NEW RESERVE BANK

Greymouth Evening Star, 16 July 1934, Page 9

NEW RESERVE BANK

OPERATION EXPLAINED In an address which he termed informal, Mr B. C. Ashwin, Second Assistant Secretary of the Treasury, held the interest of more than a hundred members of the Wellington Society of Accountants recently on the subject of “Reserve Banks.”

He began with a remark that in the establishment of a central (or reserve) bank. New Zealand , was not singular. The Dominion was in line with Canada, India, and many other countries which were adopting that policy (reports “The Post”). Any notion that a central bank would be a cure for the slump had to be put aside. However, the slump had drawn attention to the need of reform in the banking system, and had certainly accelerated the movement towards an achievement of that ideal. It was a matter of inevitable evolution in the development of a new credit structure of banking. Even apart from the slump, the time would have come when a central bank would have become an indispensable institution. In their own sphere the commercial banks had given good service and had been brought to a high state of efficiency, but the financial system had now developed to a stage where something more was wanted, something more than could be reasonably expected from such banks.

The general community had come to a stage where business and a large part of the daily life of the people were carried out in terms of money, “the oil which made the wheels of industry go round.’’ Time had proved that a collapse of banks brought down the whole economic structure, for banking was the key industry. Therefore it was necessary to have a special institution for the control of money. In essence a central bank was really nothing more than a device for pooling the liquid reserves of trading banks and using that pool for the purppse of controlling the system. Although the great majority of transactions were carried on with credit on the cheque system, a certain proportion of cash was wanted —a proportion that depended on the habits of the community. The demand for cash grew when confidence was shaken. When cash was put in the hands of a central institution and pooled, the institution that had the cash had the whip- hand.

A “FINANCIAL FIRE BRIGADE.”

Pooling of liquid resources gave financial strength. Accordingly a central bank was a kind of financial fire brigade, with a pooled water supply. If, instead of having a pooled supply, every citizen sat on two or three buckets of water, the town might be burnt down. The same thing applied in banking. The trading banks were independent units. To a certain extent, ordinarily, they might assist one another, but in a crisis each one had to be concerned with its own interests. When all the reserves were drawn into one pool, the combined strength could be used to save a bank that was seriously threatened, and thus the welfare of all could be assured. The result would be financial solidarity and strength . The idea of central banking -ad been evolved in England. The classic example was the Bank of England. It was not established as a central bank, but as a private trading bank, but had slowly evolved along, lines which dropped the commercial side of its activities and specialised in the functions of central banking, In this capacity, without the obligation of law, the Bank of England had put the public welfare ahead of the interests of its shareholders. New Zealand had a similar need of a central banking system, but the urgent need would not allow the country to wait for the slow process of evolution. . Therefore the establishment had to be effected by statute.

The essence of success in the system of central banking lay in the possession of liquid reserves. Therefore it was necessary that the central bank should have the sole right of note issue. Formerly the other banks could create their own cash, but in future they would have to buy their notes from the central bank. If any one of the commercial banks tended to get into a dangerous position by over-trading, the central bank would be able to check its perilous course. The central bank was equipped with powerful forces which it could bring into effective action when required. It was anticipated that normally there would be satisfactory cooperation between the commercial banks and the Reserve Bank. It was not intended to take over the functions of the trading banks, for that would be only increasing the overhead costs of the community. The real function of the Reserve Bank would be to determine a. monetary policy and advise a course of action, having regard to the state of trade and other relevant factors. The great objective was the welfare of the country as a whole. The Reserve Bank would set the course for the ship and use its resources to keep the vessel on that course, also to pour oil on troubled waters when storms were raging. The Bank would also look ahead, see what was coming, and warn commercial banks to shorten sail when adverse conditions were sensed. For that purpose there must be a deliberate and defined control.

WEAKNESS OF OLD SYSTEM The weakness of the existing sys- I tern had not been so apparent in the past, because the circumstances then | were different. From about 1896 until i about 1921 or 1922 business generally had run smoothly, and then the bubble burst. It was only under severe stress and strain that the weakness was seen. When widespread financial trouble came there was no policy for an easing of the shocks. It was not a function of the private trading banks to organise a policy. They were private institutions, concerned with the making of profits for their shareholders. Even in boom times, the ordinary competitive banking system had its elements of danger. That was the basic reason why New Zealand and other countries had felt obliged to adopt the central bank system. The creation of money was a prerogative of the Crown. In the same way the prerogative of note issue be longed to the State. In the past the State in New Zealand had not issued notes, but the principle of the prerogative was seen in the note tax imposed on private banks for the privilege. It was also a right of the State to prescribe the monetary standard and system as a whole, as this function was so vitally important, to tne people. Indeed, as the State was the .community, it was the State's business to look after its money. When private enterprise had control of the most important factor in the control

of prices it was in a position to exploit the situation for its own profit, although it was not suggested that the trading banks of New Zealand were guilty of such practice. Although there was much support for the principle of a Reserve Bank, there was wide disagreement as to the form of such an institution, particularly the management. What had been evolved out of the experience of the world was an institution between the various interests. It hold to be free from the State on one side, and free from commercial banks and other vested interests on the other side as far as it was humanly possible, and in order to take away the incentive on the commercial side it was provided that profits would go to the State. The Reserve Baink would not be concerned with the question of profits. but with national welfare. The State must prescribe the banking standard and monetary system, and it was the duty of the Reserve Bank to keep the value of money up to that standard.

On the question of control of the Reserve Bank there was necessarily a basis of compromise. In the ordinary course the shareholders would appoint four directors (two representing primary industries and two the commercial and industrial interests). The State representing the general public —say, the consumers —would appoint three members. Both the shareholders and the Government would be concerned in the engagement of executive officers —the Governor and the Deputy Governor —who were appointed by the Government on the recommendation of the other directors. Thus there was a delicate balance between the political side and the shareholders’ side, and both should aim at getting a directorate committed to a broad national policy. The shareholders were subscribing £500,000 of capital, and the State was providing £1,000,000, not as capital, but as a payment to the reserve fund. Any profits above a fixed dividend would go to the State. The Reserve Bank would necessarily take over Government business in banking. As the volume of Government business with balnks was very large it was obviously necessary for the Reserve Bank to be in intimatq touch with such big-scale operations. Moreover, the handling of Government business would emphasise the national character of the Reserve Bank. The Bank would also function as a clearing house for cheques. In normal times the Bank would deal only with other banks and with the Government.

STERLING—EXCHANGE BASIS The Reserve Bank -was established on a sterling-exchange basis. This had always been in operation in New Zealand, as a matter of fact, and now it would be a matter of law. During the present unsettled conditions it would be open to the Reserve Bank to fix any exchange rate, but in due course Parliament would have to fix a standard to stabilise the system. When that was done, limits would have to be set within which the Reserve Bank would fix the exchange rate. The purpose would be to preserve the value of money.

New' Zealand’s monetary system -was tied to sterling. The basic reason was that the whole economic structure had been built up on the export of primary produce, mainly to Great Britain. New Zealand had also borrowed much money in Britain and bought large ‘ amounts of goods there. All the economic threads led to London. Therefore it was most convenient to have the same basis for the monetary system as for the economic system. Although the Reserve Bank could not wave a magic wand to dismiss the slump, it would bring various benefits. It should flatten out the ups and downs in trade. It should do a great deal to make credit easier. It could help float the country on towards recovery of prosperity. It ■would bring down the interest rates for the Government, and thus induce a general easing in this direction. If, for instance, as the result of the credit conditions created by the Reserve Bank the overdraft rate of the trading hanks was lowered by 1 per cent, the saving to their customers would amount to £500,000 a year on the present volume of business.

The new' order meant a co-ordinated banking system, which gave New Zealand the control of its monetary system. The New Zealand Board of Directors would map out a definite course of action and see that it was pursued. New’ Zealand had never had such a policy previously. Some persons alleged that the Reserve Bank would be practically under the control of the Bank of England or under the grip of international Jews. Such assertions were plain nonsense, absolutely contrary to fact. Up to the present such control as there had been of New- Zealand’s monetary system had been abroad. Of the six trading banks onlj r one had its directorate resident in New Zealand. The others were located in London or Australia. Four of those banks were primarily Australian. Their Australian business was far greater- than the New- Zealand section, and naturally their policy would be one which would not be to the disadvantage of Australia in comparison with New Zealand. Far from transferring the control of New’ Zealand’s financial affairs abroad, the Reserve Bank would bring the control to New’ Zealand. The New Reserve Bank could not get into high gear suddenly. It would take some time to get into its full stride. It would build up prestige as it went along. It would be a source of helpful financial advice, not only to the Government, but to the trading community. Such advice would ho the more valuable as it would be disinterested. The Bank would do a great deal to promote confidence in the trading community as a whole when it was known that the Bank was run by experts for the public as a” whole.