Major Developments (4)
Monetary indiscipline leads to inflation
The wars with France which began in 1793 and lasted some 22
years put an enormous strain on the nation's finances. In 1797
the Government was obliged to protect the gold reserves for
the war effort by declaring the Bank's notes inconvertible.
This 'Restriction Period', as it was known, continued for six
years after the end of the war, until 1821. Because of the consequent
shortage of coin the Bank issued £1 and £2 notes
to keep the wheels of trade turning; but, inevitably, prices
rose generally and this provoked a fierce debate and the setting
up of a Parliamentary Select Committee which attributed the
country's difficulties mainly to the Bank's over-issue of paper.
The Committee argued that a paper currency which had ceased
to be convertible into gold or silver coin could only be kept
up to its proper value by limiting its quantity, in that way
it would become again a sound currency. Monetarism was born.
There were many small banks issuing notes at this time and by no means were all of them sound. The hard time road to monetary discipline, which followed the return to convertibility, inevitably led to the failure of many of these partnerships which had irresponsibly expanded their note issues. The Bank of England's difficulties were neatly summarised in 1830 by William Cobbett, who could never be described as a friend of the Bank: he wrote "The Bank is blamed for putting out paper and causing high prices; and blamed at the same time for not putting out paper to accommodate merchants and keep them from breaking, It cannot be to blame for both and indeed is blamable for neither. It is the fellows that put out the paper and then break that do the mishchief".
The Country Bankers Act, a milestone in the development of banking in England, was passed by Parliament in 1826. It breached some of the Bank's former privilege by permitting the establishment of joint-stock banks with more than six partners but not within 65 miles of London. The Act allowed the Bank to establish branches in the major provincial cities from which it was able to increase its sphere of influence by sound note issue. In 1833, the Bank's notes were made legal tender for all amounts above £5, ensuring that in the event of a crisis, as long as the credit of the Bank remained good, the public would be satisfied with its notes and its reserves would consequently be safeguarded.
The Gold Standard: the Bank's notes backed by gold
Regarded by some as the first move towards nationalisation,
the 1844 Bank Charter Act was also the key step towards the
Bank achieving the monopoly of the note issue. There were to
be no new issuers of notes and those whose issues lapsed, or
who were taken over, forfeited their right to issue. But the
crucial clause of the Act was a monetary one: it provided that
beyond the Bank's capital of £14 million, its notes were
to be backed by gold coin or bullion. This, together with a
fixed price for standard gold, laid the foundation for the gold
standard which, during the nineteenth century, spread worldwide
and created a long period of price stability with monetary policy,
in effect, on auto-pilot.
Bank assumes responsibility for financial stability
Monetary stability alone, however was not enough. There were,
of course, crises and in order to prevent systemic collapses
the 1844 Act had to be suspended: this occurred in 1847, 1857
and in 1866 when Overend Gurney, one of the most prestigious
City houses failed. Walter Bagehot, the celebrated editor of
the Economist wrote in 1866 about the Bank's part in the crisis
of that year that the Bank held, should hold and should be responsible
for holding "the sole banking reserve of the country". If the
Bank had been slow to recognise its responsibility for financial
stability in earlier cases, its reaction in 1890, when Baring
Brothers were threatened, heralded a new era in the Bank's stewardship
of the Square Mile. A rescue operation in the form of a guarantee
fund was orchestrated by the Governor of the Bank and more than
£17 million was promised, much of it from the by now powerful
joint-stock banks. The crisis was averted but the leading role
played by the Bank demonstrated the responsibility it had come
to feel for the stability of the banking system as a whole.
The Bank's second century had thus seen the two key elements of central banking emerge - the concern for monetary stability, born during the inflationary excesses of the Napoleonic wars; and the responsibility for financial stability, developed in the banking crises of the mid-19th century.
