed wholly or largely by issues of bonds or Preferred stock, and the Common stock is given away to those interested in the promotion, for them either to hold or to use in order to secure the co-operation of those who may be useful, or modify the opposition of those who may be dangerous. The net result of it is that the Common stock is represented in fact by goodwill or the power to get to work. If the company prospers, then it is the business of those who hold these Common shares to see that a.s.sets are acc.u.mulated out of profits, to be held against their Common stock, so squeezing the water out of it and making it good. The system thus possesses this very considerable advantage, that those who promote a company are interested in its future welfare, and watch over it and guide it through its subsequent existence, putting energy and good management at its disposal in order that the paper which they hold may be represented, not by water, but by real a.s.sets, and so may bring them a tangible reward. It has thus in some ways a great advantage over the English system, by which the company promoter is too often concerned merely in the immediate success of the promotion. He is, as one of the greatest of them described himself, a mere midwife, who brings the interesting infant into the world, pats its little head, says good-bye to it, and leaves it to take care of itself throughout its troubled existence. By the American system the promoter is not a midwife but a doctor who a.s.sists at the birth of the infant, and also watches over its youth and makes every effort to guide its toddling footsteps in such a way that it may grow into l.u.s.ty manhood. It is not until he has done so that he is enabled, by the sale of the shares which were given to him at the beginning, to realise the full profit which he expected.

The profits realised by this method are in many cases enormous. On the other hand, the amount of work that is put in to secure them is infinitely greater than happens in the case of the English midwife promoter; and if the enterprise is a failure, then the promoter goes without his profits.

The system, like everything else, is liable to abuse, if a rascally board of directors, in a hurry to unload their holding of Common stock on an unsuspecting public, makes the position and prospects of the company look better than they are by unscrupulous bookkeeping and extravagant distribution of profits, earned or unearned. These things happen in a world in which the ignorance of the public about money matters is a constant invitation to those who are skilled in them to relieve the public of money which it would probably mis-spend; but, if well and honestly worked, the system is by no means inherently unsound, as some English critics too often a.s.sume, and it has been shown that it carries with it a very great and substantial advantage in the hands of honest people who wish to conduct the business of company promotion on progressive lines.

XII

STATE MONOPOLY IN BANKING

_August_, 1918

Bank Fusions and the State--Their Effects on the Bank of England--Mr Sidney Webb's Forecast--His Views of the Benefits of a Bank Monopoly--The Contrast between German Experts and British Amateurs--Bankers' Charges as affected by Fusions--The Effects of Monopoly without the Fact--The "Disinterested Management" Fallacy--The Proposal to split Banking Functions--A Picture of the State in Control.

A few months ago, writing in this Journal on the subject of banking amalgamations, I referred to one of the objections against them, that they tended towards the creation of monopoly, and so encouraged hope on the part of those who would like to see all forms of industry managed by the State, that the banking business might sooner or later be taken over and worked as a State monopoly. At that time this danger of monopoly seemed to be still fairly remote, but since then the progress of amalgamations has brought it appreciably nearer, and so has vigorously stimulated both the hopes and fears of those who consider that it tends to bring nearer the seizure of banking business by the State. The fear is expressed by Sir Charles Addis, manager of the Hongkong Bank and director of the Bank of England, in the July number of the _Edinburgh Review_ in a very interesting article on the "Problems of British Banking." Sir Charles observes that:

"It may even be questioned whether the gigantic size they have already attained does not const.i.tute a menace to the predominant position which the Bank of England has. .h.i.therto enjoyed as the bankers' bank. How will the Bank of England be able to maintain its supremacy and control the money market, surrounded by banks individually greater and more powerful than itself, especially when the object in view is by raising the rate of interest to prevent an internal or external drain upon our gold reserve? It is even conceivable that the finance of the State may be threatened, and it is probably for this reason that in Germany the Prussian Minister is said to be considering a State monopoly of banking.

Nor can the psychological effect of these great aggrandis.e.m.e.nts of capital in the hands of a few banks be ignored. They are virtually Government-guaranteed inst.i.tutions. The insolvency of one of the great banks would involve such widespread disaster that no Government could stand aside. They would be compelled to make use of the national resources in order to guarantee the solvency of private banks. From Government guarantee to Government control is but a step, and but one step more to nationalisation. We are playing into the hands of Mr Sidney Webb and the Socialists."

As it happens, in the July number of the _Contemporary Review_, Mr Sidney Webb was developing the same theme, namely, the inevitability of banking monopoly and the necessity, as he conceives it, of defeating private monopoly for the sake of profit, by State monopoly to be worked, as he hopes, in the public interest. His article is headed by the rather misleading t.i.tle, "How to Prevent Banking Monopoly," for, as has been said, Mr Webb very much wants monopoly, says that it cannot be helped, and sees the fulfilment of some of his pet Socialistic dreams in the direction of it by the bureaucrat whom he regards as the heaven-sent saviour of society. His very interesting argument is most easily followed by means of a series of quotations.

"We are, it is said, within a measurable distance of there being--save for unimportant exceptions--only one bank, under one general manager, probably a Scotsman, whose power over the nation's industry would be incalculable. Even in the crisis of the war the matter is receiving the attention of the Government.

"In the opinion of the present writer, the amalgamation of banks in this country, which has been going on continuously for a century, though at varying rates, and is being paralleled in other countries, notably in Germany, and latterly in the Canadian Dominion, is an economically inevitable development at a certain stage of capitalist enterprise, and one which cannot effectively be prevented."

Mr Webb considers that there is no economic limit to this policy of amalgamation, and that the gains it carries with it are obvious. He dilates upon these as follows:--

"It may be worth pointing out:

"(a) That apart from the obvious economies in the cost of administration, common to all business on a large scale, there is, in British banking practice, a special advantage in a bank being as extensive and all-pervasive as possible. Where distinct banks co-exist, there can be no a.s.surance that the periodical shifting of business, the perpetual transformations in industrial organisation, the rise and fall of industries, localities or firms, the changes of fashion and the ebb and flow of demand, and even a relative diminution of reputation may not lead to a shrinking of the deposits and current account balances of any one bank, or even of each bank in turn. Accordingly, every bank has to maintain an uninvested, or, at least, a specially liquid, reserve to meet such a possible withdrawal. The smaller, the more numerous, the more specialised by locality or industry are the competing banks, the larger must be this reserve. On the other hand, if all the deposit and current accounts of the nation were kept at one bank, even if it has innumerable branches, as the experience of the Post Office Savings Bank shows, no such shifting of business would affect it; no mere transfers from firm to firm or from trade to trade would involve any shrinking of its aggregate balances; and it would need only to have in hand, somewhere, sufficient currency to replenish temporarily a local drain on its 'till money.' The nearer the banks can approach to this condition of monopoly, not only the lower will be their percentage of working expenses, but also the greater will be the financial stability, and the smaller the amount that they will need to keep uninvested in order to meet possible withdrawals.

"(b) That the process of amalgamation has involved an ever-increasing elimination, from the British banking business, of the typical profit-maker, first as partner in a private bank, then as a director in a Joint Stock bank, representing a large personal holding of shares; and the gradual transfer of practically the whole conduct of the business to what may be called 'disinterested management'--that is to say, management by trained, professional officers serving for salaries, whose remuneration bears no relation to the profit made on each piece of business transacted.

The part played in the business by the directors themselves seems to be, with every increase in the magnitude and scope of the concern, steadily diminishing; and these directors, moreover, come to be chosen, more and more, not because of their large holdings of shares, or because of their ancestral or personal connection with banking, but because of their reputation or influence, commercial, social or political. The result is that, along with the process of amalgamation, there has been going on a transfer of the whole management of banking to the hierarchy of salaried officials; whilst the supreme decisions on financial policy are in the hands, in practice, of a very small group of salaried general managers, only partially in consultation with an equally small group of chairmen of boards of directors, themselves usually drawing not inconsiderable salaries."