by James Grant
The contest for gold was a test of national determination. To compete in times of monetary pressure, Britain had to tolerate high interest rates. Lord Overstone, the monetary moralist of the age, writing as “Mercator” in The Times in January 1857, posed a challenge: “Is England, then, the country which is unable or unwilling to pay the rate of interest which in a temporary emergency may become requisite for retaining the amount of capital proportioned to the extent of her engagements . . . ? [W]eakness and irresolution in the hour of trial always prove false friends to those who foolishly place reliance in them. They lead not to honor or to safety, but are the fatal guide to disgrace and danger.”7 The Bank of England exhibited no weakness or irresolution as the crisis unfolded; correctly anticipating the arrival of the American hurricane, it raised its rate to 6 percent from 5.5 percent on October 8.
A timely rise in the rate of interest is “the only means” of keeping panic at bay, the Economist judged.8 Still higher interest rates were imminent. Mitigating this fact was the abundant harvest; there would be no need to ship gold abroad to pay for imported grain. Then, too, said the Economist, the blessings of the earth went far to “repair much of the mischief to which folly and inordinate cupidity have exposed the trading community”—for there had been premonitory financial rumblings in 1856.9 The Bank of England’s next move, then, could hardly have shocked the City of London, though the bankers and the brokers were evidently not expecting the full-percentage-point hammer that fell on October 12. The Economist called for calm. No feature of the situation, certainly not a 7 percent discount rate, justified panic.10
Another percentage-point rise in the discount rate, to 8 percent on October 19, moved the Economist to remark on the “calmness and confidence” with which the country was meeting the highest interest rates in ten years. “Everybody,” the paper contended, “feels that the general trade of the country is sound, and that a pressure which arises almost exclusively from foreign influences cannot be of prolonged duration.” Nor was the distress—such as it was—without its compensations. When tightening credit forced speculators to unload the sugar and tallow that they had been withholding from the market in hopes of higher prices, consumers were the gainers. Wilson believed that monetary panics and commercial crises sprang from human nature; public policy could only do so much to allay them. There had been crashes and crises under systems of both protection and free trade, under paper money and gold, and both before and after passage of the Bank Charter Act.*
Wilson’s journal was predisposed to take a confident and constructive editorial line. The founder and publisher, a rich man, was a member of the government, the right-hand man of the chancellor of the exchequer, Sir George Cornewall Lewis. Before taking up the seals of office in 1855, Sir George had edited the Edinburgh Review. He was an accomplished philologist and author of books including An Essay on the Influence of Authority in Matters of Opinion (1849) and the two-volume An Inquiry into the Credibility of the Early Roman History (1855).
In April 1857, Wilson asked his counsel: Would Sir George deem it useful for the Economist to publish some critical articles on the 1844 Bank Charter Act, now that that law was up for parliamentary review? Yes, please, Lewis replied—and “A Banker” promptly went to work on a three-part series exposing the weaknesses and fallacies of Peel’s prize monetary legislation.‡
More than just the principal monetary measure of Victorian Britain, Peel’s 1844 law was the most controversial. Proponents and detractors, Lord Overstone among the former and Wilson and Lewis notable among the latter, debated it throughout Bagehot’s lifetime and long after his death. If we consider the ideas central to the debate—discretion versus regulation in monetary management, the problem of moral hazard—the battle has raged to this day.
To secure the gold value of the pound was the monetary desideratum of the age. One might have supposed that the pound needed no such protection, as it was defined by a weight in gold. The wild card was credit, the promise to pay money, and here there was no such clarity. True, the law required that each and every issuer of bank notes, whether the Bank of England or private banks like Stuckey’s, stand ready to convert paper into gold and vice versa at the demand of the holder. What the law could not secure was coordination between the growth in paper claims, on the one hand, and the volume of gold with which to collateralize those claims—notes, bills, deposits—on the other. So the pound was as good as gold, provided that the banks of Liverpool or Glasgow or Langport or Bristol did not issue more paper claims than they had metal with which to make the required conversion. Most of the time, most Britons were happy with paper; only in a crisis did some of them clamor for the precious metal. As crises were relatively rare, the temptation was ever-present to lend and borrow beyond the limits of the metallic collateral.
It was the fearful drama of 1839, when only a timely loan from Paris saved the Bank of England from having to suspend gold payments, that had convinced Sir Robert of the need for reform. To safeguard the pound, he urged the House of Commons to control the emission of bank notes and to curtail the discretion of the directors of the Bank of England. Britons had had their fill of what Sir Robert described, in the peroration of his speech of May 6, 1844, as “the reckless speculation of some of the Joint Stock Banks, the losses entailed on their shareholders, the insolvency of so many private banks, the miserable amount of the dividends which have in many cases been paid, the ruin inflicted on innocent creditors, the shock to public and private credit . . .” To stop these recurrent spasms, as we have seen, the act split the Bank in two. In the Issue Department was vested authority to produce and distribute Bank of England notes and to exchange those notes for gold and vice versa; in the Banking Department, responsibility for conducting an everyday banking business. The division of the Bank was no mere administrative shuffle but a long and deeply considered monetary reform.
Samuel Jones Loyd, later Lord Overstone, was a strong and reasoned advocate of Sir Robert’s ideas (or Sir Robert of his, though Overstone insisted that he had never spoken with or even met the prime minister). Like Bagehot, thirty years his junior, Overstone was born above the premises of his family’s bank, Jones, Loyd & Co., which had been founded by Overstone’s father, Lewis Loyd, whose early training in the Unitarian ministry somehow put him on the path to becoming one of the richest men in Europe. By the 1820s, Jones, Loyd was generating annual profits exceeding £200,000, as much as ten times those of Stuckey’s.11 Overstone became a City nabob, far richer than Vincent Stuckey, let alone Stuckey’s brilliant nephew.
Overstone and Bagehot both wrote authoritatively on money and banking, often in opposition to each other; testament to the power of literary style is that posterity recalls only one of these forceful intellects. Overstone’s manner of speaking and writing was as dry and severe as Bagehot’s was conversational and epigrammatic. Reading the transcripts of Overstone’s voluminous parliamentary testimony, his pamphlets, or his cerebral “Mercator” letters to The Times, you can hardly imagine him smiling, even in the privacy of his grand estates (though some did attest to his lively wit). Bagehot’s bouncing essays might lead the reader to imagine that the man who wrote them could hardly stop smiling.
Overstone—like Bagehot, a clarifier of complex ideas—was among the first to identify the cycle of boom and bust, which he described in these words in 1837: “First we find it in a state of quiescence—next improvement,—growing confidence,—prosperity,—excitement,—overtrading,—convulsion,—pressure,—stagnation,—distress,—ending again in quiescence.” Later, in 1862, he elaborated:
Prosperity will generate excess, over-trading and over-production will cause a fall of prices, accompanied by temporary depression and despondency; this fall of prices will, in turn, check production, increase consumption, augment the exports, cause the precious metals to return to the country, the quantity of money will be thus increased, prices will again rise, and the country will in the end find itself very far removed from the verge of utter bankrup
tcy. Such is the “constant rotation of the unwearied wheel that Nature rides upon.”12
Overstone, once more like Bagehot, was a political Liberal, contending that the world, led by England, was ever improving in thought and material condition. Not least was the progress of the age apparent in monetary matters. The 1821 restoration of gold convertibility was one such mark of advancement; in Overstone’s mind, the 1844 Bank Charter Act was its companion piece. Under Sir Robert’s system, rules replaced discretion. The Issue Department of the Bank would run like a machine. It could circulate up to £14 million of notes against the collateral of British government securities. Beyond that sum, pound for pound, every note would be secured by gold. Of course, the Bank had competition in the note-issuing business; banks like Stuckey’s circulated their own. The act prohibited newly formed banks from copying the Stuckey’s business model, capped the amount that the grandfathered banks of issue might circulate, and ensured that a private bank would lose its note-printing privilege in case of a merger with another bank. All of this started the countdown to a future day on which the Bank of England would occupy the position of Britain’s sole bank of issue. Speed the day, said Overstone, who contended that the creation of money was the government’s business alone.13
Peel’s Act would redirect the Bank to its public obligations, unwritten though they were. The loss of gold to the Issue Department would set in motion a reciprocal contraction of the note issue. To protect its gold reserve, the Bank would be forced to raise its discount rate. By denying the management of the Bank its accustomed discretion in deciding when to act, the Peelites hoped to force early action—to nip a panic in the bud. “It is always wise,” said Overstone, “to submit to the inconvenience of early preventatives rather than incur the risk of a more distant but greater evil.”14 And indeed, in 1844, Peel broadly hinted that the changes would do more than protect the convertibility of the pound. They would, he said, spare the country future shocks “to public and private credit.”
Sir Robert foresaw neither the railway mania nor the Irish potato famine. It was to relieve the pounding pressure on British finance during the Panic of 1847 that the government of Lord John Russell suspended the 1844 Act; Sir Robert’s opponents gloated. But Overstone, called upon to defend the Act, conceded nothing. The convertibility of the pound had never been in doubt, even in the worst of the crisis, he was pleased to observe. Whether the bankers and the speculators had managed their affairs well or badly was beside the point.
Ten years later, Walter Bagehot joined the still-fierce debate. As “A Banker,” on the attack in Wilson’s pages, he charged Overstone with a failure to keep up with the times—“the enormous importance attached to the convertibility of the bank note, as distinguished from the stability of banks, is a relic of past times. The deposits are in truth the growing element in banking; they were very small in importance years ago . . .”15 The very rigidity of the rule that tied the hands of the Bank’s directors was problematical. “Where,” posed Bagehot, “are the rigid statesman to enforce the rigid rule?”16
IN THAT AUTUMN OF 1857, America’s crisis was fast becoming Britain’s. British investors held an estimated £80 million of American securities; American consumers absorbed between a fifth and a quarter of British exports.17 So shoulders sagged in the City of London on receipt of news in mid-September that sixty-two out of sixty-three banks in New York City had stopped paying gold to the depositors who had every right to demand it.§
The “foreign influences” to which the Economist was prepared to assign blame for the autumn’s financial disturbances could explain only so much of the mismanagement at the Borough Bank, Liverpool, and the Western Bank, Glasgow. Those were home-grown British disasters. The Borough’s losses would absorb every pound of its £940,000 capital. The Western Bank, likewise defunct, had the largest branch network in Scotland.18
The Western was a disaster long in the making. It had almost come to grief in 1834, two years after its founding, and would have failed in 1847 except for a £300,000 credit from the Bank of England. For the next ten years, it lent as if it were positively determined to fail. This it achieved in 1857, when it showed paid-in capital of £1.5 million and £5.3 million in deposits. How to Mismanage a Bank: A Review of the Western Bank of Scotland, an early example of the business case study, appeared in 1859.19
The Bank of England had wisely refused to lend to the Western, but, anticipating the too-big-to-fail doctrine of the twenty-first century, the wounded giant formulated a scheme to beg the government’s help anyway. The chancellor could hardly believe the bank’s presumption. It was an absurdity, Sir George wrote to Wilson: “If you hear of any such extravagant idea, pray put an immediate extinguisher upon it. The Government have no means of providing funds for banks which cannot pay their creditors.”¶
It wasn’t only the Scots who had overextended themselves: on October 28, the largest and seemingly most substantial of the London bill brokers, Overend, Gurney & Co., applied for accommodation to the Bank of England in the highly unusual form of a request for a blank check. Would the Bank furnish Gurney’s with anything and everything that it might presently require?20
Up went the Bank Rate to 9 percent from 8 percent on November 5. No more did people borrow because they needed money—they borrowed because they feared that there would soon be no money to borrow.21 George W. Norman, a director of the Bank, advised Overstone on November 5 on the developing crisis: “Exchanges are still unfavorable [i.e., gold continued to leave the country]—The pressure on the Bank heavy, and our Reserve uncomfortably low.”22
On November 9 came one final turn of the interest-rate screw, to 10 percent. It was an unprecedented and shocking rate for the City of London, but—so said The Times—hardly a ruinous one, nothing at all like the panic-induced lending rates of 24 percent or even 60 percent which were on offer in the United States. Indeed, the monetary system of Great Britain was nothing less than “perfect,” The Times contended, taking Overstone’s side of the argument, “and has upheld us in a position to command the admiration of the world.”23
Still, the structure of British credit bore every hallmark of human frailty. To a certain kind of reckless management, the protections that the law put in place to encourage sound practice and penalize incompetence and criminality—for instance, stockholders were at risk to the extent of their entire personal fortunes for their pro rata share of the debts of the firm in which they invested—seemed to have no effect. November 11 brought news of the failure of the City of Glasgow Bank, another supposed Scottish pillar, with capital of £1 million and ninety-six branches, as well as the fall of Sanderson, Sandeman & Co., a leading London discount house.
Bagehot had asked from whence the “rigid statesmen” would come to enforce Peel’s Act. They were not to be found in London. On November 12, Sir George C. Lewis signed a letter to suspend the Act of 1844 for the duration of the emergency; now the Bank could issue notes without regard to the adequacy of their gold cover. Relief was palpable, though it lacked the immediate curative power of the joy that had instantly greeted the signing of a similar letter ten years earlier. Still, the main force of the crisis was spent.
Eighty-five large firms, apart from banks, had failed in the two months preceding the suspension of Peel’s Act, and another fifty would fall before the end of the year. Employment, prices, and profits all bore the marks of what had begun to seem a crisis of morals as well as of judgment. The parliamentary committee that conducted the post-panic inquest fixed blame on “excessive speculation and abuse of credit.”24 Witnesses testified to cases of banks and merchants operating on next to no real capital. One failed merchant reportedly incurred liabilities of £900,000 on capital of less than £10,000.25 It galled Overstone and his friends to see the lucky, imprudent ones rejoice at their escape from the jaws of financial justice.26 The law had protected the integrity of the pound. It had not promoted the integrity of banks, discount houses, and bill brokers. “Is not this,” demanded Overston
e, “as much as can be reasonably expected from any monetary system?”**
Peel himself had agreed when his act had first been suspended, in 1847—as, indeed, had Overstone. As for this second abrogation of the law, a confidant of Overstone’s, the economist J. R. McCulloch, put the best face on it: “The Habeas Corpus Act has been frequently suspended, but still it is the best act in the Statute Book.”27 Neither did Bagehot and Wilson see anything to regret in the government’s action. As far as they were concerned, Peel’s Act served no useful purpose in tranquil times. In a panic it only incited the fear that the chancellor would refuse to sign a letter to suspend it.
Benjamin Disraeli, now a Tory MP, rose in Parliament a month after the suspension of the Bank Act to raise the question of moral hazard. “If,” he asked, “the House be prepared to sanction the exercise of this dispensing power at the arbitrary will of the Minister of the day, how does it propose to reconcile the difference of position between those firms who fall victims before the dispensing power is exercised and those, who, holding on a favored twenty-four hours, struck upon the clock of the Royal Exchange of London, are enabled to dominate over those with whom they ought to be fellow-victims?”28
BAGEHOT PRODUCED A REVIEW of the autumn upheaval almost before it had subsided. “The Monetary Crisis of 1857,” which appeared in the January issue of the National Review, featured the themes on which “A Banker” had harped in the pages of the Economist. The inadequacy of Britain’s gold reserve was one of these ideas,† the inadvisability of the concentration of that treasure in the basement of the Bank of England was another, the trouble with Peel’s Act a third. As was his wont, Bagehot advised against tilting at windmills. Yes, the Bank of England had thrown its weight around—overbearing monopolies usually did—but there was nothing to be done about that.29 “The use of parliamentary eloquence is not to bewail fixed habits, but to improve improvable habits.”30