Bank of England

BANK OF ENGLAND. The movement towards the estab lishment of the Bank of England dated from before the French wars of William III., and sprang from the city merchants' dislike of the London goldsmiths for their rapacity and speculative pro pensities. Commercial development too had reached the point where the advantages and significance of a sound well-backed paper currency could be appreciated, the more so as the current coin of the realm fell far short of its purported value.

Formation and Early History.

The Bank of England was not the original scheme of William Paterson, its founder. As is usual in English political history, it came into being almost by the backdoor, deriving its life from the Tonnage act of of which the preamble read "An Act for granting to their Majes ties several Rates and Duties upon Tunnages of Ships and Vessels, and upon Beer, Ale and other Liquors: for securing certain Re compenses and Advantages, in the said Act mentioned, to Such persons as shall voluntarily advance the Sum of Fifteen hundred thousand Pounds towards carrying on the war against France." The bank clearly arose from a deal between the Government and its promoters, the former receiving the cash, and the latter the privilege, and political opposition from the Jacobites and gold smiths ran upon the expected lines. It failed, and the bank came into being. The capital was £1,200,000, the whole of which sum was to be advanced to the Government at a rate of 8% plus 14,000 per annum for expenses, or f ioo,000 per annum in all. The privileges of a bank were granted for years to the corpora tion, which was allowed to deal in bills of exchange or bullion, but not in merchandise, and to issue notes up to a volume equal to that of its capital. Its profits were derived from the interest on the Government loan, and from its general banking business.

Its early days were naturally troubled. The national finances and currency were in a sad mess, and its own privileges were repeatedly threatened. Nevertheless, it survived, and provided a safe depository for the citizens' money, and thanks to its power of accumulating funds caused a marked fall in the rate of discount.

The next landmark in the history of the bank is the act of 1709, following the expiry of the bank's charter. This was the fruit of a fresh "deal" with the Government. The Government got its rate of interest reduced from 8 to 6%, a fresh loan of £400,000, and the right to ask the bank to issue exchequer bills for them. In return, the bank got its privileges renewed until 1732, the right to double its capital and so its note issue, and a monopoly of joint-stock issue banking in England. This last clause was of great importance, as for over a century it forced the banking system of the country into the hands of private individuals of varying substance, knowledge and experi ence.

Meanwhile, as the bank's own capital was lent to the Govern ment the volume of the Bank of England's note issue depended on the size of the Government debt.

South Sea Bubble.

In 1711, the South Sea Company was founded, and for nine years was conducted upon a more or less sane basis. In 17 2o, as every history hook relates, its directors and the whole financial world went mad. The company offered to take over the national debt at an interest rate of 5%, falling to 4% in seven years' time, and to pay 31 millions for the privilege. The Bank of England was not to be outdone in this form of lunacy, and bid 5 millions. The South Sea Corn pany promptly raised their bid to 71 millions. Fortunately for the bank, even their most generous (and insane) offers were rejected. When the crash came, the bank had to meet a run, but just managed to stave off disaster. Later on, the bank played its part in the solution of the numerous financial problems which were the legacy of the crash. It took over fresh obligations, and incidentally increased its capital by 13,40o,00o to As its new stock was issued at 18% premium, the bank was well rewarded for its new responsibilities.

Having been prevented from committing suicide, and subse quently saved from accidental death, the bank's fortunes were now to run on more even lines. In 1722, the Reserve Fund or "Rest" was established. In 1742, when the bank's charter expired, the Government of the day was once more in a state of im pecuniosity, and so the renewal was easily effected, the bank's capital being raised to f 9,800,000. The early successes of the Young Pretender in 1745 caused another run upon the bank, but largely owing to the loyal support of the city merchants, disaster was avoided. The years 1750-51 were notable for a more humdrum, and far more important event. At that date the national debt was consolidated upon a 3% basis, and at the same time the Bank of England was entrusted with the administration of the national debt. It, therefore, assumed at this time one of the main functions of a modern central bank.

Subsequent history up to 1797 consists of recurrent crises, the renewal of the bank charter in 1764 and again in 1781, and the famous attack on the bank by the Gordon rioters in 1780.

Napoleonic Wars.

In 1797, following the strain of war, and successive internal crises, the bank was forced to suspend cash payments. The next 25 years were some of the most interesting in the history of the bank. For the greater part of this period England was in the throes of the Napoleonic wars, with their drain upon the resources of the country. Heavy borrowings on behalf of the Government were the rule, and the money so raised was devoted not only to war expenditure at home, but also to subsidies to Britain's allies. Trade was crippled by crises at home and by war risks on the high seas, while a large proportion of the Continental markets were closed to Great Britain.

In the light of the greater economic knowledge and the ex periences during and after another and greater war, we can understand exactly what happened, why the bank was unable to encash its notes upon demand, why the foreign exchanges moved against the pound, and prices rose at home. The fact that in four years the bank was forced to lend the Government f seems to us perfectly natural, and so does the expan sion in its note issue. The Restriction act of i797, which legalized the bank's suspension of payments, found its counterpart in the currency note issue of 1914, and it is only fair to say that up to a point Pitt realized the dangers of inflation and the need for increased taxation, just as Lloyd George and McKenna did in 1914-15.

Bullion Committee.

In 1810 the famous Bullion Committee was appointed, and the fact that its deliberations were con centrated upon the Bank of England notes, shows the eminence and importance which the bank and its notes had reached during the first century of its life. For all practical purposes the bank's notes had imperceptibly become the national currency though it took the suspension of their convertibility to bring the fact home. The Bullion Report, for the first time in our history, exposed the dangers of inflation and enunciated the advantages of the gold standard. It attributed the evils of high prices to the excess issue of banknotes, which in turn was stated to arise from the suspension of cash payments by the bank. It regretted that what had been intended to be a temporary suspension had been prolonged indefinitely, and called for a resumption of cash payments and the restoration of the pound to its former value.

The report aroused a storm of controversy, and was rejected by a House of Commons who felt itself competent to pass a series of resolutions in flat contradiction of economic laws and facts. This led `.o fresh inflation and its inevitable results. It was only when the war was over, that conditions were ripe for a return to sanity and stability. The first move came from the bank itself, which in 1816 declared itself able to resume partial cash pay ments. By 1819, official opinion had swung round to the point where it could accept the doctrines of the Bullion Committee, and by 1821 the full gold standard was re-established upon its original basis of 77s. iod. per standard ounce of gold.

The next stage in the bank's history runs from 1821 to 1844. It witnessed the spread of industry and the attempts of banking to keep pace, and was punctuated by various crises, such as those of 1825 and 1836-39. The first of these crises was the direct cause of the initial breach in the bank's monopoly. The act of 1826 permitted joint-stock issue banking outside a radius of 65 miles from London, and henceforth the bank's monopoly was doomed. In 1833, another act was passed, making the bank's own notes legal tender, but at the same time legalizing joint stock deposit banking in London itself. If the former of these acts had sounded the doom of the Bank's monopoly of issue banking, the latter presaged the gradual extinction of the bank note itself as the main medium of payment. Once cheques re placed notes, the Bank of England was to change over from its role of the chief British bank of the ISth and early 19th centuries to that of the central or bankers' bank of to-day.

In 1836-39, the bank itself was involved in difficulty and only escaped having to suspend payment by a timely loan from the Banque de France (q.v.). Public opinion was now alarmed at the fact that while the bank's notes were convertible, the bank was not found to maintain any definite backing in gold behind them. Enquiries and discussions took place, culminating in Peel's Bank act of 1844 (q.v.).

Peel's Bank Act.-The

provisions of this act are dealt with elsewhere, so that it is sufficient to say that the bank's functions of note issue and general banking were separated into water-tight compartments, and that the volume of the fiduciary issue of Bank of England notes was defined rigidly by the act. In case of emergency, the Government could give the bank leave to issue notes beyond this limit, and this was the operation known as "suspending the Bank Act." Otherwise, every additional note issued had to be hacked by gold.

The one exception permitted was that if any country bank-note issue lapsed, the Bank of England could raise its fiduciary limit by an amount equal to two-thirds of the lapsed issue.

Nineteenth Century Crises.-Three

times in the 19th cen tury was the Bank act to be suspended, in 1847, 1857 and 1866. The first crisis was the aftermath of the outbreak of railway speculation, and also of high grain prices and heavy corn im portation. Numerous country bank failures occurred, and in its efforts to lend assistance, the bank put too high a strain upon its own resources. The suspension of the act immediately re stored confidence, and on this occasion no notes were actually issued beyond the normal limit.

The 1857 crisis was more widely spread, and arose in fact from over-rapid development in the United States. The crisis spread to England, and caused a heavy and continued demand for funds upon the bank. The act was suspended in the nick of time (or else the hank would have had to close its doors) and this time £998,000 excess notes came into circulation.

The 1866 crisis originally affected general industrial specula tion which rapidly attained an unhealthy volume. It was identi fied with the failure of the famous London finance house of Overend and Gurney, which caused an immediate panic and a run on the bank, who on "Black Friday," May i 1, saw its reserve shrink from 5.7 to 3 millions. As before, the suspension of the act relieved the tension. Money remained dear for a long time and further failures occurred, but as in 1847, no additional notes were issued.

The Baring collapse in 1890 caused another severe crisis, but this time the bank managed to keep things in hand, and with the help of loans from the Banque de France, managed to avoid having to ask for a suspension.

The Bankers' Bank.-It was during this generation that the bank finally recognized that it had "suffered a sea-change" and became primarily a "bankers' bank." Not that it did not from its inception accept deposits from other banks and discount bills for the market. The pre-eminence of its note circulation alone would have ensured that it should receive business from every financial institution. In 1844, deposits from London bankers amounted to £963,000, and it is reasonable to suppose that an omnibus item of £5,631,000, termed "other deposits" included a fair proportion of "bank money." The act of 1844 crystallized the whole position, and 20 years later Bagehot and Goschen interpreted it to the authorities of the bank itself. In brief, the Bank of England holds the gold at the basis of the nation's credit structure, and is responsible for maintaining a proper proportion between gold and the supply of credit. Should the proportion fall too low, it has various time-honoured means of rectifying the situation (see BANKING .

This was the main function of the bank up to 1914. The growth in its business is shown by this composite balance-sheet repre senting the years 1844 and 1903. To save space, all figures repre sent millions. Post-war figures are also given in the table, but these will be considered later.

Issue dept. 16-9-1844 29-7-1914 18-2-1920 2-11-1927 Notes issued . 28.3 126•1 Govt. debt . I I •o I I •o I I •O I I •o Other securities 2.9 7'4 8.7 Gold . . 12.7 36.7 107.7 Silver . . I.7 .. .. . .

Banking dept.

Capital . . 14.6 14.6 14.6 14.6 Rest . 3'5 3.6 Public deposits* 3.6 12.7 26.3 21.3 Other deposits* 8.6 54'4 164.8 100.7 Seven-day bills I •o Negligible Govt. securities 14.6 I 1.0 87.1 44•6 Other securities 7'8 47'3 88.8 60•7 Notest . . 8•I 25'4 32.5 32'9 Gold and silver coin '9 1•5 '8 *Represents "liabilities." i'Represents "reserve." Taking for the moment the first two columns, the note issue has expanded from 28.3 in 1844 to S5•1 millions in 1914. This is due to two causes, these being the lapse of the majority of private note issues and the great increase in the supply of gold. Re serves in the banking department have risen from 9•o to 26.9 millions and liabilities from 12.2 to 67.1 millions. The "propor tion" between the two has fallen from i4% to 40%, and this is largely a measure of the increased confidence placed in the ability of the bank to meet its obligations, and also represents the increased economy effected in the use of gold and the pro vision of greater credit facilities to the public. It will be seen that loans to the Government have fallen slightly with the result that the whole of these increased facilities have gone through the medium of "other securities" to the money market and so to the public.

The Bank and the outbreak of the World War caused an immediate run on the bank. In one week, the reserve dropped to 9.9 millions, a four days' Bank Holiday was proclaimed, and the Bank act once more suspended. This time the suspension was virtually made permanent. The Government issued one pound and ten shilling currency notes, which had little gold backing and were legal tender for any amount. With these available ad libitum, the fact that the bank's own notes were speedily restored to their normal limits was a matter of purely academic importance : for as long as notes are indefinitely available and are made legal tender, it does not matter who issues them. In point of fact, until currency notes could be printed and issued, the bank did have to take advantage of the suspension. This only lasted for a few days, has never been generally known, and in any case is of minor importance.

The subsequent history of the bank is wrapped up with the general financial history of the country. War expenditure forced the Government to borrow heavily, and as the 1920 return shows part of these loans were raised direct from the bank. The money so borrowed quickly found its way into the deposits of the clear ing banks at the bank, so Government securities and other or private deposits swelled apace. As a consequence of this, the whole credit structure was inflated, and prices rose and business expanded accordingly.

The other war change of importance was the concentration of the country's stocks of gold in the hands of the bank. This explains the huge increases in the issue department. The increase since 192o is due to the substitution of bank-notes for gold in the backing to the currency note issue.

The deflation of 1920-22 was an act of the bank in conjunc tion with and in compliance with the wishes of the Government. The Government repaid its debt, and the items in the banking de partment were contracted. This caused the whole credit structure to shrink.

The issue of the various war loans and subsequent conversions entailed an enormous increase to the work of the bank. At times, help was obtained from the staffs of other banks, and in general this side of the bank's work has ga_ned enormously in size and importance.

The Gold Standard Restored.—The next development of the bank came with the restoration of a modified gold standard in 1925. Till then, bank and currency notes alike had been nominally convertible, but as the gold so obtained could neither be used commercially, nor exported, convertibility was but an empty name. The act of 1925 made both notes inconvertible. The bank was still bound to buy gold in any q'iantity and to sell gold in multiples of 400 ozs., but gold could not be withdrawn in smaller or broken quantities. It was decided that to allow gold to become a medium of circulation was then a luxury Great Britain could not afford.

In 1928, the anomalous covering position created by the war was at last ended by the amalgamation of the two note issues under the control of the bank. According to the act passed in that year, the bank was to have power to issue notes up to a fiduciary limit of 1260,000,00o, while to give some measure of elasticity to the British currency system the bank might obtain permission from the Treasury to exceed this limit, such leave being granted for six-monthly periods but not for more than two years in all.

Simultaneously, two changes were made in the bank return. "Other deposits" were divided into "bankers' deposits" and "other deposits," the former representing the balance held at the Bank of England by the British banks. "Other securities" were divided into "discounts and advances" and "other secur ities." The distinction here was one of initiative. If the market borrowed from the bank or discounted bills, the operation came under discounts and advances. If the bank bought bills on its own initiative, these bills rank as Government securities in the case of Government stock or Treasury bills and as other securities in the case of anything else.

During the financial crisis of 1931, the outflow of foreign funds from London was so large as to bring about a fundamental change. The bank lost gold so heavily that in order to main tain the banking departments' reserve, the fiduciary issue had to be raised from f 26o to £275 millions. To replenish its gold reserves the bank itself first obtained credits in New York and Paris, and a few weeks later the Treasury in its turn obtained further credits in those centres. Even these reinforcements proved insufficient and in September, 1931, legislation was passed suspending the gold standard. Henceforward the bank has ceased to be obliged to sell gold bars at its statutory price on demand.

By the middle of 1932 confidence was restored, and foreign funds began to return. The result was an almost embarrassing influx of gold. Furthermore the rise in the sterling price of gold, due to the abandonment of the gold standard and the deprecia tion of the pound, stimulated gold production and also dishoard ing in India. Enough of this gold came to London to add sub stantially to the British gold reserves. On September 16, 1931, at the height of the crisis, the bank only held 1135.6 millions of gold. By June, 1937, the bank's reserve had risen to £376.4 mil lions (still valued at 84s. 'lid per ounce fine), while the Ex change Equalization Accounts held £537 .6 millions of gold (valued at 14os per ounce fine, this being approximately the sterling price of gold at that date).

Meanwhile the government had adopted a policy of cheap money and moderate reflation, designed to rescue trade from the 1932 depression and to facilitate internal debt conversion. Bank rate was reduced to 2 per cent in the summer of 1932, and re mained there until Aug. when it was raised to 4 per cent on account of the gravity of the international situation. The rate was lowered to 3 per cent on Sept. 28, 1939, following the introduction of the emergency war budget on the previous day. The bank's heavy gold acquisitions up to 1937, supplemented by a deliberate increase in the banking department's government securities from 149.4 to f98.0 millions, facilitated this reflation process. The note circulation expanded from f352 to 1484 mil lions, bankers' deposits from 158.4 to L95.0 millions. It was even possible to reduce the fiduciary issue from 1275 to f Zoo millions, without depleting unduly the bankers' reserve.

In early 1938 the influx of foreign funds ceased, and was suc ceeded by a heavy and prolonged outflow of funds and gold. These gold losses were borne initially by the Exchange Equaliza tion Account, but by the end of 1938 the Account's gold reserves needed reinforcement. In January, 1939, therefore, the bank sold £200 millions of gold to the Exchange Equalization Account. To compensate for this heavy loss of gold by the bank, the fidu ciary issue was raised to 1400 millions.

During all this time the bank, by statute, had continued to value its gold at 84s. I I 1d per fine ounce. This practice was anomalous, for gold had risen to over 140s. per fine ounce. It was also inconvenient, for every time the bank bought or sold gold, it incurred a loss or made a profit; and by the Finance Act, 1932, these profits and losses were transferred to the Exchange Equalization Account. It was also anomalous for the fiduciary issue to be f 40o millions, when the 1928 Act envisaged a normal fiduciary issue of 1260 millions.

To put an end to these anomalies, a new Act was passed in February, This Act laid down that the bank's gold should be written up to a price to be agreed by the bank and the Treasury. This was not to be a fixed price, but should be calculated afresh each Wednesday in readiness for the week's bank returns. In practice, the agreed price corresponds very closely with the London market price of the day.

The immediate consequence was to revalue upwards the bank's gold from 1126 to 1226 millions, and so the Act further provided that the fiduciary issue should be fixed at 1300 millions instead of the level of f400 millions then prevailing. This put an end to the other anomaly, but the power in the 1928 Act to vary the fiduciary issue still holds good. The reduction in the fiduciary issue off-set the re-valuation of the bank's gold, and so the gen eral position of the bank remained unchanged.

To complete this picture, Table I summarizes post-war bank returns at various key dates, showing the exact effect on the bank of the various changes described above.

The duties and functions of the bank have been considerably enlarged during recent years. As the Government's agent and technical adviser, it has played a leading part in the evolution of British monetary policy since 1931. It did important technical work in the War Loan conversion and subsequent issue of funding loans and defence loans. It also exercises on behalf of the Gov ernment an unofficial but effective control over financial affairs. Thus it controls municipal borrowing, so as to prevent too heavy demands on the capital market. It also issues instructions re garding such matters as loans and investments overseas, control over dealings in gold and forward exchange and other measures designed to protect the stability of the pound. It operates clear ing and payments agreements with countries such as Italy and Turkey.

Last but not least, it operates the Exchange Equalization Ac count, buying and selling gold and foreign exchange each day in accordance with the Government's policy.

Through its subsidiary, the Banker's Industrial Development Company (in which most British banks also have a shareholding), the bank has for many years played a part in industrial rational ization and the elimination of redundant plant. The Lancashire Cotton Corporation and National Shipbuilders Security, Ltd., owe their origins to the Banker's Industrial Development Company. The first brought a partial measure of consolidation to the cot ton trade, while the second provided for the closure of surplus shipyards.

The Bank has also taken a share in the re-organization of cer tain large individual companies.

Altogether, in both its structure and its functions the Bank occupies a position vastly different from that existing before the war or even as recently as 1929. Its new functions are both national and, through its association with the Bank for Inter national Settlements, international. And it has not yet reached its final evolutions.

Internal Affairs.

The government of the bank is in the hands of a governor, deputy-governor, and 24 directors. By custom, none of these are connected with the London clearing banks, but were originally drawn from the partners and directors in the big London accepting houses and merchant banking firms.

Fundamental changes, however, have been made in recent years. First, Mr. Montagu Norman, who became Governor in 1920, was still holding that office in 1939. Next, both Mr. B. G. Catterns, who in 1939 was Deputy-Governor, and his predecessor, Sir Ernest Harvey, came from the staff of the bank. Many of the present directors, too, are today prominent industrialists, with no previous connections with merchant banking or the City. Finally, the di rectorate includes three "whole-time" directors, who take a lead ing executive part in the conduct of the bank's affairs.

(N. E. C.)