From The Spectator, 5 September 1914:

THE general public is quite excusably befogged by the repeated references in the Press to the financial difficulties which are blocking the way to a general resumption of international trade. The sea has been opened by the power of our Navy, but commerce still hesitates to resume its normal course. At the same time, our Stock Exchange remains rigidly closed, and the mora- torium has been extended for another month. These two facts alone suffice to prove that there must be some very grave interruption to the ordinary machinery of finance and commerce. Yet it is known that the Government have taken the unprecedented step of guaranteeing an enormous number of financial transactions with the very object of putting the machinery of finance again in motion. It is estimated that this guarantee of the Government covers a liability of something like £500,000,000, and might conceivably involve actual losses of anything from £50,000,000 to £100,000,000.

To make these facts generally intelligible is no easy matter, for the finance of commerce, though in normal times marvellously efficient, is necessarily intricate. It is as if an inquiring person were suddenly to ask why a big piece of electrical machinery had been brought to a stop. No doubt an expert electrician could give an accurate explanation, but the chances are that not one layman in a thousand would be any the wiser. The machinery of commerce- is not quite so far removed from ordinary experience as electrical machinery, nor can it be brought to a stop quite so easily by a trivial interruption. It is, however, necessarily complicated, and is liable to break down when a grave external cause affects its ordinary working.

In the hope of making the matter clear to our readers, let us begin at the beginning by briefly explaining the nature of a bill of exchange, which is the basis of the machinery of commerce. In effect a bill of exchange is a cheque, with this difference, that it is not necessarily drawn upon a banker, and that it is not necessarily payable at sight. Bills of exchange are constantly made payable at three months’ date, or even six months’, and are drawn upon merchants and private individuals as well as upon bankers. In practice, owing to the specialization of business, they are constantly drawn upon firms who are known as accepting houses, because these firms have made a speciality of lending the credit of their names for this purpose. Suppose, for example, an American textile manufacturer wants to buy German dye-stuffs. He will go to his banker in some New England town and ask the banker to open a credit with a London accepting house for the benefit of the German dye manufacturer. He will then write to the dye manufacturer giving the order for the dyes, and instructing him to draw a bill on this accepting house for the amount due. The German manufacturer, having drawn the bill, will take it to his banker, who, if satisfied. with regard. to the drawer’s financial status, will endorse the bill, and thus give the bill a guarantee which will render it locally saleable. The bill can then be sold in Germany to any person who has remittances to make to London. It will thus find. its way to some London bank. That London bank will at once present it to the accepting house, and they, assuming the bill to be in order, will write their acceptance across it, thus acknowledging their liability to pay. But that liability may not accrue until three months after the date of the acceptance. In the interval the banker who owns the bill may want to turn it into cash. To do this he will go to the discount market, where, again, another group of specialists exists who make a business of giving ready cash for bills which will not mature before a subsequent date. These discounters in turn deposit the bills they have bought with their own bankers, who hold. them until they have matured and then present them for payment to the acceptor. In normal times the acceptor will then pay the bill out of the remittances which he will by that time have received from the bank on whose authority he agreed to accept the bill, and to whom he looked to hold him scathless.

The difficulty which faced the City of London when the war broke out was that an enormous number of bills were maturing, but the remittances on which the accepting houses had been counting were not coming to hand, primarily because Continental firms who owed money in London suddenly found themselves faced with ruin in their own countries, and therefore were unable to pay what they owed ; and, secondly, because this sudden collapse in the machinery of European credit induced a similar collapse in credit all over the world, with the result that it became difficult for Americans and other neutrals to make remittances to London by the ordinary methods. It was to meet this situation that the moratorium was granted. That enabled the acceptors of the bills to postpone payment, and thus prevented whole- sale bankruptcies. But this step alone clearly would not start the machinery again ; it meant, indeed, a complete stoppage, for the joint stock banks held a large number of bills for which they could obtain no cash owing to the moratorium and to the general breakdown of credit. Con- sequently they had no funds to lend to their clients, and were thus unable to give the accommodation which it is their business to give to merchants and manufacturers. Hence the Government took the further step of guaranteeing the Bank of England. against loss if it would give cash for good bills drawn before the moratorium. So far as the joint stock banks are concerned, the guarantee has been successful. It has put them in possession of large funds, so that they are now free to lend money wherever they believe they can safely do so. The difficulty is that many of the firms to whom they would in the ordinary course freely lend remain in a position of grave embarrassment, for the Government guarantee was limited to assuring the Bank of England against ultimate loss, and to relieving the last holders of the bills—namely, the joint stock banks—from their liability. The guarantee did not relieve from liability any of the other persons or firms in the long chain of names attached to an ordinary bill of exchange. It did not relieve the acceptors, who are primarily liable ; it did not relieve the endorsers who in succession put their names on the back of the bill ; nor did it relieve the original drawer. The Bank of England has a right to claim the money from the acceptors, and the acceptors in turn have a right to claim from the endorsers, and they in turn have a right to claim from the original drawer. It is only when all these people have failed that the Government guarantee comes into operation. Therefore, all these firms have hanging over them an unknown liability for the pre- moratorium bills, and as long as that liability exists bankers and other people with money to lend. will be shy of lending it. As a necessary consequence, it is extremely difficult to open up new international business, for the whole machinery of international commerce depends upon credit, and if the credit of any one of the links in the long chain of merchants and banks engaged in international commerce is impaired, the chain breaks.

This, however, is only one aspect, though perhaps the most important, of the problem. Another aspect is provided by the Stock Exchange. The man in the street is accustomed to look upon the Stock Exchange as a place where he can conveniently apply when he has a little money to invest or to gamble with, and in time of war he sees no particular objection to the Stock Exchange being closed. It may throw a good many clerks and a good many principals out of work, but he thinks they would. be better employed in fighting for their country. But apart from these functions of the Stock Exchange which are obvious to the man in the street, there are others which are vitally important to the machinery of commerce. International commerce is a form of barter, goods or services in one country being exchanged for goods or services in another. This exchange, as already explained, can only be effected. by an elaborate financial mechanism which finally rests upon credit. But a man who possesses Stock Exchange securities can always increase his credit by pledging those securities to a banker. Having done this, he is able to draw against his credit for the ordinary purposes of his business. The result is that bankers hold in pawn an enormous volume of Stock Exchange securities. These have been pawned on the basis of pre-war prices. If the Stock Exchange were now to be opened, it is certain that prices would be very greatly lower than before the war Consequently the margin of security which the banker had allowed for himself would. disappear ; he would call upon his customer to make good his debt ; and the customer would be unable to do so. That is the reason why the Stock Exchange remains closed ; yet while it is closed. the business of commerce cannot receive the essential aid which it normally obtains through the utilization of Stock Exchange securities.

This article is only intended to explain how the difficulties arise. How they are to be solved is another and much more difficult problem.