Bagehot Page 2
Still, monetary virtue, like many another kind, was more popular in the abstract than in the living moment, and not a few bankers were attached to the paper pound. The gold standard clipped their wings.
IN PARLIAMENTARY HEARINGS AFTER the dust of the 1825 panic had settled, an inquisitor asked a former governor of the Bank of England about the nature of the business in which he and his brother directors were engaged. Is not “the essence of banking,” came the question, that a man “issues promises which it is universally known by the takers of those promises that he cannot fulfill?” The witness, John B. Richards, hedged, but the short and correct answer would have been, “Sometimes, yes.”4
Accidents occurred in banking, just as they did on the newfangled railroads. The bankers, like the engineers wrestling with steam power, were only just beginning to understand the risks and power of the forces they were attempting to harness. In banking, though, accidents came in clusters. Bank runs, unlike train wrecks, were contagious.5
Cascading mishaps are in part owing to the nature of banking. Even the most liquid institution would be hard-pressed to return every shilling to every depositor if all came running at once. But the particular nature of English banking was another source of distress. The banking business in the early nineteenth century was stunted by the law that no more than six partners could share ownership of a single institution. Nor were the half dozen invariably informed, attentive, or proficient. Vincent Stuckey disparaged the quality of his country competition: “they lent their property on very inadequate security,” he testified, “and we have seen the unfortunate result in many instances.”
Stuckey’s criticism of the banking profession might have almost passed for praise six years later. The Times, assigning blame for the 1825 panic even while it raged, charged that “In large Provincial towns, certainly, the word Bank makes a showy figure, and is placed over a respectable structure; but we have known cases in which the word Dairy, or Cheese-Room, would be a much more suitable description of the tenements from which so great a proportion of the circulating medium of England issues, than that of a Bank.”6
But the Bank of England itself was no model of managerial competence. The merchants, insurance underwriters, industrialists, ship owners, and mining executives who oversaw the direction of the Bank—no commercial bankers were allowed—lacked neither intelligence nor business experience, and over the course of a twenty- or thirty-year tenure they did develop banking experience. However, as to the day-to-day business of lending and deposit-taking, not to mention the more rarefied work of crisis management, they had to learn on the job.7 When the House of Commons registered its lack of confidence in the Bank in 1819, it was not “from any doubt of its wealth, or integrity, but from a conviction of its total ignorance of the principles of political economy.”8
WHEN THE SHOOTING STOPS, governments reduce the pace of their spending and borrowing. Shipyards and munitions makers lay off workers, who compete for peacetime employment with demobilized soldiers and sailors. War-inflated prices and wages start falling—or, to say the same thing, the value of money starts rising.
In England, many regretted the transformation. The country had had twenty years to adapt to the paper pound. Debtors in particular had welcomed it, as the money they owed had become easier to obtain than the money they had borrowed. Farmers, industrialists, wage-earners, and merchants had all come to terms with the new inflated state of things. At the end of the war, England resembled a middle-aged man who finds he can no longer fit into an old pair of trousers. He must either lose weight or see his tailor.
Should Parliament validate the wartime inflation by redefining the pound as a lighter weight of gold? Or reaffirm the inviolability of the pound by sticking to the old standard of £3 17s 10½ d? Something had to give: either the value of money or the wartime level of prices and wages.
Sir Robert Peel, a rich factory owner and father of a rising Tory politician—also Sir Robert Peel—pushed hard for the adjustment to fall on the pound, not prices. The Bank of England took the same side.
Opposing them were the young Sir Robert, chairman of the House of Commons committee investigating the monetary question, and David Ricardo, Parliament’s trusted voice on economic questions. The economist expected no difficulty in resuming gold convertibility at the old rate: a decline of 3 percent in prices and wages should do the trick. It would not come close to doing the trick, countered Hundson Gurney, MP for Norwich and a non-economist but a member of the Royal Society and heir to a Quaker banking fortune. Prices would have to fall by as much as 20 percent, Gurney predicted.
Young Sir Robert got his way—in 1819, Parliament voted to return to gold at the prewar rate, with the transition occurring in stages, starting in 1821—but the critics proved the wise ones. Britain’s gross domestic product, as historians piece it together, reached a postwar peak of £462 million in 1818 and proceeded to plunge. At the bottom of the business cycle in 1822, it registered £399 million. The hard times left deep scars. On August 16, 1819, at St. Peter’s Field, Manchester, tens of thousands gathered to protest against a system of parliamentary representation that left hungry and jobless Britons politically mute. When the people refused to disperse, a pair of local cavalry units, green and excitable, charged them with sabers drawn. Fifteen civilians were killed, including a mother of seven, a two-year-old boy, and a veteran of the Battle of Waterloo. Five hundred more were hurt. “Peterloo,” the citizens of Manchester bitterly called the massacre.
Low grain prices, a transatlantic depression, high unemployment, and tight money sent up a clamor for relief. Heeding the call, the Bank of England, with encouraging prods by the government, took steps to make credit cheaper and more abundant.
On June 20, 1822, came a laconically worded announcement of the first adjustment to the discount, or lending, rate of the Bank of England to take place in more than a century. “Resolved,” read the text in its entirety: “That Bills and Notes approved in the usual manner, and not having more than 95 days to run, be discounted at the rate of 4 per cent. on and after the 21st of June 1822.” The rate had not wavered from 5 percent since 1719.
Changes almost as historically momentous followed. In May 1823, the Bank announced its intention to lend against mortgage collateral. In September it widened the class of assets against which it was prepared to lend to include government securities and shares of the Bank of England itself. A stockholder-owned business, the Bank needed profits, and its mainstay line of commercial lending was not supplying them.†
TO RESTORE BRITISH MONETARY affairs to prewar trim meant a wider circulation of gold coins and a smaller issuance of currency; the country banks’ £1 and £5 notes, especially, were on the chopping block. But the push to boost lending—and thus, it was hoped, spread prosperity—caused the government to backtrack. In 1822, Parliament enacted legislation to allow the banks to continue to emit small-denomination notes through 1833.9 These reflationary policies bore fruit, as prices, wages, and national output recovered from the depression lows of 1822. Princess Lieven, wife of the Russian ambassador to Britain, sensed that something new and cheerful was in the wind. “I have lived in this country for eleven years,” she wrote to Prince Metternich in Vienna in August 1823, “and for the first time I hear no grumbling.”
Falling bond yields contributed to the high spirits. The British Treasury had borrowed at high rates of interest during the war, and now refinanced at lower rates. In 1823 it exchanged a 5 percent issue for one paying 4 percent, and, in 1824, a 4 percent issue for one paying 3½ percent. In response to falling interest rates, securities prices rallied. Savers abandoned safe, sane—and now low-yielding—gilt-edged securities for the high-yielding alternatives.
Alternatives abounded in South America. As the armies of Simón Bolívar pushed Spain and Portugal out of the New World, British capital, encouraged by the foreign secretary, Lord Canning, came rushing in. In 1822, the brand-new republics of Chile, Colombia, and Peru raised £3.4 million in London at
rates of interest more than double the yield available on sovereign British debt. Brazil, Buenos Aires (then a sovereign borrower), Mexico, and Guatemala followed in 1824 and 1825.10 Also in 1822, a Scots adventurer named Gregor MacGregor succeeded in borrowing £200,000 at 6 percent on behalf of a supposed Principality of Poyais, situated in what today is Belize. The country was a fraud and MacGregor was a fabulist.
Whatever else the Bank’s and the government’s policies achieved, they quelled the long-running monetary controversy. The gold pound was back, and people rushed to invest it. The Liverpool and Manchester Railway, organized in 1823 as the first British steam-powered line to provide intercity passenger service, found seed capital. So did a less promising £1 million scheme to plant mulberry trees in order to propagate silkworm culture.11 The teenaged Benjamin Disraeli quit his legal training to write purple marketing copy for South American mining promotions. Foreign governments and domestic joint-stock companies raised £42.9 million in the London capital markets in 1824 and 1825—not much less than the combined market value of all listed equities on the London exchange in December 1825.12 “There never was a period in the history of this country,” declared the Lord Chancellor, reading the King’s Speech at the opening of Parliament in February 1825, “when all the great interests of the nation were at the same time in so thriving a condition, or when a feeling of content and satisfaction was more widely diffused through all classes of the British people.”13
Arthur Wellesley, 1st Duke of Wellington, dissented from the royal view. He warned the diarist Harriet Arbuthnot in March that “all the companies are bubbles invented for stockjobbing purposes & that there will be a general crash, which [would] be almost as fatal as the failure of [John] Law’s schemes.” Law, as the Duke’s contemporaries were well aware, was the Scottish adventurer whose monetary innovations first inflated, then deflated, Regency France a century earlier.
It was a point in Wellington’s favor that “the foreign exchanges” were adverse —the Bank of England was paying out more gold than it was taking in. Between October 1824 and November 1825, £7.5 million’s worth of coins and bars left the Bank,14 or 62.5 percent of the treasure that the Old Lady’s vaults had held as recently as 1821. In July 1825, Vincent Stuckey found it singular and worrying that the ship on which he was crossing the English Channel was carrying almost £1 million of sovereigns earmarked for French buyers.15 Money left England in loans to foreign governments, in payment for shares in South American mining speculations, in exchange for commodities—for there was a bull market in produce as well as in bonds and shares.16 The loss of gold was public proof that the Bank had lent too much or that the interest rate it charged was too low, or both.
In Bristol, in June 1825, Frederick Jones presented himself at the Castle Bank, handed six £1 Castle notes to the clerk, and demanded six gold sovereigns in exchange. The clerk, refusing, offered notes of the Bank of England instead. Jones turned on his heel, left, and returned with £45 of Castle Bank paper for which he again demanded the gold equivalent. Again he was refused. Incensed, Jones took his case to Joseph Hume, his MP, who presented it to the House of Commons. The treatment of his constituent by the Bristol bank was no isolated insult, Hume contended, but a “disgraceful and growing evil”17—and grow it did.
By mid-July, bankers all over the country were denying accommodation to loan applicants accustomed to hearing a cheerful “yes.” By the end of July, the Bank of England had restricted lending against the unimpeachable collateral of British government securities. In September, the country banks began to turn away applications for loans against the all too impeachable collateral of South American bonds. The Plymouth Bank stopped payment altogether in late November.‡ There was a spate of failures across the West Country.
On December 12, the crisis shook London. Pole, Thornton & Co., the London correspondent for more than forty country banks, had been stretching to earn the extra income that safe investments never pay.§ Not even a £300,000 advance from the Bank of England, whose directors gathered on a Sunday morning to discuss the situation,18 could save it.
Now crowds replaced Frederick Jones at the counter of the Castle Bank in Bristol. The notes of local banks, so readily accepted in boom times, were money no longer. Frightened people demanded cash, meaning gold, and the notes of the Bank of England. To obtain them, country bankers trooped to London to beseech their correspondents or the haggard Bank clerks, bringing gilt-edged British securities, exchequer bills, prime commercial bills, and first mortgages to offer in exchange for cash. The quality of the collateral was pristine—but there was, simply, no cash to be had.
To get gold—to bring it in from abroad and shake it from the grasp of frightened Englishmen—the Bank returned its discount rate to 5 percent. A certain “eminent capitalist,” perhaps Nathan Rothschild, imported £300,000 of sovereigns, which he deposited at the Bank of England. The exchanges began to turn in favor of the pound, but not fast enough.
Would the government not lift a finger to help? It would not, said Lord Liverpool, espousing faith in the curative properties of markets.19 The directors of the Bank of England acted to push the healing processes along, and lent against the shares of their own institution and against the bonds of the British Treasury, classes of securities they had previously held to be ineligible for discount. The volume of their discounts—that is, funds advanced against collateral—had jumped from £7.5 million on December 8 to £11.5 million on December 15 and to £15 million on December 29.20
The demand for sovereigns seemed insatiable; the Royal Mint, working nonstop, was unable to keep up. The Bank of England’s £1 notes were as good as sovereigns, though none had been printed for many years and, for all anyone seemed to know, no adequate supply existed. It was therefore a godsend when the Bank discovered a sizable cache of previously unissued £1 notes, precious pieces of paper that the clerks duly started handing out.21
No formal announcement told the public that the Bank was relaxing monetary policy; it fell to the press and the financial community to sense that things had changed. “[N]ot only liberal, but profuse,” The Times characterized the Bank’s new M.O. In subsequent parliamentary testimony, Bank of England directors revealed that they had lent against merchandise—not securities but goods themselves—and the most marginal categories of commercial bill.
The Bank, a profit-making institution with some definite but indistinct obligation to help in times of crisis, was stretched thin. No government guarantees were in place to save it should it suffer a debilitating loss,22 and its gold reserve was being fast depleted. Its staff worked through the night so they could be ready to distribute signed notes to clamoring customers the next day. The Bank had suspended gold convertibility in 1797. In the third week of December 1825, it was rumored that the Old Lady had only 60,000 sovereigns to her name.
“The evil will cure itself,” Liverpool had prophesied, and so it did—with more than a little help from the Bank. The crisis subsided just before Christmas. Even at the worst of the December panic, the pound had held its own on the foreign exchanges; it was the English people, the Frederick Joneses—not the foreigners—who ran on the banks.
There had been 770 banks in England before the panic; seventy-three failed. To prevent a recurrence of the disaster, Parliament, in May 1826, enacted a law to allow joint-stock banks the freedom to expand beyond a 65-mile radius of London (provided they had no office in the capital city) and to permit them any number of partners they wished.
Stuckey’s was among the first to avail itself of the new freedom to expand, counting twelve partners and fourteen branch offices by 1832. The crash had brought the number of Bristol banks down from ten to five, and before long, the premises of the now-shuttered Castle Bank housed the Bristol office of Stuckey’s Banking Company. The Panic of 1825, the undoing of so many, was the making of the enterprising Vincent Stuckey. It would likewise furnish an important case study for any who would delve into the workings of the British financial system—for o
ne, Stuckey’s nephew, Walter Bagehot.
* In the drawing, a suitor, William Pitt the Younger, the prime minister of Great Britain, is wooing a woman of a certain age who has seated herself on a money chest. She—which is to say, the Bank of England—is properly suspicious of his advances. To wage his war with France, gold is what Pitt needs and doesn’t have.
† Mortgage lending, in particular, represented a radical turn in policy. The asset of choice for any well-tempered bank was the short-dated commercial IOU. Cash changed hands at the end of its brief life more or less automatically. There was no such assured liquidity in a mortgage, which took years to mature. And when a mortgage did fall due, there could be no guarantee that the property that secured its value could find a buyer. If a central bank prizes liquidity, it should confine its investments to self-liquidating assets and gold, no matter the temptation to earn a higher yield. This doctrine the Bank laid aside. L. S. Presnell, Country Banking in the Industrial Revolution (Oxford: Clarendon Press, 1956), 477–79.
‡ The Plymouth Bank went wrong by lending against illiquid mortgages, the Morning Chronicle reported. “It would have been well if the Bank of England had not set the example of this mode of extending the paper circulation.” Morning Chronicle, November 30, 1825.
§ The Times’s post mortem read in part: “The decline of this house in credit is generally attributed to the anxiety felt by the partners at the time when the rate of interest was low, to make a profitable use of their capital, and hence they were led to employ it on securities capable of being realized only at a distant period, or of an inferior degree of credit.”
BAGEHOT
CHAPTER 1
“LARGE, WILD, FIERY, BLACK”
Walter Bagehot was born on February 3, 1826, in the West Country market town of Langport, in the county of Somerset, England. Bank House, on Cheapside, part of the main street in Langport, was the family residence as well as his birthplace. Immediately adjacent was Stuckey’s Banking Company, otherwise known as S & G Stuckey & Co., which employed Walter’s father. It was said in later years that the townspeople could set their clocks by Mr. Bagehot’s arrival at work in the morning.