§9. There seem to me, therefore, to be strong general reasons for keeping the function of issuing notes---and of providing a reserve of gold for their conversion---under the responsibility of Government; instead of merely regulating the issue on some such plan as that above proposed. If, however, we yield to these reasons and assume that it is desirable to have a monopolized issue of notes, sustained (in the last resort) by the credit and authority of Government, in order to guard against the extreme perils of a panic; it is manifest that a step in governmental interference, beyond what we have so far expressly considered, will become necessary. For in order that this end may be attained, in order that the abnormal issues of notes required in a panic may be properly managed, the Government must undertake---directly or indirectly---not merely the function of buying gold with notes and redeeming notes with gold, but also the function of lending notes on adequate security. Thus the department that issues notes must either (1) become a regular bank, or (2) be prepared to perform from time to time, under specially difficult circumstances, the most delicate and important part of the work of a bank; or (3) it must constitute, or enter into alliance with, some individual bank doing ordinary banking business, and entrust these duties to its management. The third of these courses seems the best; since, in the first place, the business of lending money on credit does not seem to be generally more suitable to governmental management than any other branch of commerce; rather it would seem to require the close and keen observation of the state of trade generally, and of individual traders, which it is the special advantage of private enterprise to call forth. And, secondly, a department that bad no regular banking business at ordinary times, would hardly be likely to have the knowledge and trained skill required for solving correctly difficult problems of banking at special crises; it would have to depend on the advice of outsiders, liable to be biassed by urgent private interests. But even the establishment of a bank in special connexion with---though not a department of---Government tends to produce very important incidental effects on the banking system of the country. The unique security that such a governmental bank affords to depositors gives other banks an inducement to use it for the custody of their reserves; money lodged with the governmental bank is thought as safe as money in a strong box, and less troublesome; transfers of sums in its books are a very convenient mode of settling accounts among banks; and thus bankers slide naturally into the `one-reserve system' that actually exists in England. It must be admitted, I think, that this system, increasing as it does the instability of the vast edifice of credit that is supported on this small basis of gold, renders the danger of crisis and panic proportionally greater; that is, the very need, of which the existence (as we have seen) forms the main justification for governmental interference with banking, must be partly attributed to that interference itself On the other hand the same interference must to an equal extent be credited with the merit of the system, which lies in its economy; it enables a vast banking business to be transacted at a small expenditure in metallic reserve: and therefore those critics of our Bank Act of 1844 who complain of the large amount of gold lying idle in the vaults of the Bank of England, ought at any rate to recognise that the aggregate expense incurred by the community in keeping gold is less than it would probably be under a system of free banking, under which the leading banks (at any rate) would be likely to keep each its own reserve.
This does not of course prove that the metallic reserve actually kept under the English system might not be safely reduced; or that it might not be turned to better account, if the connexion between the Government and what we have called the `governmental bank' were established on a different plan. Indeed it seems evident that if the Bank of England had full discretion in determining the proportion of reserve to notes issued, it would at least have the power of performing its functions in a manner more advantageous to the community than at present. To show this, we will suppose that the Bank is now keeping practically about eleven millions of metallic reserve to meet the liabilities of the banking department, and about ten millions more to meet those of the Issue Department. Under the present strict regulation of the Issue Department this latter reserve cannot be used for banking purposes, so that its existence does not give any additional strength to the banking department; hence any given drain of gold acts on the banking reserve with much greater force than it would ordinarily exercise if the bank were left free to treat the two reserves as one. Hence it would seem that if the Bank were unfettered, the rate of discount would ceteris paribus be decidedly less liable to be affected by slight and transient movements of gold than is now the case; so that the rapid and large fluctuations in interest which are recognised as a bad result of our existing system, would be reduced, other things being the same. On the other hand it is bold to assume that other things would remain the same: or rather---for the present reserve may be too large---that the Bank would take all due precautions to avoid the risk of having to suspend payments. Indeed when we consider merely from an abstract point of view the proposal to give a particular joint-stock company an exclusive privilege of issuing notes the value of which will, in the last resort, be sustained by the authority of Government, without subjecting its exercise of this privilege to any governmental control whatsoever; it certainly appears a very hazardous measure. If we suppose the Bank to be governed by the vulgar desire of private gain, it will, in determining the proportion of notes to reserve, consider the risk to itself and not the risk to the community; and though the danger to itself from an inadequate reserve would be serious, it would be less than in the case of an ordinary bank---since we have supposed that Government would, in the last resort, intervene to sustain the currency of the notes.
It remains to consider briefly whether, supposing that there is a legally determined normal limit of the uncovered note-issue, it is desirable that the relaxation of this restriction should be only obtainable---as in England---by irregular governmental interference, or that it shall be regularly purchaseable by the Bank. If the price of the relaxation were placed sufficiently high, if (e.g.) the bank had to pay 5 per cent. for any excess over the normal amount of uncovered note-issue, the difference between the two plans would seem to be chiefly political rather than economical: neither resource would be brought into play except in an extreme emergency, but the former would have the advantage of avoiding the bad constitutional precedent set by the irregular suspension of a law. But the former measure would work very differently, if the price paid were so small that the extra issue could be counted on as an ordinary mode of relieving the pressure on the money-market; such a regulation would, I think, be an awkward combination of control and freedom: just when the Bank's relations with the commercial world became most difficult and delicate, the responsibility for yielding to the pressure for loans would be partly taken off its shoulders by what would appear to be express governmental provision for extended issue.
I have said that that part of an ordinary banker's function which consists in lending money to traders and other employers of capital is not a business in which governmental management is likely to have any special advantage. On the other hand, as a borrower of money the Government of a well-ordered and prosperous community is able to give a higher degree of security to its creditors than even a large joint-stock company can do. Hence governmental agency is specially adapted for taking charge of the savings of persons, to whom security is generally of more importance than high interest, whether such savings take the simple form of depositing money, or the more complicated form of payment for life-insurance, purchase of annuities, &c. Moreover there are particular departments of the business of lending, where the risk may be reduced to a small amount, which appear, from their routine character, to be not ill suited to governmental management. Thus there seems to be no particular reason why Government should not lend money on the security of land, as I shall presently notice; or even, for short periods, on moveable pledges, the value of which is not likely to change materially in a short time nor difficult to ascertain approximately: and in fact experience renders it probable that, by establishing a governmental monopoly of pawnbroking, loans can be remuneratively made to the poor on easier terms than open competition would enable them to secure. There is the further argument for such a governmental monopoly that it considerably decreases the difficulty of preventing pawnbrokers from becoming practically receivers of stolen goods.