Lombard Street: A Description of the Money Market

by Walter Bagehot

II.

The monarchical form of Lombard Street is due also to the note issue. The origin of the Bank of England has been told by Macaulay, and it is never wise for an ordinary writer to tell again what he has told so much better. Nor is it necessary, for his writings are in everyone's hands. Still I must remind my readers of the curious story.

Of all institutions in the world the Bank of England is now probably the most remote from party politics and from 'financing.' But in its origin it was not only a finance company, but a Whig finance company. It was founded by a Whig Government because it was in desperate want of money, and supported by the 'City' because the 'City' was Whig. Very briefly, the story was this. The Government of Charles II. (under the Cabal Ministry) had brought the credit of the English State to the lowest possible point. It had perpetrated one of those monstrous frauds, which are likewise gross blunders. The goldsmiths, who then carried on upon a trifling scale what we should now call banking, used to deposit their reserve of treasure in the 'Exchequer,' with the sanction and under the care of the Government. In many European countries the credit of the State had been so much better than any other credit, that it had been used to strengthen the beginnings of banking. The credit of the state had been so used in England: though there had lately been a civil war and several revolutions, the honesty of the English Government was trusted implicitly. But Charles II. showed that it was trusted undeservedly. He shut up the 'Exchequer,' would pay no one, and so the 'goldsmiths' were ruined.

The credit of the Stuart Government never recovered from this monstrous robbery, and the Government created by the Revolution of 1688 could hardly expect to be more trusted with money than its predecessor. A Government created by a revolution hardly ever is. There is a taint of violence which capitalists dread instinctively, and there is always a rational apprehension that the Government which one revolution thought fit to set up another revolution may think fit to pull down. In 1694, the credit of William III.'s Government was so low in London that it was impossible for it to borrow any large sum; and the evil was the greater, because in consequence of the French war the financial straits of the Government were extreme. At last a scheme was hit upon which would relieve their necessities. 'The plan,' says Macaulay, 'was that twelve hundred thousand pounds should be raised at what was then considered as the moderate rate of 8 per cent.' In order to induce the subscribers to advance the money promptly on terms so unfavourable to the public, the subscribers were to be incorporated by the name of the Governor and Company of the Bank of England. They were so incorporated, and the 1,200,000 L. was obtained.

On many succeeding occasions, their credit was of essential use to the Government. Without their aid, our National Debt could not have been borrowed; and if we had not been able to raise that money we should have been conquered by France and compelled to take back James II. And for many years afterwards the existence of that debt was a main reason why the industrial classes never would think of recalling the Pretender, or of upsetting the revolution settlement. The 'fund-holder' is always considered in the books of that time as opposed to his 'legitimate' sovereign, because it was to be feared that this sovereign would repudiate the debt which was raised by those who dethroned him, and which was spent in resisting him and his allies. For a long time the Bank of England was the focus of London Liberalism, and in that capacity rendered to the State inestimable services. In return for these substantial benefits the Bank of England received from the Government, either at first or afterwards, three most important privileges.

First. The Bank of England had the exclusive possession of the Government balances. In its first period, as I have shown, the Bank gave credit to the Government, but afterwards it derived credit from the Government. There is a natural tendency in men to follow the example of the Government under which they live. The Government is the largest, most important, and most conspicuous entity with which the mass of any people are acquainted; its range of knowledge must always be infinitely greater than the average of their knowledge, and therefore, unless there is a conspicuous warning to the contrary, most men are inclined to think their Government right, and, when they can, to do what it does. Especially in money matters a man might fairly reason—'If the Government is right in trusting the Bank of England with the great balance of the nation, I cannot be wrong in trusting it with my little balance.'

Second. The Bank of England had, till lately, the monopoly of limited liability in England. The common law of England knows nothing of any such principle. It is only possible by Royal Charter or Statute Law. And by neither of these was any real bank (I do not count absurd schemes such as Chamberlayne's Land Bank) permitted with limited liability in England till within these few years. Indeed, a good many people thought it was right for the Bank of England, but not right for any other bank. I remember hearing the conversation of a distinguished merchant in the City of London, who well represented the ideas then most current. He was declaiming against banks of limited liability, and some one asked—'Why, what do you say, then, to the Bank of England, where you keep your own account?' 'Oh!' he replied, 'that is an exceptional case.' And no doubt it was an exception of the greatest value to the Bank of England, because it induced many quiet and careful merchants to be directors of the Bank, who certainly would not have joined any bank where all their fortunes were liable, and where the liability was not limited.

Thirdly. The Bank of England had the privilege of being the sole joint stock company permitted to issue bank notes in England. Private London bankers did indeed issue notes down to the middle of the last century, but no joint stock company could do so. The explanatory clause of the Act of 1742 sounds most curiously to our modern ears. 'And to prevent any doubt that may arise concerning the privilege or power given to the said governor and company' that is, the Bank of England' OF EXCLUSIVE BANKING; and also in regard to creating any other bank or banks by Parliament, or restraining other persons from banking during the continuance of the said privilege granted to the governor and company of the Bank of England, as before recited; it is hereby further enacted and declared by the authority aforesaid, that it is the true intent and meaning of the said Act that no other bank shall be created, established, or allowed by Parliament, and that it shall not be lawful for any body politic or corporate whatsoever created or to be created, or for any other persons whatsoever united or to be united in covenants or partnership exceeding the number of six persons in that part of Great Britain called England, to borrow, owe, or take up any sum or sums of money on their bills or notes payable on demand or at any less time than six months from the borrowing thereof during the continuance of such said privilege to the said governor and company, who are hereby declared to be and remain a corporation with the privilege of exclusive banking, as before recited.' To our modern ears these words seem to mean more than they did. The term banking was then applied only to the issue of notes and the taking up of money on bills on demand. Our present system of deposit banking, in which no bills or promissory notes are issued, was not then known on a great scale, and was not called banking. But its effect was very important. It in time gave the Bank of England the monopoly of the note issue of the Metropolis. It had at that time no branches, and so it did not compete for the country circulation. But in the Metropolis, where it did compete, it was completely victorious. No company but the Bank of England could issue notes, and unincorporated individuals gradually gave way, and ceased to do so. Up to 1844 London private bankers might have issued notes if they pleased, but almost a hundred years ago they were forced out of the field. The Bank of England has so long had a practical monopoly of the circulation, that it is commonly believed always to have had a legal monopoly.

And the practical effect of the clause went further: it was believed to make the Bank of England the only joint stock company that could receive deposits, as well as the only company that could issue notes. The gift of 'exclusive banking' to the Bank of England was read in its most natural modern sense: it was thought to prohibit any other banking company from carrying on our present system of banking. After joint stock banking was permitted in the country, people began to inquire why it should not exist in the Metropolis too? And then it was seen that the words I have quoted only forbid the issue of negotiable instruments, and not the receiving of money when no such instrument is given. Upon this construction, the London and Westminster Bank and all our older joint stock banks were founded. But till they began, the Bank of England had among companies not only the exclusive privilege of note issue, but that of deposit banking too. It was in every sense the only banking company in London.

With so many advantages over all competitors, it is quite natural that the Bank of England should have far outstripped them all. Inevitably it became the bank in London; all the other bankers grouped themselves round it, and lodged their reserve with it. Thus our one reserve system of banking was not deliberately founded upon definite reasons; it was the gradual consequence of many singular events, and of an accumulation of legal privileges on a single bank which has now been altered, and which no one would now defend.