by Felix Martin
There was one proposal, however, which was to prove altogether more effective. It was a plan for a bank which would fundamentally reorganise the funding of the king’s debts. Investors would subscribe capital to the bank, and the bank would lend money to the government. The establishment of a bank to raise money for the sovereign was certainly not an innovation in itself. There had been public banks in the city states of the Mediterranean on and off since the Middle Ages. Holland had had a public bank at Amsterdam since 1609; Sweden, one in Stockholm since 1656. What was new about the Projector William Paterson’s proposal was that this Bank of England would in effect be a public–private partnership. The Bank’s primary role would undoubtedly be to put the sovereign’s credit and finances on a surer footing. Indeed, its design, governance, and management were to be delegated to the mercantile classes precisely in order to ensure confidence in its operations and credit control. But in return the sovereign was to grant important privileges. Above all, the Bank was to enjoy the right to issue banknotes—a licence to put into circulation paper currency representing its own liabilities, which could circulate as money.17 There was to be, quite literally, a quid pro quo.
Paterson’s scheme might easily have been lost in the crowd. But the idea of the hybrid Bank of England found a powerful group of supporters in the circle of ambitious Whig grandees who were soon to dominate the first party-political administration of the country. They realised that Paterson’s Project could deliver a Great Monetary Settlement. If they and the private money interest they represented would agree to fund the king on terms over which they, as the Directors of the new Bank, would have a statutory say, then the king would in turn allow them a statutory share in his most ancient and jealously guarded prerogative: the creation of money and the management of its standard. To be granted the privilege of note issue by the crown, which would anoint the liabilities of a private bank with the authority of the sovereign—this, they realised, was the Philosopher’s Stone of money. It was the endorsement that could liberate private bank money from its parochial bounds. They would lend their credit to the sovereign—he would lend his authority to their bank. What they would sow by agreeing to lend, they would reap a hundredfold in being allowed to create private money with the sovereign’s endorsement. Henceforth, the seigniorage would be shared.18
The worldlier men of the age were well aware that the outwardly technical business of reforming public financial management was in reality intensely political. Conservative types deemed any concessions to the Whig money interest to be unwise, if not seditious. It was not the first time that the mysterious magic of banking had been put forward as a solution to the problem of the crown’s fiscal incontinence. In 1665, Sir Charles Downing had proposed that the Treasury become a virtual state bank. The Earl of Clarendon, the king’s chief adviser, had dismissed the plan on explicitly political grounds as “introductive to a commonwealth, and not fit for a monarchy.”19 Such suspicions did not dissipate with the founding of the Bank of England in 1694. Ruling in a test case in 1702, the Chief Justice John Holt attempted a counter-reformation, calling the newfangled technology of bankers’ promissory notes—of which the Bank of England’s notes were by now establishing themselves as the pre-eminent representatives—“a new sort of specialty unknown to the Common Law, and invented in Lombard Street to give laws to Westminster Hall.”20
Other observers saw that there were benefits to both parties, however—and this was to be the secret of the settlement’s success. The quid pro quo nourished a virtuous circle. The state’s blessing afforded general circulation to the Bank’s notes. The commercial ownership and management of the Bank improved the state’s creditworthiness. Unreconstructed partisans of the money interest against the monarchy tended to stress this latter advantage to the exclusion of the former. Sir James Steuart, for example, was quick to remind doubters that “[t]he ruling principle of [the Bank], and the ground of their confidence, is mercantile credit.”21 That was true, as far as it went. But Steuart’s compatriot and contemporary Adam Smith saw the bigger picture, and summarised it succinctly: “The stability of the Bank of England is equal to that of the British government.”22 Smith’s epigram captured the nature of the virtuous circle exactly. Without the state, the Bank would have lacked authority; without the Bank, the state would have lacked credit.
Smith delivered his verdict in 1776. It had taken the best part of a century from the Bank of England’s first charter in 1694 for the great monetary compromise that it represented to become so ingrained in the political economy of the United Kingdom. Over that period, the Bank’s role as a source of emergency fiscal financing declined as the government bond markets expanded. Meanwhile, its role as the monetary agent of the state—the keeper of its accounts, the agent of its payments, the manager of its bond issues—grew inexorably, and its position at the apex of the monetary pyramid was continually reinforced. In 1709 the Bank was given an effective monopoly on banknote issue within England.23 In 1710 it was appointed receiver of public money for the state lottery, and five years after that of all payments for government annuities.24 By the 1760s the Bank was administering more than two-thirds of the national debt.25 By 1781, any doubts about the constitutionality of the Bank were long forgotten. In June of that year, the Prime Minister Lord North spoke to a febrile Parliament in the midst of Britain’s traumatic war with its own colonists in America. Revolution was in the air—but there were still some constants from which to take comfort. When other gods were failing, the Prime Minister consoled the House, there was always the Bank, “from long habit and the use of many years … a part of the constitution,” or “if not part of the constitution, at least … to all important purposes the public exchequer.”26
With the foundation of the Bank of England, the money interest and the sovereign had found an historic accommodation. The Monetary Maquis at last had its share of power; and in return, the “Army of Shadows” worked—at least in part—for the government. This compromise is the direct ancestor of the monetary systems that dominate the world today: systems in which the creation and management of money are almost entirely delegated to private banks, but in which sovereign money remains the “final settlement asset,” the only credit balance with which the banks on the penultimate tier of the pyramid can be certain of settling payments to one another or to the state. Likewise, cash remains strictly a token of a credit held against the sovereign, but the overwhelming majority of the money in circulation consists of credit balances on accounts at private banks. The fusion of sovereign and private money born of the political compromise struck in 1694 remains the bedrock of the modern monetary world.
If the practical consequences of the Great Monetary Settlement are obvious, its implications for monetary thought were just as revolutionary; and perhaps, in the long run, even more momentous. Western thought on the central question of who should control money was poised to undergo a second major transition. Before Oresme, money had been understood implicitly as a tool of government: part of the sovereign’s feudal domain, and an instrument of his policy. Oresme had challenged this, and proposed an alternative objective of monetary policy—to supply the needs of the community. But he had done so from a position of weakness: there was no alternative to the sovereign money. The result had been stalemate. The rediscovery of banking, however, had turned the tables on the sovereign. Now there was genuine competition in the creation and management of monetary networks. Monetary thought abandoned its plaintive tone, and addressed itself to this new reality. Money was no longer a tool of the sovereign, but a tool against the sovereign—no longer an instrument with which the king could “bridle the Sovereigns of Destiny,” as the Chinese Guanzi had put it, but James Steuart’s “most effective bridle ever was invented against the folly of despotism.”27
These successive answers to the question of who should control money seemed diametrically opposed—but the next revolution in monetary thought was to reveal how much they had in common. The Great Monetary Settlement
was about to provoke a new theory of monetary society: the social science of economics. And in this theory, money would undergo a radical transformation. It would no longer be understood either as a tool of the sovereign, or a tool against the sovereign: it would cease to be understood as something political at all. Until now, money had been understood as a powerful social technology; its central idea of economic value as an ingenious shared concept for the co-ordination of social activity; and the monetary standard as a potent tool for the redistribution of wealth and the stimulation of commerce, whose manipulation was therefore the deserving object of heated contention. But money was about to become an inert lump of metal, value an innocuous property of the natural world, and monetary policy, let alone any debate over it, a contradiction in terms.
In short, the conventional view of money was about to make its entrance.
8 The Economic Consequences of Mr. Locke
THE GREAT RECOINAGE DEBATE
To its enthusiastic promoters in the City and in Parliament, the Great Monetary Settlement represented a magnificent advance in the progress of England’s new constitutional monarchy. But there were others who were not so sure. For all the ingenuity of the new arrangements, one critically important question remained open: what was to be the standard on which the Bank of England was to issue its new public–private money?
It was the immemorial dilemma of monetary policy—the very question over which sovereigns and their subjects had argued interminably for hundreds of years. It was all very well to have cooked up a Project which claimed to be capable of mediating the interests of the sovereign and the commercial classes. But could it really engineer a monetary policy that would strike a compromise between their competing priorities? And if so, what would it look like? It was all wholly uncertain—and it was taking place at the very moment that the broader political settlement between King and Parliament was itself only just bedding down. It was a leap of faith to make the advocates of constitutional monarchy very nervous: the future of the system they had striven so long to see, and over which England had fought a civil war, was being risked on a financial scheme dreamt up by a cabal of City bankers. If the Great Monetary Settlement represented by the Bank of England turned out to be nothing more than a means for the money interest to get its way, it would surely collapse; and, more disastrously, bring the political settlement represented by the Glorious Revolution crashing down with it. There were no two ways about it: the supporters of the new system of government had to nip this baleful possibility in the bud. Fortunately, a golden opportunity to do so appeared almost immediately—and it was afforded by one of the oldest monetary problems in the book.
In 1696, less than two years after embarking on its historic experiment with a new form of currency issued by the Bank of England, Parliament resolved that the time had come to confront the problems of the old form—the coinage—as well. There was nothing particularly new about these problems: but they had become impossible to ignore. As we have seen, the use of precious-metal coinage involves an automatic technical challenge. If the market price of the bullion contained in the coins was allowed to exceed the legal value of the coin itself, disaster would quickly follow. Coins would be melted down and sold to silversmiths or exported from the country as bullion. Alternative means of representing money—wooden tallies, copper tokens, written notes—could in principle supply the deficiency. But in practice, the country’s silver coinage was still the central support of the monetary architecture, and a shortage of coins was therefore a serious obstacle to trade. England had been suffering from a chronic case for decades: since the early years of the seventeenth century, the market price of silver bullion had consistently hovered around the critical value, and had frequently risen above it.1 The result had been the gradual emaciation of the coin supply.
Parliament had taken remedial action in 1666 by passing an “Act for the Encouraging of Coinage” which took the unprecedented step of abolishing the seigniorage levy and raising the price paid by the Mint for silver bullion by the same amount in an attempt to bring it back into line with the market price—but the ground made up had not been enough.2 The market price for silver continued to be a penny or two an ounce higher than the tariff, with a full-weight silver coin therefore worth 2–3 per cent more as bullion than as coin. As a result, although some £3 million worth of silver was minted into coins after 1663, almost all was found to have disappeared from circulation again by the early 1690s.3 To make matters worse, the coins that did remain in circulation were subject to a merciless assault of clipping, filing, and shearing, as unscrupulous users scavenged as much bullion as they could without actually rendering the coins unrecognisable. Since the increasing general shortage meant that only the most monstrous mutilation could prevent coins from passing at their legal value, this was a racket that could be seriously profitable. By 1695, the authorities’ samplings suggested that the vast majority of coins in circulation contained only around one half of the silver they had originally been minted with, and that full-weight silver coins were now worth nearly 25 per cent more as bullion than as coin.4 It was clear that on the current trajectory, the little coin left in England would be shorn into oblivion. The question was what on earth could be done about it.
For an answer, Parliament turned to William Lowndes, a lifelong veteran of the Treasury and newly appointed its Secretary. Lowndes combined vast practical experience and an unrivalled network of financial and commercial contacts with a clear intellect and a comprehensive knowledge of English monetary history, and his report was a model of diligence, logic, worldliness, and common sense. He discovered that precisely the same difficulties had occurred on several occasions in the later Middle Ages. The underlying problem was that the value of sterling had, for one reason or another, fallen. There had been inflation, in other words—and the price of silver in pounds, shillings, and pence had risen. In response to such developments it had, he found, been “a Policy constantly Practised in the mints of England … to Raise the Value of the Coin in its Extrinsick Denomination from time to time, as Exigence or Occasion required.”5 The coinage had been periodically “cried up,” in other words, with the tarriffed, nominal value of coins of a given silver content raised to reflect the depreciation of sterling. On both historical and logical grounds, Lowndes concluded, this was indeed the only reasonable policy response. The fall in value of money must be acknowledged by raising the price paid for silver by the Mint—or by reducing the quantity of silver in an official, full-weight coin. The monetary standard had shifted—a pound was worth less than before. The Mint policy had to accommodate itself to this fact: there was no point in fighting the market.
Lowndes estimated that a one-off, 20 per cent reduction in the silver content of the coinage would do the job.6 The Mint price of silver was 62d. per ounce, but by the time of Lowndes’ report, the market price was 77d.7 As a result, the silver crown piece, containing just under an ounce of silver at its full, official weight, had a tariffed, nominal value of 60d. but a market value as bullion of 77d. It was hardly surprising that the coin was disappearing from circulation. Following the proposed recoinage, a full-weight English crown would contain only about four-fifths of an ounce of silver—worth around 60d. as bullion, in line with the crown’s tariffed, nominal value and hence presenting no incentive for clipping or export. Barring any unexpected further increase in the market price of silver, the reset Mint price would remain attractive enough that silver bullion would start to be brought in for coining again, and the coin supply would recover. All in all, it was an eminently sensible and realistic solution, based on sound historical precedent. Unfortunately, it encountered an implacable opponent in the person of the most highly respected public intellectual of the age: the philosopher John Locke.
As the leading theorist of the new system of constitutional government, and the chief intellectual guardian of its principles, Locke was invited by Parliament to comment on Lowndes’ report. He responded, in December 1695, with a scathing
polemic against the proposal and the ideas underpinning it. In Locke’s view, Lowndes’ argument depended upon a fundamentally incorrect understanding of money and the monetary standard. Lowndes talked about money as if it were different from the coinage itself. This was, Locke warned, at best a confusion, and at worst a typical City smokescreen designed to conceal some no-good trickery. The reality was that money was nothing more nor less than silver itself. “Silver,” Locke began his response unequivocally, “is the Instrument and Measure of Commerce in all the Civilised and Trading Parts of the World” and “the Measure of Commerce by its quantity, which is the Measure also of its intrinsick value.”8 As for the monetary standard, that was therefore much less mysterious than Lowndes was making out. A “pound” was simply an objective reference to a definite weight of silver. The fact of the matter was that “[m]en in their Bargains contract not for denominations or sounds, but for the intrinsick value: which is the quantity of Silver by publick Authority warranted to be in pieces of such denominations.”9 Lowndes’ fanciful justification that there was some metaphysical plane on which a coin would retain its “value” despite losing 20 per cent of its silver was therefore as bare-faced and ridiculous a deceit as claiming “to lengthen a foot by dividing it into Fifteen parts, instead of Twelve” while still “calling them Inches.”10
