CENTRAL BANKING

Poverty Bay Herald, Volume LX, Issue 18190, 11 September 1933, Page 5

CENTRAL BANKING

MISTAKEN IDEAS MONETARY STANDARDS PARLIAMENTARY CONTROL ill VlKny people seem to have the idea that the setting-up of a, central bank implies the adoption of the gold standard as a matter of monetary policy, or, alternatively, means handing over the whole question of currency and banking to the central bank with power to act as it thinks fit. Both of these ideas are mistaken. The central bank, is nothing more than a machine or device for coordinating and controlling the banking system in accordance with the monetary übiicv as laid down by Act of Parliament. No matter what monetary system was adopted it could best be given effect to through the medium of a central institution. In fact, it is being increasingly recognised throughout the whole ■ civilised world that a central bank is essential whatever the. monetary system of the country. Parliament determines the- system-to be adopted,-but-the management, of. that-. system, should be nonpolitical.' -.. .' ' • .-- : ■ : :'v The essentials of -a good monetary system cun, be briefly stated as a stable unit of value and an efficient method of maintaining that value. Money evolved out of the idea of using some generally acceptable object of value to facilitate the exchange of goods in general, and throughout the ages in different countries many things have served the purpose. The pound originally meant a pound of silver by weight. We have now reached a stage, however, when money is represented for most part by nothing more than pieces of paper, banknotes, cheques, bills, etc., and intricate machinery to preserve its value has be come necessary. STABILISING OF VALUES ; The value of money is, of course, the quantity of goods or services that can be obtained with it, and from the nature of things it is obvious that the unit of value can never be fixed in the same hard-and-fast way as the unit of length or weight is fixed. As we know to our cost, values- do change considerably, and for the infinite benefit of all mankind it is to be hoped that with the advance of monetary science better methods of preserving stability of values will be evolved. Deliberate control by a central bank is a step in that direction. To start with, however, there must be a definite standard on which the contralling authority can base its operations. It is for Parliament to say what that measuring-rod shall be, but as money is only a tool to facilitate trade, obviously the wise thing to do is to look at our particular trading circumstances and choose a basis for our monetary unit that will best suit our purposes. On this point it is interesting to note that the framers of our present permanent banking legislation, the essential portions of which are contained for the most part in the private Acts governing the several banking institutions, evidently intended that the complete gold

standard should operate in this country. Our trading conditions, however, led in fact to the adoption of a purely voluntary sterling exchange system. The permanent statutory provisions are for the most part still suspended by war regulations, but such suspension had no real effect, as the provisions had always been practically inoperative. LIMITATION OF CREDIT The principal pre-war regulative provisions provide, in effect — (a) That the notes in circulation shall not exceed the total of the coin, bullion, and public securities held in New Zealand, or more than three times the gold held in New Zealand: fb) That the debts, engagements, and liabilities shall not exceed three times thfe coin, bullion, and public securities held in New Zealand. From a regulative point of view the first provision says, in effect, that the note-issue shall not exceed three times the gold reserves. The reference to Government securities is merely to ensure ultimate redemption of the fiduciary f>art of the issue in the case of a bank ailure. The second section is intended to limit the credit structure that might be created by the banks. In Great Britain, of course, the ratio of cash to liabilities is governed not by legislation, but by the traditional policy of the banks. In New Zealand, however, it was apparently intended to provide by law that credit expansion through advances should not exceed three times the amount of coin, bullion, and public securities held by the banks. Thus a high ratio of cash to liabilities was to be maintained. It is easily demonstrated that even in pre-war times the amount of gold held by the banks in New Zealand was not, in fact, the controlling factor of the volume -of credit and the price-level. For the June quarter of 1914, for instance, the note-issue amounted to .£l,700,000, whereas coin and bullion held amounted to £5,600,000. In this instance the note-issue could legally have been increased to £16,500,000, provided the required amount of Government securities had been purchased. INFLUENCE. OF LONDON This possible maximum issue would not have been advisable in practice, as gold was in circulation at that time, and could be demanded from the banks. Still, the fact that the maximum noteissue amounted to over half the deposits —at that time about £29,000,000—is a clear indication that further credit expansion was not prevented by lack of Cash resources. Further, a study ol the published banking figures over a period of years will show that deposits and advances have varied without any apparent relationship to notes in circulation or rash resources, and, in fact, in a manner that would be quite inexplicable in a self-contained banking system. The exp'.antion, of course, is that our banking system is not self-contained, in that the Yanks normally hold a large amount of funds in London. In fact, these London balances are the real regulative factor and the key to the whole banking system. In New Zealand there is no bullion market, no bill-market, or short-loan market, and generally no money-market in the full sense of the term. The allimportant work of our banks is financing our external trade, which per head is one of the highest, if not the. highest, in the world. Furthermore, a very large part of our trade is with Great Britain, wherein is situated the premier international money-market of the world. Under these circumstances, supported by the ties of Empire, and the fact that this r°Untry has been borrowing steadily in Gmt Britain ever since these islands were brought under the British flag, the dominating portion of our banking business has centred in London. CONTROL OF EXCHANGE

The deposits and advances which constitute the credit system of this Dominion are thus governed predominantly hy the rise and fall In the aforesaid London balances, but up to the end of 1930, at least the system was rendered definite and complete on a voluntary basis by the uniform traditional ex-

change policy adopted by the banks. J Ins intuitional excliange policy consisted of maintaining steady even rates of exchange, unaffected by any but very exceptional trade disturbances. For instance, the rates of excliange for telegraphic transfers New Zealand on London stood at 17s 6d per cent, for at least it) years prior to 1914, despite marked variation in the trade, balance between 1907 and 1911. This exchange policy was the real regulative factor m ■joinrolling the volume of credit, and .uroiigli credit the issue of currency in .Sew Zealand. The result was to keep iln- New Zealand pound at approximate parity with sterling. As is now well known throughout this Dominion a decline in British prices results in a lessened yield in sterling for our exports. This means so much less added to tlie Loudon balances of the banks, and correspondingly so much less nlded to deposits in New Zealand. With loss credit available in New Zealand, there is less scope for the purchase of imports, and Jess spent on imports, which means less drain on the London balances. When British prices rise the effects are in the .reverse direction. Wide swings in prices bring booms and slumps alternately, and while international co-operation between Governments and central banks may do much to prerent such undesirable, features it has to be recognised that this Dominion has no option lint to accept the prices ruling in the British markets. In fact, the London, balances must obviously increase or decrease bv the amount of the balance of international payments, but this, of course, does not prevent us from taking any necessary appropriate action at this ■ml to cushion the shock, and spread the loss involved in a heavy fall in sterling prices. CURRENCY AND CREDIT All these facts definitely prove that ilie New Zealand banking system ii operating on a sterling exchange standard. Credit is not controlled through the currency, but, on the contrary, tin volume of the currency is controlled through credit, which in turn is contiolled through the operation of the exchanges with London. Further, the • lanking habit is well developed in this country, and notes and coin are definitely subsidarv, being required for little beyond payment of wages and till-money in the retail trade. The chief characteristics of tlie New Zealand banking system may be summarised as follows;—• (1) That in fact the system is, and always lias been, a sterling-exchange standard. (2) That it has centred round an approximate fixed par of exchange between the British and the New Zealand pound. (3) That our external trade is cleared through London, and the London balances of the banks are the chief factor iti regulating the volume of credit in New Zealand. ((4) That the banking habit is strongly developed in New Zealand, and notes are very subsidnry, being used for little beyond payment of wages, petty disbursements, and till-money. (5) Tliat. the legislative restrictions on the note-issue have been quite, inoperative. as the demand lias always been considerably less than the maximum amount the banks were in a position to issue. (6) That, tlie volume of credit has regulated the note issue, and not vice versa. Throughout the war and since, the pre-war sterling-exchange system was maintained without any fundamenta l change, an I the rise in New Zealand prices which reached the peak about 1920 and the subsequent fall in prices was not due to any independent action taken in New Zealand, but. was simple a reflex of a similar rise and fall in British expoii prices. ADHERENCE TO STERLING Economic facts and the tradition;: exchange policy of tlie banks—which hitherto have pursued a common policy —are at piesent the only real regulative factors of the banking system.

The control, however, was not deliberate and disinterested, but was simply evolved as the system best suited for the purpose of carrying oil commercial banking in the Dominion. Such vital matters obviously should not be left to the discretion of institutions that may at times have to choose between the national interests and the immediate interests of their shareholders, who look upon the commercial banks as protitearning concerns. Obviously the national interests should always prevail, and to ensure that this will be the case it is essential that the control be placed in the hands of a national institution set u)i for that purpose alone. On the question of the monetary standard, however, the experience of the past has shown that our trade is facilitated if our currency is based on sterling. This being so. the onus is on those who advocate any other basis to demonstrate that it would he more beneficial in practice, having regard to the fact that external trade and particularly trade with Great Britain is so important to the Dominion. Accordingly, in the reserve bank legislation it is proposed to do no more than confirm the existing voluntary system and place the administration of it in the hands of an institution specially constituted for the purpose. A sterling-exchange system simply means working on Loudon balances instead of on a stock of gold held in the country,' the rates of exchange indicating when the value of our pound is rising or fulling relative to sterling.

It may he emphasised, however, that the setting- up of the reserve hank does not involve forcing the exchange-rate back to parity with sterling if that is not in the interests of the Dominion. The commercial banks will continue to transact exchange and other banking business for their customers exactly as they do at present. The only immediate outward change so far as the public are concerned will be that the commer-cial-hank notes will all be replaced by reserve hank notes, but later it is anticipated that considerable benefit will accrue from cheaper credit in the form of lower discount rates for agricultural hills and commercial paper generally.