Lombard Street: A Description of the Money Market

This is a reprint of an 1873 classic on the Bank of England. It is short, less than 150 pages. It is both a timeless classic and a time-bound discussion of the peculiarities of late 19th century British finance. The classic part of the work is in its discussion of why the business cycle exists, and why a central bank is needed as a lender of last resort to save the system from collapse. This is material familiar to the modern reader through Kindleberger and Hyman Minsky. Bagehot stated their logic, almost a hundred years before them in clear, dramatic language. The time-bound part of the work focuses upon the peculiar history and even more peculiar structure and functioning of the pre-World World One Bank of England. It is easy to assume that all central banks are much the same. They are not, and this discussion underlines that. Central banks have at least two functions: issuer of currency, and lender of last resort. Under the Peel Act of 1844, the Bank of England had no discretion about issuing currency; the amount it could issue was rigidly set by the amount of gold which it held. Thus, to carry out its role of lender of last resort, the Bank of England was very focused upon creating and preserving a huge reserve. Our Federal Reserve, which can issue as much currency as it feels like, operates in a radically dissimilar environment. The basic job, viewed from a great distance, is much the same, but the details are almost all very different.

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Written in the 1860's Baghot gets it exactly right. An easy read, often witty, hugely enlightening as to the very soul of joint stock banking (new we call it fractional reserve banking) and explains what can go right and what can go wrong - big time! What can go wrong is loss of confidence such that interbank lending simply stops. In such cases, the central bank (he refers to the Bank of England) MUST intervene and lend, lend, lend. This is exactly what is happening now in the US. Baghot foresaw it all, defines the solution and reminds us that the system will survive. I call it a credit cycle reset and it happens once every 20 years or so. Hence: be of good cheer! This, too, shall pass. And huge opportunities are being created for those who have a sense of perspective. Reading Lombard Street is NOT OPTIONAL for those who wish to gain this perspective.

An engrossing read for anyone who has an interest in business and economic history as written by contemporaries of yesteryear. Enjoy!

Walter Bagehot was the first editor of the now world-famous Economist magazine, which has in many ways remained faithful to the liberal philosophy (in a European sense)of its founder. Lombard Street might be difficult to read at first, but as with Charles Dickens once you get used to the style the tale is riveting. And his advice on how a central bank, as the lender of last resort, should behave in the face of a banking crisis remains valid to this day.