Bagehot

  No portrait of Walter Bagehot is known to exist except for the famous profile that a photographer snapped in Bagehot’s middle years. The image you see here is the product of the remote collaboration between the former New York City Police Department forensic artist, Stephen Mancusi, and the illustrator and book designer, Katherine Messenger. Together, the two have imagined the face in full that no one has seen since Bagehot’s death in 1877.

  BAGEHOT

  THE LIFE AND TIMES OF THE GREATEST VICTORIAN

  James Grant

  for Edward Chancellor,

  who insisted

  We are looking for a man who was in and of his age, and who could have been of no other: a man with sympathy to share, and genius to judge, its sentiments and movements: a man not too illustrious or too consummate to be companionable, but one, nevertheless, whose ideas took root and are still bearing; whose influence, passing from one fit mind to another, could transmit, and can still impart, the most precious element in Victorian civilization, its robust and masculine sanity. Such a man there was: and I award the place to Walter Bagehot.

  —G. M. Young, “The Greatest Victorian,”

  Spectator, June 18, 1937

  CONTENTS

  AUTHOR’S NOTE

  Prologue:“With devouring fury”

  CHAPTER 1:“Large, wild, fiery, black”

  CHAPTER 2:“In mirth and refutation—in ridicule and laughter”

  CHAPTER 3:“Vive la guillotine”

  CHAPTER 4:The literary banker

  CHAPTER 5:“The ruin inflicted on innocent creditors”

  CHAPTER 6:“The young gentleman out of Miss Austen’s novels”

  CHAPTER 7:A death in India

  CHAPTER 8:The “problem” of W. E. Gladstone

  CHAPTER 9:“Therefore, we entirely approve”

  CHAPTER 10:“The muddy slime of Bagehot’s crotchets and heresies”

  CHAPTER 11:The great scrum of reform

  CHAPTER 12:A loser by seven bought votes

  CHAPTER 13:By “influence and corruption”

  CHAPTER 14:“In the first rank”

  CHAPTER 15:Never a bullish word

  CHAPTER 16:Government bears the cost

  CHAPTER 17:“I wonder what my eminence is?”

  ACKNOWLEDGMENTS

  NOTES

  BIBLIOGRAPHY

  INDEX

  AUTHOR’S NOTE

  “The immense fluctuations in our commerce, caused by protection, were aggravated by immense fluctuations in our credit, and the combined result was unspeakably disastrous.”

  —Walter Bagehot on the commercial and monetary conditions prevailing in England around the time of his birth1

  IN 1832, JEREMIAH HARMAN, a long-serving director of the Bank of England, testified before a parliamentary committee on how the Bank rose to meet the occasion of the Panic of 1825. It was a desperate time, and the Bank lent money in unprecedented ways. “We lent it by every possible means, and in modes that we never had adopted before,” Harman explained;

  we took in stock as security, we purchased exchequer bills, we made advances on exchequer bills, we not only discounted outright, but we made advances on deposit of bills of exchange to an immense amount; in short by every possible means consistent with the safety of the Bank; and we were not upon some occasions over nice; seeing the dreadful state in which the public were, we rendered every assistance in our power.2

  Bagehot (pronounced Badge-it), who wrote the still-canonical prescription for stopping a run on the banks, Lombard Street, never recommended a policy so extreme. Faced with a crisis, he famously asserted, a central bank should lend freely at a high rate of interest against good banking collateral. He said much more than that, but those words—customarily abbreviated to omit the part about the high interest rate—are invoked to this day. No sooner do the banks bring down a crisis on themselves, or stock prices take a tumble, than the call goes out for the Federal Reserve to infuse the market with emergency credit. In his memoir of the Great Recession, The Courage to Act, Ben S. Bernanke, chairman of the Federal Reserve from 2006 to 2014, cited Bagehot more frequently than any living economist.

  Bagehot was a banker, a man of letters, and a financial journalist; most famously, he edited the Economist. But he was no economist himself—that is, he made no original contribution to the body of economic theory.

  It is a comment on the nature of economics as much as it is on the genius of Bagehot that his dicta on central banking continue to hold sway almost a century and a half after he propounded them. In the physical sciences, progress is cumulative; we stand on the shoulders of giants. In economics, the most ostensibly rigorous of the social sciences, progress—and error, too—are cyclical; we keep stepping on the same rakes.

  There is a misconception that Bagehot originated the idea of a lender of last resort. It’s obvious he could not have done so; Jeremiah Harman and his fellow directors were doing more than Bagehot would later recommend two months before the author of Lombard Street was even born. He did, however, popularize and legitimize the proposition, controversial at the time but now taken as revealed truth, that a central bank owed a public duty to private persons dealing with large sums of money. Unfortunately, he seriously underestimated the extent to which this supposed obligation would induce people to take risks they would not otherwise accept in the absence of expected government help.

  Perhaps Bagehot himself would agree. He believed—at least, at age thirty-nine, when a monetarily astute friend took the trouble to make a careful inventory of his views—that money was gold and silver and that alone. All forms of currency, including the notes of the Bank of England, were credit instruments, no different than personal checks, from which it followed that the government had no business intervening in the business of banking. Bagehot came to modify his ideas about financial regulation—but, unacknowledged by the many who approvingly quote him on the imperative of central bank crisis management, he never changed his publicly expressed view about the gold standard or the abomination of fiat currency.

  Bagehot was not the only virtuoso writer on money and banking in nineteenth-century England: Karl Marx, London correspondent for the New York Tribune, was an accomplished financial reporter (bear markets brought out the best in him). George Goschen’s brilliant matched set of essays, “Two Percent” and “Seven Percent,” can be read for sheer pleasure—no small feat considering the subject matter is interest rates.

  Yet Bagehot—eclectic, fearless, aphoristic, prolific—stands apart. The twentieth-century American journalist A. J. Liebling said of himself that he wrote faster than anyone who wrote better, and better than anyone who wrote faster. Bagehot made no such claim—it would have been un-English. But with a glance at periodical journalism in the 1850s, 1860s, and 1870s, the boast would have been defensible.

  An adviser to statesmen, notably the Liberal parliamentarian and long-serving prime minister William E. Gladstone, he himself failed to win election to Parliament in three attempts. Nor did he make a fortune in the City of London. His writing is what secured his reputation, and it certainly won my admiration. Forty years ago, I discovered bound copies of the Economist from the Bagehot era on deposit at the New York Public Library. Bagehot’s articles, like everyone else’s in that newspaper, were unsigned, but his style was unmistakable. His output astounded me—5,000 words a week at least, and each word placed just where it should be. Was such a thing possible?

  Nevertheless, the reader will find that my Bagehot comes in for a certain amount of criticism. I spent three years in his biographical company, and have had my fill of his hauteur, his studied forgetfulness about forecasting errors, however understandable, and his embrace of the dubious notion, so corrosive to financial prudence, that the central bank has a special obligation to the ci
tizens who present themselves as borrowers and lenders, investors and speculators. No other class of person enjoys access to the government’s money machinery. On the credit side of the ledger—I draw up the assets and liabilities with a libertarian’s biases—Bagehot opposed the demand of aggrieved English bondholders that the British Foreign Office intervene on their behalf with the governments of defaulting states. As a financial journalist, the editor of the Economist possessed another, apolitical virtue: his paper was evidently incorruptible.

  Bagehot himself, like many in the age before antibiotics, was susceptible to bronchial disease—yet during the period of his worst illness, he produced his most celebrated work. In sickness or health, he wrote as few have ever written, before or since.

  PROLOGUE: “WITH DEVOURING FURY”

  The Panic of 1825 almost pushed Britain to the pre-banking dark age—to “within eight and forty hours of barter.”

  The remote cause of the upheaval was the great war with France. In 1797, four years after the start of hostilities, there was a run on Britain’s banks, including the Bank of England. The depositors demanded gold in exchange for paper pounds, which was their right, but King George III, Prime Minister William Pitt, and Pitt’s senior ministers judged it impossible. An Order in Council on the morning of Sunday, February 26, 1797, relieved the Bank of England of its obligation to pay gold coin in exchange for paper currency.

  The suspension was a stopgap; a subsequent act of Parliament ordered gold payments to resume within six months. But the war dragged on for another eighteen years, and the paper pound remained the functional coin of the realm for nearly another quarter century.

  The Panic was a consequence of this monetary experiment, and of the attempts at financial reform that followed the crisis.

  •••

  THE TWENTY-FIRST-CENTURY READER, accustomed not only to paper money but also to digital scrip—accustomed, too, to the institution of deposit insurance, and the idea that some banks are too big to be allowed to fail—will require some acclimation to this financial world. Following the paper-pound interregnum, money was gold; small change was silver. This was the monetary foundation, over which rose credit, the promise to pay money. The English house of credit, haphazardly designed, was prone to structural problems, and from time to time it nearly collapsed. The interplay between money and credit was the source of the recurrent cycles of boom and bust that bedeviled the nineteenth century—and continue to plague and mystify the twenty-first.

  There was no standard, uniform, nationally circulating paper currency at the time; many private banks, essentially unregulated, issued their own. In law, the bearer might present these notes to the issuing bank in exchange for a like amount of gold. In any case, such notes were not legal tender. Neither were the notes of the Bank of England. Gold was the only money that a creditor was bound to accept in payment of a debt.

  The institutions of nineteenth-century banking bear only small resemblance to their millennial descendants. The Bank of England was the hegemon: in contemporary American terms of reference, a cross between JPMorgan Chase and the Federal Reserve. It was the government’s bank but it belonged to its stockholders, conducting a private banking business while discharging a limited number of public duties. Up until the 1797 restriction of gold payments, and following the 1821 resumption of gold payments, the Bank’s one and only formal public obligation was to keep the gold value of the pound on an even keel—to make sure it did not significantly vary from the statutory, or Mint, price.

  The Bank was a monopoly, no better loved than a twenty-first-century cable TV provider. In London, no private institution was allowed to issue currency; that right was the Bank’s alone. And no English private bank, in or out of London, could organize itself with more than six shareholders. Only the Old Lady of Threadneedle Street—the Bank was an Old Lady even then, so depicted in 1797 in a famous cartoon by James Gillray*—was allowed to achieve a tolerable scale of operations.

  The shareholders of any bank bore considerable risks. The law regarded them as general partners, responsible for the solvency of the institution in which they owned a fractional interest; if their bank should fail, the owners were personally liable for its debts, “down to their last shilling and acre.” The depositor’s only security against loss was the prudence of his bankers and the assessable wealth of the bank’s shareholders.

  Wealth was measured in pounds, shillings, and pence. Twenty shillings, or 240 pence, made a pound; 240 silver pence, properly struck, weighed a pound. By the 1820s, Britain was formally on the gold standard, no longer the century-old mixed, bimetallic standard of gold and silver. A pound was defined in law as 123¼ grains of 22-carat gold. Three pounds, seventeen shillings and ten and one-half pence, expressed £3 17s 10½ d, was exchangeable for an ounce of gold.

  At the outbreak of war with France in 1793, £1 coins, called sovereigns, furnished the principal portion of the British money supply. Twenty to thirty million pounds’ worth was in circulation or under lock and key. The rest of the circulation was filled out by roughly £12 million in Bank of England notes and another £12 million in the notes of more than two hundred small private banks—including Stuckey’s.1 Vincent Stuckey, eponymous president of the small family bank, boasted that his customers, given the choice, would pick Stuckey’s notes over the Bank of England’s (which were easily counterfeited) or even over gold coins (which were sometimes short of standard weight).2 Even under the gold standard, many preferred portable paper to bulky metal.

  Still, the 1797 suspension of gold payments was a shock to the monetary system; to some it seemed a catastrophe. In 1798, the first full year of the suspension, British consumer prices actually declined, and it seemed as if the Bank were managing its issuance in accordance with the doctrines and signposts of the gold standard. But it later came to light, amid stiff inflation, that the Bank was not steering by the gold standard—neither by the relation of the quoted price of gold to the official Mint price, nor by the value of the pound against foreign currencies. By 1809, the gold value of the pound commanded not its customary 123¼ grains but only 113 grains. A parliamentary commission called the Bullion Committee resolved in 1810 “That the only certain and adequate security to be provided, against an Excess of a Paper Currency, and for maintaining the relative Value of the Circulating Medium of the Realm, is the legal Convertibility, upon demand, of all Paper Currency into lawful Coin of the Realm.” Parliament voted down that contention by a margin of two to one.

  After Waterloo came peace and—again—the monetary question: Should Britain return to gold? If so, when and at which gold value should the pound be set? Should it be the old familiar one or some new measure, adjusted for the myriad changes that war-induced finance had brought about?

  Years of easy money had facilitated many necessary and pleasant things: victory over Napoleon, high wages, high and rising crop prices. The English usury law capped interest rates at 5 percent, a respectable rate in times of stable prices, a cheap and bewitching one in times of hot inflation. Seizing that rate, squires had borrowed to expand their profitable farming operations, high wartime crop prices having furnished the profit. The government had borrowed to fund the war, running up a national debt of more than £800 million (compared to £247 million in 1793). Debtors wanted a cheaper pound, creditors a dearer one. Radicals—such as Thomas Atkinson, a Birmingham banker and crusader for monetary notions that only entered the public policy mainstream in the mid-twentieth century—made cause with the debtors, proposing the adoption of cheap silver, or much cheaper paper, in lieu of gold.

  The Atkinson radicals made no headway. Resumption of gold payments at some undetermined rate of exchange had been on the political agenda since the moment of the 1797 restriction. Resumption would re-anchor the value of sterling. It would, its proponents promised, restore banking discipline and furnish a check on public spending.

  It would also return the monetary antennae to working order. The option to convert paper into gold
, and gold into paper, was the sensory device of the monetary system, and the Old Lady was determined to give that device free play: “The Bank,” said one director, “are very desirous not to exercise any power, but to leave the Public to use the power which they possess, of returning Bank paper for bullion.”3

  A high and rising demand for coin would have told the Bank’s directors, if they’d been listening, that paper money was in oversupply. To set matters right, the Bank had to reduce its note issuance and raise its interest rate, in order to assure the note-holding public that its claims on gold were promptly payable.

  The gold standard was no mere domestic contrivance. In theory and practice, it integrated the economies of all who played by the gold standard rules. The first of these conventions was that gold should move freely across national boundaries. If, for instance, the metal bought more in France than it did in England, watchful people would collect gold sovereigns—those common £1 coins—melt them into ingots and ship them across the Channel. Losing gold, the banks—especially the Bank of England, whose job it was to defend convertibility—would curtail lending. As credit tightened, commercial activity would stall. To raise cash, merchants would sell whatever they could. Prices and wages would fall. They would not fall indefinitely, because the very decline in domestic prices and wages would make England a more desirable destination for foreign capital. The pound, its purchasing power restored, would appreciate against the currencies of Britain’s trading partners. Gold would retrace its steps back to Britain. Such movements of gold and credit, with minimal direction by governments and central banks, served to balance the accounts of one gold-standard nation with another and to stabilize prices across national boundaries. The adjustments were irksome but salutary.