Before and After the Act of 1844.

We have seen that part of the Bank of England's monopoly was annulled in 1826, and that in 1833 a clause was inserted in the charter to the effect that joint stock banks of unlimited liability could open in London, provided they did not issue notes; and though the state of the law still allowed the Bank to harass and annoy the new companies, its power was thoroughly broken, and its monopoly of joint stock banking gone—fortunately for ever.

The country enjoyed a period of prosperity from 1833 to 1836, but the speculative fever soon began to develop, and by the end of 1835 it was burning fiercely, for men and women possessed an extraordinary faith in those much advertised short cuts to wealth in the early thirties. No path, if it were sufficiently short, was too precipitous. Hope was boundless, credit was unlimited, and companies in profusion were formed by the philanthropists and dreamers of those times.

Then came the crisis of 1837, when the Bank's policy rose almost to the verge of madness. Just at a critical moment, when it was imperative that no untoward incident should occur to disturb the already depressed state of credit, the Bank of England refused, and persisted in its refusal, to discount bills bearing the endorsement of the joint stock banks.

The action of the Bank added to the confusion, and, as speculation in America had been rampant, it dealt a final blow to the houses engaged in the American trade by issuing instructions that their bills also should not be discounted. Then, as might have been expected, the fury of the storm beat against the Bank itself; and by the end of February, 1837, its bullion was reduced to £4,077,000. In 1839 another crisis occurred, and the bullion declined to £2,522,000. Upon this occasion £2,500,000 was borrowed from the Bank of France, and the discount rate of the Bank of England was gradually advanced to six per cent.

These constantly recurring panics thoroughly alarmed the Government, which, having stripped the Bank of England of its monopoly of joint stock banking, now turned its attention to the currency, and by the Bank Act of 1844 secured the convertibility of the note. In fact, the chief aim of the Act was to reduce the issues of the country bankers, who, by forcing large numbers of their one pound notes into circulation and neglecting to maintain a sufficient proportion of cash in hand to meet them on presentation, helped to finance the gamble of 1824. Some of the banks paid the penalty in the year following, and disappeared from the scene.

In 1821 the Bank of England, after a period of restriction, began to pay off its notes under the value of £5, but the Government allowed the country bankers to continue issuing their small notes until the expiry of the Bank Charter in 1833. In 1826 an Act was passed prohibiting the stamping of notes under £5, and forbidding the circulation after April, 1829, of those then current.

The Bank Act of 1844 confirmed the alterations of 1826 and 1833, and, in addition, made great alterations in connection with the currency. The Issue Department of the Bank of England was to be kept entirely distinct from the Banking Department. Notes, to the extent of £14,000,000, might be issued against the debt owing by the Government to the Bank and against other securities, but coin and bullion must be deposited in the Issue Department against every note issued in excess of that sum.

Notes issued by the Bank of England are, therefore, secured principally by specie, and by the Government debt, which amounts (1902) to £11,015,100; and as every note is a warrant entitling the holder to gold on demand, a Bank of England note is really and truly equivalent to gold. However, under certain possible, if improbable, conditions, the Bank could not fulfil its obligations or promises to pay cash on presentation, for if all its notes in circulation were presented simultaneously there would not be sufficient coin in the Issue Department to meet them; but that is a most unlikely contingency.

Further, these notes are "legal tender" in England. In other words, a debtor can compel his creditor to accept them in discharge of his debt; but nobody is obliged to give out change should the value of the notes tendered exceed the amount of the sum owing. In Scotland and Ireland Bank of England notes are "current" but not "legal" tender. Neither are they by the Bank itself, nor by any of its branches, and sovereigns, though not half-sovereigns or silver, may be demanded in exchange. All notes are convertible at the London Office of the Bank, whose branches, however, are only responsible for those notes issued therefrom.

The Bank still retains the monopoly of issuing notes in London and at a distance not greater than sixty-five miles from the Metropolis. No new bank of issue may be formed; and as the private bankers in London had ceased circulating their notes prior to 1844, the Act practically gave the Bank the monopoly of note issue within the prescribed area. This monopoly alone is of great value; but when we remember that its notes are legal tender in England as well, it is evident that the Bank of England still enjoys a most important concession.

The private bankers of London, and the joint stock banks in London and within sixty-five miles of it, were debarred by the Act of 1844 from issuing notes. Of course the private bankers who still issued notes within the prescribed space retained their privilege, but they were no longer able to circulate as many as they could persuade the public to accept.

Bankers, both joint stock and private, who claimed the privilege of issuing notes were compelled to make a return of their issues for a period of twelve weeks to a given date, when the average amount was ascertained, and the extent of the future issue of each bank settled in accordance therewith. The issues, in other words, were fixed, and they could not exceed the sum authorised without breaking the law, and exposing themselves to a fine equivalent to the average excess during any one month. The Government, anxious to avoid a repetition of the scandals of 1825 and 1836, was evidently determined to limit the note circulations of the country banks, and there seems little doubt that, when the Act was framed, one of its aims was the slow but sure extermination of the country bank note.

Banks which intend giving up their note circulations may compound with the Bank of England, which is then allowed to increase its own issue by two-thirds of the disappearing issues. The Government, however, takes all the profit accruing from such arrangements.

The result of these regulations can be seen in the accretions made from time to time to the Bank's authorised issue of £14,000,000, which has now increased to £18,175,000. The majority of the issues of the private bankers fixed by the Act of 1844 have since lapsed; and the same may be said of the more progressive of the country joint stock banks, which, as their deposits grew, opened branches in London, thereby sacrificing their note circulations to the monopoly of the Bank of England, whose notes are fast driving those of the small country bankers out of circulation. Broadly speaking, it may be said that Bank of England notes are the only notes accepted readily by the English public; but the mere fact of their being legal tender ensures that.

Readers who are not acquainted with the history of Banking must not assume that the Act of 1844 affects either Scotland or Ireland. The note circulation of both those countries is regulated by the Act of 1845, but in neither country are the provisions identically the same as those affecting England.

Any person may demand of the Issue Department notes in exchange for gold bullion of standard fineness at the rate of £3 17s. 9d. per ounce.

The Bank Act of 1844, according to its framers, would make panics and crises evils of the past; but, as a matter of fact, it was a new broom, and its sweeping powers were greatly overestimated. Its provisions, we can see, related entirely to currency reform; and though the country bankers could no longer borrow on their notes to an unlimited extent, it must be remembered that Sir Robert Peel's famous Act, if it fixed the maximum amount of their issues, did not take the precaution to also fix the minimum reserve of cash in hand to be held against them. Obviously, no Act could strengthen the position of the banks against panics unless it laid down the minimum or legal reserve of cash to be maintained against deposits, and we shall see that, in this respect, the Act of 1844 did not realise expectations.

Controversy raged furiously around Peel's Act, and, needless to say, it became the bone of party contention. Whenever a subject reaches that stage in this country, its merits are forced into the background. Sides are taken, critics and politicians range themselves upon either the one or the other, and the subject, consequently, speedily gets all the truth lashed out of it. The number of people who really understand the question thoroughly is infinitesimal; and they, as a rule, by a strange irony of fate, do not dabble in politics. The important subject is therefore handed over to the tender mercies of the multitude, which, quite ignorant of its underlying principles, splits itself into two hostile camps, beats out the dust with sticks, and then returns a man to Parliament to vote on this side or on that.

When in 1847, three years after the passing of the Act, another crisis occurred, public opinion attached all the blame to Peel's Act; but public opinion was wrong. Public opinion is usually based upon instinct rather than upon reason, and, consequently, carried away by a sense of indignation or wrong, it rushes madly at what it considers the cause of the mischief. In this case its bugbear was Peel's Act. The real reason was to be found in the simple fact that neither the Bank of England nor any of the large banks held a sufficient proportion of cash in hand to meet those sudden demands for gold which may be made upon a banker at any moment, and to which his business is peculiarly exposed during periods of bad credit.

It was the old, old story, which in these days seems hardly to require an explanation. After a period of exceptional prosperity, there almost invariably follows a lean year or two, when loanable capital is cheap and the prices of commodities depressed. Then is the company promoter's opportunity, and schemes, wise and otherwise, are brought to the notice of the public. Presently there comes a gradual expansion of enterprise, and rising prices beget confidence, when a whisper goes round to the effect that good times are coming.

At first business improves slowly and surely. Then, as prices mount higher and higher, every producer increases his output, anxious to share in the general prosperity. Suddenly, just before the end, there is a boom. Prices rush madly upwards, until every prudent man sees that business has degenerated into a mere gamble, and that he must act quickly if he does not wish to be caught by the receding tide. Unless the banks are strong at that moment, disaster is inevitable; and as they had not taken the necessary precaution in 1847, the result was a crisis.

Capital was cheap during the last quarter of 1844, the Bank rate remaining stationary at two-and-a-half per cent. from September of that year to October, 1845. Cheap money gives the promoter his opportunity; and in 1845 the railway mania was at its zenith. England was in the hands of the surveyor, and the "boom" began in real earnest. As usual, everybody was to become immensely rich, and, as usual, most people were again bitterly disappointed. By a strange process of reasoning, experience does not count in finance. Hope, after a very little while, drives out of the memory of human beings the nightmare of disaster; so, in an astonishingly short space of time, they are gambling again. The crisis of 1837 had lost all its significance by 1845; and then, of course, the Bank Act was to prevent commercial panics in the future!

At the end of 1846 the Bank rate was raised to four per cent., and in October, 1847, it touched eight per cent. The speculation in railways naturally resulted in a gamble in iron; and, after the terrible famine in Ireland of 1846, when thousands died of fever and want in their wretched hovels and even on the roadsides, the suspension of the Corn Laws led to large importations of foreign grain. A sudden fall in prices immediately followed the increased supply, and the merchants in Mark Lane began to fail. Then people looked gravely at one another, and inquired what would happen next.

Credit is the disposition of one person to trust another; therefore as business gradually expands, credit or confidence increases at precisely the same ratio; and when prices are high and profits large, the impression prevails that everybody is making money—consequently, confidence begins to drive out caution; so, towards the end of a period of prosperity the acquisitive fever burns fiercely. Everybody is in mad haste to get rich; caution is flung to the winds; and we get a dÉbÂcle. Then follows a time of bad credit. That is to say, immediately after the reaction, everyone is disposed to be sceptical of his neighbour's position, to wonder whether he were hit by the recent upheaval, and to be extremely cautious in granting credit to his customers. This took place after the crisis of 1847. For a little while everybody was afraid to trust his neighbour; but by 1857 speculation was in full swing again, and the inevitable collapse followed. These periods of good and bad times, or good and bad credit, run their course with the regularity of a fever.

So it was in 1847. Directly a few failures were announced, the public became alarmed, and speculation received a check. The failures continued, and every holder of bills, anxious to have money at his credit at the banks, tried to discount them. But the banks were totally unprepared for this sudden demand, and in Liverpool and Newcastle some of them closed their doors. The London bankers refused their customers ordinary accommodation, and the Bank of England at first declined to advance against securities. Bills, consequently, could not be met at maturity, and the result was panic and a run on the banks.

The situation was saved by the suspension of the recently passed Bank Act, and on 25th October, 1847, the Government authorised the Bank of England to issue notes at its discretion, until the feeling of apprehension had subsided. The Bank thereupon advanced on bills and stock, and, although the rate of discount was eight per cent., the fact that money could be obtained on good bills and first-class securities speedily allayed the panic, and by 23rd November following the Act was again in force. Further, the amount issued by the Bank beyond the limit imposed thereby did not exceed £400,000, although its reserve, by 23rd October, was reduced to £1,547,000.

Perhaps we shall now be better able to understand the Act of 1844, and to see that, though it effected a most useful reform in the currency, and prevented a host of weak country bankers inundating the provinces with their doubtful paper, it does not contain a single clause which would either prevent or alleviate a panic. Indeed the paradox is that during a crisis relief can only be obtained by breaking the Act, and allowing the Bank of England to advance notes freely against the better-class securities. The power to issue notes was taken out of the hands of numerous weak banks, and confided to one strong one. Perhaps, however, it would be more correct to say that the power for evil of the small country bankers was "fixed" by the Act; and, as we have seen, the Bank of England's notes are gradually driving those of the English provincial banks out of circulation. Then, again, the extinction of the country issues gave a marked impetus to our modern system of deposit banking. The cheque soon became the principal credit document in circulation, and the country joint stock banks relied absolutely for their advancement upon their ability to attract deposits to their books.

So long as the Bank of England's notes can be exchanged for gold on demand, it is impossible for them to depreciate in value, and they cannot drive more gold out of the country than is equal to the Bank's fixed or authorised maximum, because, against every note issued in excess, specie for a like amount must be deposited in the Issue Department. Certain writers urge that this limitation is an interference with the freedom of the banker; but, seeing that our modern system of banking rests upon so small a cash basis, surely it is absolutely essential that our currency at least should be above suspicion in times of falling credit. The public does not require notes then. It wants credit; and this it obtains in the books of the banks.

The currency, certainly, should be left absolutely to the laws of supply and demand; and though it is true that the Bank of England sometimes has to protect the convertibility of its notes by raising its rate of discount, still, our present system approaches very near to perfection in so far as the exchange of the note for gold is concerned, and it certainly does not seem desirable to have the country again flooded with paper money which may, or may not, be paid on presentation.

Any person who possesses gold can have it turned into coin immediately; so, under our present system, every addition to the currency must come either direct from the mines or else be received in settlement of the balance of indebtedness owing by foreign nations to this country. We are, therefore, spared those evils which result from an over-issue of paper, and which were sometimes so greatly in evidence before the passing of the Act of 1844.

The absurdity of the attack on the Act must now be apparent, inasmuch as the only reform it could possibly effect was a currency reform, which was certainly badly needed. Viewed in that light it must surely be acknowledged that the Bank Act of 1844 is one of the soundest financial Bills that has ever become an Act of Parliament. The fact that, in spite of the great change in our banking system—which may be said to have been revolutionised since 1844—the Act has successfully stood the test of time, is also proof positive (if proof were required) that it was framed with great skill and judgment.

Had the Act further decreed that every bank should maintain a ratio of, say, at least eighteen per cent. of legal tender against its public liabilities, even panics might have been avoided. At any rate, the banks would have been better prepared to meet drains upon their resources, though even then—as has been pointed out is the case with the Act itself—the law would have to be broken directly a run was made on the banks by their customers. For all that, such a regulation would keep the banks in a fair state of preparedness during normal times, and consequently every bank in the land would be ready to face a panic.

Our system of credit is based on a small cash reserve; and it would be impossible to devise any workable scheme which would afford bankers absolute security, because it would prove too costly both to the banks themselves and to their customers, who would have to pay much higher rates in proportion as the depositors' money was secured. The most prudent banker can only insure his business up to a certain point, as, if he kept more than a certain proportion of cash in hand, he would conduct his business at a loss; so if a panic take possession of his customers and they rush for gold, he is lost if the demand should drain his reserve and encroach on his till-money. No system in the world could possibly save him then. The most our banks can do, therefore, is to be prepared to a certain extent, and, viewed in the light of past history, it is criminal of directors not to take the ordinary precautions. A clause in the Act, as already suggested, would at least ensure a fair state of preparedness in all our banking companies, and beyond that it is impossible to go.

It has been shown that the Act works most effectively in a time of panic when it is broken. It is, perhaps, interesting to recall that the Bank of Germany, in order to remedy this defect, is allowed to issue notes beyond the authorised amount at its own discretion; but the German Government, in order to check abuses, makes over-issue an unprofitable transaction for the Bank by imposing a fine of five per cent. on any amount issued in excess of the authorised limit. Were our own Government to adopt the same expedient, the Bank of England, during a time of stress and excitement, could meet all demands automatically, and the Act would be almost perfect of itself. On the other hand, the Government might not like to see so much power pass into the hands of the directors of the Bank, though there can be little doubt that they would use it with the greatest moderation and to the public advantage.

The object of this chapter is to show that panics were not lessened in any degree by the Act, and perhaps it may be said that the fact has been dinned into one's ears to the verge of irritation. But an ardent reformer's feelings are strong, and it is difficult to make this subject clear to those who are not conversant with the history of Banking, and who, perhaps, are disposed to think the subject both dry and uninteresting.

The panic of 1847 was followed by another in 1857, and in 1866 the Overend and Gurney crisis occurred. From 1866 down to the present day, unless we include the Baring scare in 1890, the country has been free from these scourges, and the reason is not very far to seek.

The Act of 1844 placed the currency of the country on a sound basis, and experience, by teaching the banks caution, did the rest. The large banking companies, after the terrible panic of 1866, plainly recognised that advances must be made with great discretion, and that, if they valued their own safety, speculation must be either kept well within bounds or discouraged entirely. Merchants and traders who require capital for speculative purposes can only obtain it by making application to the banks, which, in the very great majority of instances, now refuse to make advances unless tangible securities be deposited to cover their loans.

Merchants, therefore, unless their credit be exceptionally good, or unless they possess first-rate stocks and shares, cannot speculate to the same extent as was possible forty years ago and, of course, those persons who possess marketable securities, which bring them in incomes, are the last people in the world to risk an assured position for possible great future gain. They are accustomed to the good things of this earth, and though they may earnestly desire a large accretion to their wealth, the thought that, in the event of failure, they may lose what they already possess, checks the impulse to finance a scheme, which, while holding out promises of great success, is also not without possibilities of grave disaster. As a rule, only small men will take such risks, and the banks will not finance them at any price.

By refusing to accommodate weak speculators, the banks have kept business in a healthy channel, and have largely confined speculation to those people who can afford to pay their losses—always a cautious class. The rank speculator, therefore, has been driven to outside houses, and such houses, we know, are constantly failing; but Lombard Street, having weeded this dangerous element out of its system, is now more stable.

Recognising that their system of credit is always exposed to possible disaster, and having had the fact brought forcibly home to them upon so many occasions, the banks, since 1866, have gradually accumulated larger and larger cash reserves in order to be better prepared to deal immediately and effectively with those cataclysms which from time to time are certain to assail them; and though it is an open question whether their reserves are even now sufficient, the most casual observer must acknowledge that, with a few exceptions, our banking companies are in a better state of preparedness at the moment than perhaps during any other period of their history.

By compelling the schemers to deposit securities against their loans and advances the banks secure themselves against large bad debts; and by accumulating fair cash reserves they insure their business against suspension during panics. Having taken these precautions, it is not surprising that their path has been rendered comparatively smooth during recent years; and, further, the more prudent manner in which the business of a banker is now conducted makes the shares of the large banking companies less speculative holdings, and greatly reduces the risks of shareholders in connection with their liabilities on the uncalled portion of their shares, though that liability should by no means be forgotten or accepted in any other light than that of serious responsibility.

This brings us to another point in their history. It was not until 1858 that banks could be registered as limited liability companies, and, needless to say, no unlimited bank has been formed since that date; whilst every joint stock bank now in existence (although, in the great majority of instances, the members are liable for certain known sums on each share held by them) has limited the liability of its shareholders, those companies formed prior to 1858 having since taken the necessary steps.

Naturally, persons of wealth would not risk their fortunes by holding shares in an unlimited bank, but now that the exact liability is known the responsibility is accepted with a lighter heart, and, consequently, this class of security is considered a desirable investment by those who can afford to take a little risk in return for higher interest than that yielded by the so-called "gilt-edged" variety of securities.

The reader cannot but be struck by the gradual evolution of our banking system; and it must be evident to him that the present more secure position is the outcome of a bitter struggle with adversity. It is usual, when discussing the Bank of England's position in the money market, to degenerate into abuse, and to show that the Old Lady of Threadneedle Street has committed every conceivable folly in dealing with questions of finance. No doubt the accusations are true in the light of past experience. But they were the follies of her times, and, if we are to believe the critics, we are not greatly in advance of our own. Then is it not a little unreasonable to expect the Bank directors of 1825 to be in advance of the financial opinion then current in the City? They had the very best advice of the day at their disposal, and had the present-day critics lived in 1825 they would have urged the Bank directors to take the very course that was then adopted.

English history, at a certain period, seems an account of one long struggle between the will of the people and the power of the Crown; and Banking history, prior to 1844, reads like one long struggle between the banks and the Bank of England. But there is this distinction, to wit, the sterling honesty of the Bank. Surely, in the whole world's history there is not another such instance of unbroken faith on the part of a financial institution which has enjoyed a life of more than two hundred years. While anxious to give an accurate account of the Bank's history, and to explain all its faults and all its failings, it is impossible, the closer one examines its actions, not to be the more impressed by its honesty of purpose.

Every new movement gropes its way out of the darkness into the light. The process is, however, a slow one; and if, in the future, there are new problems to be solved, then future generations will have to learn the laws affecting them in the school of experience. Despite their increased knowledge, they will probably make the same mistakes as those recorded in these chapters, for it is astonishing, as our environment changes, how short a distance we can see in front of our noses. Banking in 1950 will in all probability be very different to banking in 1902—especially if population increases at its present rate all the world over.