The Mystery of Banking

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The Mystery of Banking
Chapter Twelve.qxp 8/4/2008 11:38 AM Page 178

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From 27 July 1694, when the books were opened with the
words “
Laus Deo
in London,” the Bank was surrounded
with an aura of prestige and mystery which has never
entirely evaporated—a sense that it was not as other busi-
nesses, yet as businesslike as any. It was like some great ship,
with its watch of directors always on duty during its busi-
ness hours, and its studied display of operational efficiency.
The un-English title of “director,” the Italianate contraction
“
Compa
” on its notes, were deliberate touches of the exotic
and modern, showing those who handled the new currency
or dealt with the Bank that, though this was something new
in England, it had borrowed its tradition from the glorious
banks of Genoa and Amsterdam. And although the Bank
had grown from, and continued as the preserve of, a partic-
ular business syndicate who as a group and as individuals
had many other interests, it bred and drew a particular type
of man, capable of sustaining its gravity.
1
William Paterson urged that the English government grant his
Bank notes legal tender power, which would have meant that
everyone would be compelled to accept them in payment of
money debt, much as Bank of England or Federal Reserve notes
are legal tender today. The British government refused, believing
that this was going too far, but Parliament did give the new Bank
the advantage of holding all government deposits, as well as the
power to issue new notes to pay for the government debt. 
The Bank of England promptly issued the enormous sum of
£760,000, most of which was used to buy government debt. This
had an immediate and considerable inflationary effect, and in the
short span of two years, the Bank of England was insolvent after
a bank run, an insolvency gleefully abetted by its competitors, the
private goldsmiths, who were happy to return to it the swollen
Bank of England notes for redemption in specie. 
It was at this point that a fateful decision was made, one
which set a grave and mischievous precedent for both British and
The Origins of Central Banking
179
1
John Carswell, 
The South Sea Bubble
(Stanford, Calif.: Stanford Uni-
versity Press, 1960), pp. 27–28.
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American banking. In May 1696, the English government simply
allowed the Bank of England to “suspend specie payment”—that
is, to refuse to pay its contractual obligations of redeeming its
notes in gold—yet to continue in operation, issuing notes and
enforcing payments upon its 
own
debtors. The Bank of England
suspended specie payment, and its notes promptly fell to a 20 per-
cent discount against specie, since no one knew if the Bank would
ever resume payment in gold. 
The straits of the Bank of England were shown in an account
submitted at the end of 1696, when its notes outstanding were
£765,000, backed by only £36,000 in cash. In those days, few
noteholders were willing to sit still and hold notes when there
was such a low fraction of cash. 
Specie payments resumed two years later, but the rest of the
early history of the Bank of England was a shameful record of
periodic suspensions of specie payment, despite an ever-increas-
ing set of special privileges conferred upon it by the British gov-
ernment. 
In 1696, for example, the Whig magnates who ran the Bank
of England had a scare: the specter of competition. The Tories
tried to establish a competing National Land Bank, and almost
succeeded in doing so. As one historian writes, “Free trade in
banking seemed a possibility. Bank of England stock fell on the
market.”
2
Though the Land Bank failed, the Bank of England moved
quickly. The following year, it induced Parliament to pass a law
prohibiting any new corporate bank from being established in
England. Furthermore, counterfeiting of Bank of England notes
was now made punishable by death. As Sir John Clapham, in his