by James Grant
It was in a style more didactic than Bagehot’s, though with a sentiment identical to his, that the article concluded: “People who lend to States like Spain and Turkey and Egypt deserve to lose their money, and the clever people who think they will go in for a little time and get out before the crisis comes are among the most likely to lose.”18
The clever people seemed unconvinced: preparations were soon under way for a mammoth new Egyptian loan. In 1868 the Khedive had pledged to issue no new bonds for five years, though he continued his heavy borrowing through other channels. On the dot of the fifth year, Egypt and its bankers returned to the City of London.
With the new Egyptian debt prospectus lying open before it, the Economist passed critical judgment. The country was still “semi-barbarous,” the Khedive was his unregenerate self, and his illiterate people were still borne down by taxes. As for the merits of the pending bond issue, “incessant borrowings have been necessary for many years to pay the interest on an always augmenting debt; the revenue is now so deeply pledged that the debt charge can only be paid with more borrowings.” The Economist was pleased by reports that the public was giving the bonds a wide berth.
Those securities proved, indeed, a hard sell, though they were immensely lucrative to the promoters, who presented old, heavily discounted Egyptian securities—available in the market at a price of 63—as scrip with which to buy quantities of new bonds, accepted at a value of 93. The dealers resold at a handsome profit to whatever remnant of clever people remained in the game. So it was that the Egyptian government realized a net cash receipt of only £11,750,000‡ on the sale of securities that bore a face value of £32 million. “The annals of State loans probably record no operation so ruinous for the borrower, or so profitable for the lenders and their friends as this,” was the judgment of one eyewitness to the disaster, J. Carlile McCoan, author of Egypt Under Ismail.
SUPPOSEDLY BANKRUPT FOREIGN GOVERNMENTS would find the means to pay if the British lion would only growl at them. So contended an element of unhappy English creditors. In 1868, the Economist commended George Goschen for urging the British government not to become an international debt collector. Goschen, then thirty-seven, a rising Liberal MP for the City of London and a former director of the Bank of England, was addressing what would prove to be the nucleus of a contemplated Corporation of Foreign Bondholders. The founders envisioned an organization to prod sovereign states to honor their commitments to English investors. The role of the British government in this useful work was the question on Goschen’s mind; there would be no harm in Whitehall using its good offices to advocate fair dealing, he said. Government-to-government coercion was another matter. “We should be damaged by the result of the meeting held today,” Goschen told the investors,
if it went forth that the meeting have endorsed the view that it is the duty of the English Government to compel foreign Governments to pay the debts incurred to English subjects. If the Government were to go to war for such a purpose with Venezuela, they would involve themselves in this position—that if larger Powers should act in the same way, they should also go to war with them. I think it is dangerous to have the idea go forth that when an Englishman lends money to a foreign Government he is creating a national obligation, guaranteed by the full weight of the English Government. The Englishman lends his money to a foreign Government, and gets a high rate of interest, because he incurs a risk.
Amen, said the Economist, adding the point that no one would know what a bond was really worth if the navy of the bondholder’s government was forever on call to settle contractual disputes.
By 1876, the Corporation of Foreign Bondholders, now in its third year, was able to count seventeen defaulting borrowers. Among them were the ones on which the Economist had so presciently harped—Honduras, Santo Domingo, Peru, Paraguay, Bolivia, Turkey. The last-named was far and away the greatest of these truants, owing £197.3 million. Its default, formally acknowledged on October 7, 1875—it had been paying 18 percent to borrow the funds with which to keep current on interest to its foreign creditors—roiled the overseas loan market, especially the Egyptian branch.
Later in October, English holders of Turkish debt, under the Corporation’s aegis, gathered to sound off and to chart a negotiating strategy with the authorities in Constantinople. Someone asked if the British government should not press the Turks to honor their engagements, “for was it not something that the interests of thousands of families should be imperiled?” The question drew cheers. Others, echoing the demand for official British intervention, recalled England’s sacrifices on behalf of Turkey during the Crimean War, or invoked long-ago testimonials to Turkish financial solidity by Lord Palmerston and Lord Russell. And when J. Carlile McCoan, a self-described eighteen-year resident of Turkey—and, probably, the author of Egypt under Ismail—rose to berate the Turkish government for its corruption and insolvency and to marvel at the ignorance of the British press in its coverage of Turkish affairs,§ he was shouted down. “He’s a bear,” the bondholders cried.
Bagehot was at least as bearish as McCoan. Commenting on the default (“The event will not surprise our readers”),19 the Economist batted away the notion that the government owed a duty to the gullible bondholders:
We cannot as a nation undertake to make foreign Governments perform their contracts to individuals; and the promise to pay particular persons first out of particular funds is but one of such contracts. If we once begin to interfere in such matters, the loan dealers of Europe will soon manufacture enough first mortgages to give us incessant employment.20
The Turkish default marked the end of an era in the English overseas loan market as well as a milestone for the Economist. Bagehot had carried the bearish torch for years, and collapsing prices for Central and South American debt had repeatedly proven him right. Now his vindication was nearly complete. One thing still puzzled him, however: “we still find it difficult to explain how the Turkish collapse did not come long ago.”21
AT ABOUT THE TIME that Turkey admitted its inability to pay its creditors all that was due them, the Egyptian treasury was struggling to meet its December 1875 interest payments; not even a proffered 20 percent interest rate could bring forth the necessary funds.22 Competing consortia of bankers in Paris and Alexandria proposed various exorbitant terms for a kind of margin loan: the Khedive would borrow £3 million to £4 million on the security of the government’s holdings of shares in the Suez Canal Company (Egypt owned some 177,000 shares out of a total of 400,000). The Khedive blew hot and cold on the terms, as he did on the French bankers. The conditions were punitive, but his need was great.
It was not Bagehot but another English journalist, Frederick Greenwood, editor of the Pall Mall Gazette, who, on November 15, alerted the British Foreign Office to the state of things in Egypt. Here was the chance to secure Britain’s sea lane to India, Greenwood urged the foreign secretary, Lord Stanley, 15th Earl of Derby.¶ The available shares would confer no outright control but would at least deny that strategic advantage to the French. Benjamin Disraeli, by now prime minister—he had defeated Gladstone in the general election of 1874—was of the same mind.
It took just ten days from Greenwood’s call to action for the cabinet to approve the purchase. On November 24, Disraeli wired his bid to the Khedive: £4 million for the outright purchase of 177,000 shares (or, as the figures finally fell out, £3,976,583 for 176,602 shares). The deal was done, though the government had nothing like £4 million in the bank. Disraeli dispatched his private secretary, Montagu Corry, to call on the banker Baron Lionel de Rothschild.
“Rothschild,” as Corry reminisced, “picked up a muscatel grape, ate it, threw away the skin, and said deliberately, ‘What is your security.’ ‘The British Government.’ ‘You shall have it.’” Whatever the literal truth of this story, shares and money changed hands, and Parliament—which was not sitting when Disraeli leapt into action—voted to ratify the transaction.
“It is just settled,” Disraeli
wrote to Queen Victoria:
you have it, Madam. The French Government has been out-generaled. They tried too much, offering loans at an usurious rate, and with conditions which would have virtually given them the government of Egypt. The Khedive, in despair and disgust, offered your Majesty’s Government to purchase his shares outright.
Four millions sterling! and almost immediately. There was only one firm that could do it—Rothschilds. They behaved admirably; advanced the money at a low rate, and the entire interest of the Khedive is now yours, Madam.
Announcement of the purchase secured for Disraeli more than the approval of his countrymen: it also won him the intense, if momentary, gratitude of the suffering holders of Egyptian debt, not least that of the French Crédit Foncier, a state-chartered mortgage bank shockingly caught out holding £6.7 million of Egyptian treasury bills against stockholders’ equity of £l.8 million. The Turkish default had opened a trapdoor under the prices of the Khedive’s bonds. Britain’s investment in the Suez Canal Company shares could be read not only as a shrewd investment, which it proved to be, but also as a wedge for Western influence in Egyptian financial affairs, which it likewise became.
But these constructive influences—constructive, at least, from the Western vantage point—would play out over the course of years. At that moment, the Khedive and his government continued to careen toward default. The first, partial suspension of interest payments came on April 6, 1876.
The Economist had opposed Britain’s purchase of the Canal Company shares on the grounds that it would lead to entanglements neither Disraeli nor his government could anticipate—and so it did. By and by, France and Britain dispatched, respectively, M. Joubert and George Goschen to Egypt to draw up a plan for financial reform. (The Goschen family investment bank, Fruhling and Goschen, had marketed at least one of the Egyptian issues in London.) Their recommendations gave rise to European control of Egyptian fiscal affairs, European military and naval intervention—including, in 1882, the bombardment of Alexandria by a flotilla of Royal Navy ironclads to beat back an Egyptian nationalist uprising against the then incumbent Khedive and his friends, the foreign bankers—and, at length, long after Bagehot’s death, the temporary British occupation that, under Evelyn Baring, 1st Earl of Cromer, became a thinly veiled British protectorate.
Reflecting on the glittery appeal of Egyptian investments in 1876, the Economist posited what might fairly be termed “Bagehot’s law of 15 percent”:
the human mind likes 15 percent; it likes things which promise much, which seem to bring large gains very close, which somehow excite sentiment and interest the imagination. The manufacturers of “financial schemes” know this, and live by it. A long and painful experience is necessary to teach men that “15 percent” is dangerous; that new and showy schemes are to be distrusted; that the popular instinct on them is essentially fallible, and tends to prefer the brilliant policy above the sound—that which promises much and pays nothing, above that which, promising but little, pays that little.
As the John Bull of Bagehot’s day could not stand 2 percent, neither could he seize the chimera of 15 percent. Nor can his modern descendants.
* “Third world,” “lesser developed countries,” “developing countries,” and (most recently and optimistically) “emerging markets” are the successor labels of the late twentieth and early twenty-first centuries.
† Ismail, the Khedive of Egypt, spent lavishly on the journalists he hoped to influence, including the gift of an all-expense-paid junket to attend the opening of the Suez Canal in 1869. It appears that Bagehot did not avail himself of this hospitality. It is impossible to prove it, but the strongest circumstantial evidence suggests that neither he nor the Economist was ever for sale. J. Carlile McCoan, Egypt Under Ismail: A Romance of History (London: Chapman and Hall, 1889), 104.
‡ Estimates varied widely, even within the same source; page 208 of McCoan’s book states that Egypt realized £17 million out of the £32 million nominal value. In either case, the adjectives “ruinous” and “profitable” would seem to be well chosen.
§ The Economist and the Money Market Review each published a comment on prospects for Turkey’s debt in issues dated September 19, 1874. Those prospects, according to the Review, were bright and brightening, as the Turkish government was shifting responsibility for administering state revenue to the Ottoman Bank. Alluding to a rally in Turkish bond prices from the lows of 1873, the paper made bold to declare, “It should be borne in mind that the tendency of Turkish Securities is unmistakably upward.” The Economist, while conceding that the reform was better than nothing, concluded that Turkish and Egyptian securities remained the speculative playthings they had always been. An advertisement for a new issue of Turkish debt appeared in the September 19 issue of the Review. There was no such ad in the Economist.
¶ The 15th Earl of Derby and son of Edward Smith-Stanley, the 14th Earl of Derby, in whose three governments in the 1850s and 1860s Disraeli had served as chancellor.
CHAPTER 16
GOVERNMENT BEARS THE COST
In 1865 the financial thinker and doer George W. Norman took the trouble to commit to paper the monetary views of the editor of the Economist and to contrast those opinions with his own. It was a mark of respect for Bagehot, as Norman was one of the grand old men of English monetary matters. A long-serving director of the Bank of England, he had joined the Court of Directors in 1821 at the age of twenty-eight. His nonpecuniary interests ranged from cricket to the language and literature of Norway, which he had studied while making his fortune in the family timber business, to Saxon archeology and the English poor laws. Bagehot and he likely exchanged ideas at the Political Economy Club, of which Norman was a founding member. They no doubt conferred on the topics that Norman addressed in his occasional contributions to the Economist. Still, two of England’s most formidable monetary thinkers could not seem to agree on what money was.
According to Norman, Bagehot believed that nothing was money but gold and silver. Was not paper money also money? Bagehot denied it, absolutely. Norman just as insistently affirmed it, fixing on an etymological proof: the “universality” of the words “paper money.” The phrase could be found in “all languages.”
If gold and silver alone were money, it followed that bank notes, even the notes of the Bank of England, must be something other than money. To Bagehot, they were only credit instruments—promises to pay money, like personal checks or bills of exchange. He likewise held that “as a necessary consequence . . . any interference on the part of the state with the issue of bank notes as pernicious, and would leave every individual and corporation free to issue, and make use of such instruments as they might deem most conducive to their own interest.”
So, in Bagehot’s view, the doors to the banking business should be flung wide open; let anybody try his hand at taking deposits, issuing notes, and extending credit. It amazed Norman that someone so smart could be so wrong. Because bank notes were money, the older man was quite certain, not just anybody should be allowed to circulate them, certainly not any hole-in-the-wall country banker. Money was the government’s business, or the business of the government’s central bank. The value of notes in circulation should vary as “the metallic money which would be required to supply their place might vary.” In the best of all worlds, there would be just one bank of issue, the Bank of England. Alas, that was politically impossible; the note-issuing English country bankers would never stand for it. So England must make do with the second-best solution, which had, indeed, become the law in 1844. The Bank Charter Act capped the size of the country circulation and denied the right of issuance to newly formed banks, to banks that had ever failed to redeem their notes in gold, and to banks of issue that had entered into a merger.
Bagehot’s ideal was one of numerous competing banks of issue, all well managed and amply capitalized, “each keeping its own reserves and able to meet at any time the claims of note holders as well as its other liabilities.” It was
a pipe dream, Norman said. England had had its innumerable country issuers, and a quarter of them had gone to the wall in 1825. America still had its myriad currency-emitting banks, which competed to print, issue, and, inevitably, overissue their own functionally inconvertible scrip.
Norman and Bagehot naturally found themselves on opposite sides of the perpetually contentious question of the Act of 1844. It seemed not to matter to Norman that he was writing a memo to himself; he defended the law with all the vehemence of one who shared its intellectual paternity. The act was successful, Norman averred, because it achieved its authors’ intention—his and Lord Overstone’s—of removing any doubt that the pound was convertible into gold at the fixed and inviolable rate of £3 17s 9d to the ounce.
Norman made no attempt to deny that the English banking system was still subject to breakdown, Sir Robert Peel’s law notwithstanding. In 1847, the railroad bubble had burst. In 1857, the American banks had stopped payment. And yes, in response to those crises, chancellors of the exchequer had overridden the 1844 Act to allow for an extralegal emission of Bank of England notes. Only after the panic subsided was the law reinstated.
These perhaps regrettable interventions were chargeable not to the act, but to human nature, Norman wrote to himself: “no conceivable arrangements as to the supply and arrangements of the currency can obviate all or indeed many of the evils which arise from the cupidity, the folly and the ignorance of mankind.” Ricardo, too, had concluded that legislation was powerless against a panic.