Part II of Monetary History discussed the creation of paper currency, the advent of fractional reserve banking, and the bizarre concept of banks creating ‘money’ to loan to governments. This novel and absurd arrangement, however, had not yet been accepted as normal. Historically, the poster child for the institutionalization of this macabre racket is without question the Bank of England. The Bank of England (founded circa 1694) is commonly considered the mothership of modern central banking. Strictly speaking it was not created as such but evolved gradually (or perhaps mutated?) into the beast that it would become.
During his reign King Charles II (1660-1685) ran up huge amounts of debt. In 1672 he repudiated the debt, causing 10,000 depositors to lose their hard-earned savings and ruining the King’s credit in the process. Additionally, England was economically weakened following 50 plus years of war with France and various civil wars waged “largely over excessive taxation.”(1) By 1694 King William III and Parliament were keen to find another way to finance the ongoing war with France. As the solution, William III awarded wealthy Scottish trader, businessman, and financier William Patterson a Royal Charter to establish the Bank of England. It is noteworthy that this was accomplished via a lesser provision included in the Tunnage Act of 1694. (People of the day referred to the new bank as the ‘Tunnage Bank.’)(2) The Bank’s founders were to raise £1,200,000 in pledged capital to get things started, with this amount immediately being lent to the state.(3) Thus “a loan to the government was the occasion of the Bank’s founding.”(4) The politicians were able to finance their war with France and the bankers in turn were able to issue £1,200,000 worth of their own private notes.(5) G. Edward Griffin, commenting on the Bank of England’s founding, writes,
…what is usually omitted is the fact that, at the time the loan was made, only £720,000 had been invested, which means the bank ‘lent’ 66% more than it had on hand.(6)
In this first official act of the world’s first central bank can be seen the grand pretense that has characterized all those which have followed. The Bank pretended to make a loan but what it really did was to manufacture the money for government’s use. If the government had done this directly, the fiat nature of the currency would have been immediately recognized, and it probably would not have been accepted at full face value in payment for the expenses of war. By creating money through the banking system, however, the process became mystifying to the general public. The newly created bills and notes were indistinguishable from those previously backed by coin, and the public was none the wiser.(7)
As previously stated the Bank of England, strictly speaking, was not created as a Central Bank. Over the course of 150 years it evolved into the strange beast that it would become. But some of the banks corrupting characteristics were present from the very beginning.
Prestigious – The Bank took on an aura of prestige from the outset. “Britain, rapidly increasing in wealth, required a prestigious, powerful bank.”(8) Its cozy relationship with the British Monarchy virtually assured that the Bank’s esteem would be understood.
Private – “…from the date of its foundation a private corporation calling itself the ‘Bank of England’ assumed total control of the credit of the British nation.”(9) It was a joint-stock bank with limited liability.(10) The Bank was nationalized in 1946 but became an “independent public organization” in 1998.(11)
Monopoly – The Bank of England assumed the management and total control of the British national debt from its inception.(12) In the beginning the burgeoning bank created gold-backed bills that it issued to the government as short-term loans.(13) The public had the option of using these notes but it was not required to do so. Importantly, there were competing currencies and banks at that time. Soon smaller banks had difficulties competing with Bank of England notes (see Privilege and Protection below). By 1780 the majority of London’s competing private notes had been abandoned. Smaller disadvantaged banks began keeping balances with the Bank of England, a core characteristic of central banking.(14) The Bank of England Act, 1833, made Bank of England notes Legal Tender for all sums above £5 in England and Wales.(15) The basic definition of Legal Tender is coins or banknotes that must be accepted if offered as payment for debt.(16) The Bank Act of 1844 was the capstone of this monopoly system because through it the Bank of England became the sole issuer of legal tender notes.(17) Other banks were allowed to issue demand deposis (a deposit of money that can be withdrawn without prior notice) but these were redeemable in Bank of England notes.(18) The result of this was that in order for other banks to have access to the cash being demanded by the public they had to hold checking accounts at the Bank of England.(19)
Fractional Reserve – Only a fraction of the currency issued by the Bank of England was backed by coin. The majority of ‘money’ created for government loans was backed by government I.O.U.s”(18)(More on this later.) Predictably, the British government abandoned the Gold Standard in 1931 and thus the British Pound has been true fiat currency ever since – it is created from nothing and backed by nothing.(More on this later as well.)
Privilege and Protection – Perhaps most importantly of all, from the day that it opened the Bank of England enjoyed privileges and protections not afforded to its competitors. Amazingly, the Bank of England was insolvent after only two years. Had it been a normal private business it would have been forced to close its doors, liquidate, and be relegated to the dustbin of history. The British government however granted the Bank suspension of payment, thus keeping the game afloat and ensuring its own ‘easy money’ revenue stream.(21) Whether it was the implementation of laws eliminating the possibility of competition, extensions of its charter coinciding with additional loans to the government, or injections of liquidity from French and German banks, the Bank of England came to dominate the British financial system because that system was rigged. This rigged system became the model for all of the world’s central banks.
The next installment of Monetary History will cross the pond and begin examining the evolution of the American monetary system.
1 G. Edward Griffin, The Creature From Jekyll Island, pg 175. (American Media.)
2 Bank of England, Mises Wiki https://wiki.mises.org/wiki/Bank_of_England
4 Gold and Money 7: The Bank of England http://www.overlordsofchaos.com/html/gold___money_7__bank_of_englan.html
5 Bank of England, Mises
6 Griffin, Jekyll Island, pg 177.
7 Ibid., 177-178.
8 Gold and Money 7: Bank of England
11 Bank of England, Wikipedia https://en.wikipedia.org/wiki/Bank_of_England
12 Gold and Money 7: Bank of England
13 Griffin, Jekyll Island, pg 174.
14 Bank of England, Mises
15 Bank of England, ‘A Brief History of Banknotes’ http://www.bankofengland.co.uk/banknotes/Pages/about/history.aspx
16 Google definition, legal tender
17 Gold and Money 7: Bank of England
18 Bank of England, Mises
20 Griffin, Jekyll Island, pg 176.
21 Bank of England, Mises