The Consequences to the Banks of the Collapse of Money Values

A year ago it was the failure of agriculture, mining, manufactures, and transport to make normal profits, and the unemployment and waste of productive resources ensuing on this, which was the leading feature of the economic situation. To-day, in many parts of the world, it is the serious embarrassment of the banks which is the cause of our gravest concern. The shattering German crisis of July 1931, which took the world more by surprise than it should, was in its essence a banking crisis, though precipitated, no doubt, by political events and political fears. That the top-heavy position, which ultimately crumbled to the ground, should have been built up at all, was, in my judgement, a sin against the principles of sound banking. One watched its erection with amazement and terror. But the fact which was primarily responsible for bringing it down was a factor for which the individual bankers were not responsible and which very few people foresaw—namely, the enormous change in the value of gold money and consequently in the burden of indebtedness which debtors, in all countries adhering to the gold standard, had contracted to pay in terms of gold.

Let us begin at the beginning of the argument. There is a multitude of real assets in the world which constitute our capital wealth—buildings, stocks of commodities, goods in course of manufacture and of transport, and so forth. The nominal owners of these assets, however, have not infrequently borrowed money in order to become possessed of them. To a corresponding extent the actual owners of wealth have claims, not on real assets, but on money. A considerable part of this "financing" takes place through the banking system, which interposes its guarantee between its depositors who lend it money, and its borrowing customers to whom it loans money wherewith to finance the purchase of real assets. The interposition of this veil of money between the real asset and the wealth owner is a specially marked characteristic of the modern world. Partly as a result of the increasing confidence felt in recent years in the leading banking systems, the practice has grown to formidable dimensions. The bank-deposits of all kinds in the United States, for example, stand in round figures at $50,000,000,000; those of Great Britain at £2,000,000,000. In addition to this there is the great mass of bonded and mortgage indebtedness held by individuals.

All this is familiar enough in general terms. We are also familiar with the idea that a change in the value of money can gravely upset the relative positions of those who possess claims to money and those who owe money. For, of course, a fall in prices, which is the same thing as a rise in the value of claims on money, means that real wealth is transferred from the debtor in favour of the creditor, so that a larger proportion of the real asset is represented by the claims of the depositor, and a smaller proportion belongs to the nominal owner of the asset who has borrowed in order to buy it. This, we all know, is one of the reasons why changes in prices are upsetting.

But it is not to this familiar feature of falling prices that I wish to invite attention. It is to a further development which we can ordinarily afford to neglect but which leaps to importance when the change in the value of money is very large—when it exceeds a more or less determinate amount.

Modest fluctuations in the value of money, such as those which we have frequently experienced in the past, do not vitally concern the banks which have interposed their guarantee between the depositor and the debtor. For the banks allow beforehand for some measure of fluctuation in the value both of particular assets and of real assets in general, by requiring from the borrower what is conveniently called a "margin." That is to say, they will only lend him money up to a certain proportion of the value of the asset which is the "security" offered by the borrower to the lender. Experience has led to the fixing of conventional percentages for the "margin" as being reasonably safe in all ordinary circumstances. The amount will, of course, vary in different cases within wide limits. But for marketable assets a "margin" of 20 per cent to 30 per cent is conventionally considered as adequate, and a "margin" of as much as 50 per cent as highly conservative. Thus provided the amount of the downward change in the money value of assets is well within these conventional figures, the direct interest of the banks is not excessive;—they owe money to their depositors on one side of their balance-sheet and are owed it on the other, and it is no vital concern of theirs just what the money is worth. But consider what happens when the downward change in the money value of assets within a brief period of time exceedsthe amount of the conventional "margin" over a large part of the assets against which money has been borrowed. The horrible possibilities to the banks are immediately obvious. Fortunately, this is a very rare, indeed a unique event. For it had never occurred in the modern history of the world prior to the year 1931. There have been large upward movements in the money value of assets in those countries where inflation has proceeded to great lengths. But this, however disastrous in other ways, did nothing to jeopardise the position of the banks; for it increased the amount of their "margins." There was a large downward movement in the slump of 1921, but that was from an exceptionally high level of values which had ruled for only a few months or weeks, so that only a small proportion of the banks' loans had been based on such values and these values had not lasted long enough to be trusted. Never before has there been such a world-wide collapse over almost the whole field of the money values of real assets as we have experienced in the last two years. And, finally, during the last few months—so recently that the bankers themselves have, as yet, scarcely appreciated it—it has come to exceed in very many cases the amount of the conventional "margins." In the language of the market the "margins" have run off. The exact details of this are not likely to come to the notice of the outsider until some special event—perhaps some almost accidental event—occurs which brings the situation to a dangerous head. For, so long as a bank is in a position to wait quietly for better times and to ignore meanwhile the fact that the security against many of its loans is no longer as good as it was when the loans were first made, nothing appears on the surface and there is no cause for panic. Nevertheless, even at this stage the underlying position is likely to have a very adverse effect on new business. For the banks, being aware that many of their advances are in fact "frozen" and involve a larger latent risk than they would voluntarily carry, become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible to make them. This reacts in all sorts of silent and unobserved ways on new enterprise. For it means that the banks are less willing than they would normally be to finance any project which may involve a lock-up of their resources.

Now, in estimating the quantitative importance of the factor to which I am calling attention, we have to consider what has been happening to the prices of various types of property. There are, first of all, the principal raw materials and foodstuffs of international commerce. These are of great importance to the banks, because the stocks of these commodities, whether in warehouse or in transit or embodied in half-finished or unsold manufactured articles, are very largely financed through the banks. In the last eighteen months the prices of these commodities have fallen on the average by about 25 per cent. But this is an average, and banks cannot average the security of one customer with that of another. Many individual commodities of the greatest commercial importance have fallen in price by 40 to 50 per cent or even more.

Next come the ordinary or common shares of the great companies and corporations which are the market leaders in the Stock Exchanges of the world. In most countries the average fall amounts to 40 to 50 per cent; and, this again, is an average which means that individual shares, even amongst those which would have been considered of good quality two years ago, have fallen enormously more. Then there are the bonds and the fixed interest securities. Those of the very highest grade have, indeed, risen slightly, or, at the worst, not fallen by more than 5 per cent, which has been of material assistance in some quarters. But many other fixed interest securities, which, while not of the highest grade, were, and are, good securities, have fallen from 10 to 15 per cent; whilst foreign government bonds have, as is well known, suffered prodigious falls. These declines, even where they are more moderate, may be scarcely less serious, because such bonds (though not in Great Britain) are often owned by the banks themselves outright, so that there is no "margin" to protect them from loss.

The declines in the prices of commodities and of securities have, broadly speaking, affected most countries alike. When we come to the next category of property—and one of great quantitative importance—namely, real estate, the facts are more various as between one country and another. A great element of stability in Great Britain, and, I believe, in France also, has been the continued comparative firmness in real estate values:—no slump has been experienced in this quarter, with the result that mortgage business is sound and the multitude of loans granted on the security of real estate are unimpaired. But in many other countries the slump has affected this class of property also; and particularly, perhaps, in the United States, where farm values have suffered a great decline, and also city property of modern construction, much of which would not fetch to-day more than 60 to 70 per cent of its original cost of construction, and not infrequently much less. This is an immense aggravation of the problem, where it has occurred, both because of the very large sums involved and because such property is ordinarily regarded as relatively free from risk.

Finally, there are the loans and advances which banks have made to their customers for the purposes of their customers' business. These are, in many cases, in the worst condition of all. The security in these cases is primarily the profit, actual and prospective, of the business which is being financed; and in present circumstances for many classes of producers of raw materials, of farmers and of manufacturers, there are no profits and every prospect of insolvencies, if matters do not soon take a turn for the better.

To sum up, there is scarcely any class of property, except real estate, however useful and important to the welfare of the community, the current money value of which has not suffered an enormous and scarcely precedented decline. This has happened in a community which is so organised that a veil of money is, as I have said, interposed over a wide field between the actual asset and the wealth owner. The ostensible proprietor of the actual asset has financed it by borrowing money from the actual owner of wealth. Furthermore, it is largely through the banking system that all this has been arranged. That is to say, the banks have, for a consideration, interposed their guarantee. They stand between the real borrower and the real lender. They have given their guarantee to the real lender; and this guarantee is only good if the money value of the asset belonging to the real borrower is worth the money which has been advanced on it.

It is for this reason that a decline in money values so severe as that which we are now experiencing threatens the solidity of the whole financial structure. Banks and bankers are by nature blind. They have not seen what was coming. Some of them have even welcomed the fall of prices towards what, in their innocence, they have deemed the just and "natural" and inevitable level of pre-war, that is to say, to the level of prices to which their minds became accustomed in their formative years. In the United States some of them employ so-called "economists" who tell us even to-day that our troubles are due to the fact that the prices of some commodities and some services have not yet fallen enough, regardless of what should be the obvious fact that their cure, if it could be realised, would be a menace to the solvency of their institution. A "sound" banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.

But to-day they are beginning at last to take notice. In many countries bankers are becoming unpleasantly aware of the fact that, when their customers' margins have run off, they are themselves "on margin." I believe that, if to-day a really conservative valuation were made of all doubtful assets, quite a significant proportion of the banks of the world would be found to be insolvent; and with the further progress of Deflation this proportion will grow rapidly. Fortunately our own domestic British Banks are probably at present—for various reasons—among the strongest. But there is a degree of Deflation which no bank can stand. And over a great part of the world, and not least in the United States, the position of the banks, though partly concealed from the public eye, may be in fact the weakest element in the whole situation. It is obvious that the present trend of events cannot go much further without something breaking. If nothing is done, it will be amongst the world's banks that the really critical breakages will occur.

Modern capitalism is faced, in my belief, with the choice between finding some way to increase money values towards their former figure, or seeing widespread insolvencies and defaults and the collapse of a large part of the financial structure;—after which we should all start again, not nearly so much poorer as we should expect, and much more cheerful perhaps, but having suffered a period of waste and disturbance and social injustice, and a general re-arrangement of private fortunes and the ownership of wealth. Individually many of us would be "ruined," even though collectively we were much as before. But under the pressure of hardship and excitement, we might have found out better ways of managing our affairs.

The present signs suggest that the bankers of the world are bent on suicide. At every stage they have been unwilling to adopt a sufficiently drastic remedy. And by now matters have been allowed to go so far that it has become extraordinarily difficult to find any way out.

It is necessarily part of the business of a banker to maintain appearances and to profess a conventional respectability which is more than human. Lifelong practices of this kind make them the most romantic and the least realistic of men. It is so much their stock-in-trade that their position should not be questioned, that they do not even question it themselves until it is too late. Like the honest citizens they are, they feel a proper indignation at the perils of the wicked world in which they live,—when the perils mature; but they do not foresee them. A Bankers' Conspiracy! The idea is absurd! I only wish there were one! So, if they are saved, it will be, I expect, in their own despite.