By September 1915, one of the government’s concerns was the state of the exchange rate between Britain and the US. Before the war, both sterling and the dollar had been on the gold standard. One pound and one dollar were each worth a fixed amount of gold, and therefore their value relative to each other had barely changed for a generation. By 1915, however, there were signs that the pound’s value was slipping.
To prevent sterling from collapsing against the dollar, the British government organised a series of measures aimed at stabilising the exchange, including the transfer of £100m of gold from the Entente powers to American ownership. £20m of that total was raised from the British banks, and represented about half of all their gold reserves. In return, they received Treasury notes of equal value.
Once the gold was lodged in London, the government used it to negotiate a loan from American banks of £100m. In this case, too, a contribution was called for from the banks; they were asked to lodge large amounts of war loan stock with the Bank of England as security for the American loan. Once organised, the loan gave the British government a lever for stabilising the exchange rate, because it placed a large value of US dollar assets in its control. For the rest of the war the exchange rate was $4.76 to the pound, just a fraction less than the pre-war parity of $4.86.
In August 1917, the government announced plans to acquire all the remaining gold coin and bullion in the United Kingdom, to help it meet its ongoing obligations in America. In practice, it actually demanded 90% of whatever each bank had, leaving a tiny fraction of pre-war reserves which should, it was hoped, be enough to meet day-to-day necessity.
The banks’ business had grown significantly during the war, making their liabilities greater than ever before. The Royal Bank of Scotland, for example, had around £26m of deposits, compared to £16.6m in 1913. Its banknote circulation had reached £2.6m, compared to £1m in 1913. It was still obliged to repay its banknotes in gold or treasury notes upon demand at head office, but after giving up 90% of its gold, it had only £68,000 left, plus £10-15,000 of treasury notes. In other words, only about 3% of its banknote circulation, or 0.3% of its deposits, was backed by ready cash. A relatively small demand could have wiped out those reserves, forcing the bank to call upon currency note certificates held at the Bank of England in London, which would take considerable time to obtain. Although the banknotes aspect of this problem only affected the Scottish banks, the reduction in cover for deposits was a significant change across the sector. Banks were utterly dependant on all participants in the British economy holding their nerve. Fortunately they did so.