In late medieval and early modern England, banking was mostly the domain of goldsmiths. The wealthy merchants of London needed somewhere to store their gold and the vaults of the wily goldsmiths were the safest place. The merchants paid a fee, and the goldsmiths issued receipts certifying the quantity and purity of the metal they held. Only the original depositor could collect the stored goods.
These certificates evolved into promissory notes, redeemable to the bearer whether he was the original depositor or not, and so did the goldsmiths’ paper become currency. The goldsmith paid one rate of interest to depositors and then lent out the gold at higher rates. The notes he issued to depositors – known as running cash notes, effectively a promise to pay the bearer of the note gold or silver – were the first bank notes and the goldsmiths of London became the forerunners of its great banking tradition, creating this new money based on credit.
No surprise, the rates of interest payable on the gold the smiths lent out were high, often as high as 20%. Interest rates got so high that in 1624 King James I declared they must not exceed 8% and then in 1660 Parliament passed The Usury Act 1660 – “An Act for restraining the taking of Excessive Usury” – which reduced the maximum rate to 6%.
In that same year, Charles II was restored to the throne following years of civil war – ultimately a conflict over who had ultimate power, Parliament or the crown. Parliament won, but something like 4% of the population lost their life in the process.
Charles II was a big spender. A war monger (which king wasn’t?) almost constantly fighting the Dutch during his reign, and a notorious bon viveur – hence his nickname the Merry King – who fathered at least 12 illegitimate children. His spending habits were considerable. But Parliament had a tight grip of the amount of money he could raise through traditional means.
Charles was not a man to be held back, however. To support the Royal Household, which “needed” an annual income of £1.2 million, he persuaded Parliament to impose hearth taxes on the British people. Twice a year tax inspectors would demand entry into your home, rather in the manner of a BBC licence fee collector today, to count the number of fireplaces, and you then had a tax imposed on you. The English hated it, but it became the Crown’s largest single source of income.
Charles secured an alliance with his cousin, King Louis XIV of France, and a pension, by promising to convert to Catholicism.
But above all, he borrowed like mad. By borrowing from the goldsmiths of London, who had a virtual monopoly on banking, Charles was able to bypass Parliament. He effectively sold “tax futures” – future tax tallies to the goldsmiths at a discount, in exchange for gold now. These tax futures were recorded on sticks of wood – tally sticks. Wood for gold has never been a bad trade.
With promissory notes now payable to the bearer, the smiths were able to sell the King’s debt into the secondary market. Thus could the King raise funds for his wars against the Dutch. It was a good trade at first and the Crown would never default on its loans, thought the smiths. But there was a limit to this debt expansion: the amount of gold in London’s goldsmiths’ vaults. Eventually it ran out.
By 1671, the discount on the King’s tax debt reached 10%. New funds barely covered maturing loans. At which point that 1660 Usury Act was cited: interest rates above 6% were against the law – thus were all those recent loans made to the Crown illegal. The King’s tally sticks became worthless. The goldsmiths and their customers had “drawn the short end of the stick”, as the saying derives. They owned the King’s debt, which was illegal for him to repay.
“Gentlemen”, Charles wrote in a letter to the goldsmiths – or words to this effect – “I’m an honest man but unfortunately I am unable to pay my debts back on this occasion. Sorry – will see what I can do”.
This became known as the Great Stop of 1672. Most of London’s goldsmiths were ruined and 10,000 wealthy families in England were “financially embarrassed”. Just as the third Anglo-Dutch War was beginning, the goldsmith bankers of London ceased all further credit to the Crown, and Charles II was forced to recall Parliament to plead for funds for the 82 ships with which he wanted to attack the Dutch.
In 1673, Parliament, concerned with Charles’ alliance with the Catholic French King Louis XIV in a war against the Protestant Dutch, and fearing invasion from Catholic Ireland, declared that all office-holders must deny Catholic ‘transubstantiation’ and take Anglican Communion. Charles’ brother James refused and, suddenly, the possibility that Charles would be succeeded by a Catholic became very real in the public eye. Parliament refused to fund Charles II’s war, and it soon ended with the Second Peace of Westminster, a treaty ratified with exceptional speed and greeted with enthusiasm in both countries, perhaps most of all by commercial interests in Amsterdam and London.
To ease public fears that the royal family was too Catholic, Charles had his brother James’s daughter, Mary, marry the Protestant King William of Orange. The pair would soon become monarchs, overthrowing King James II, Charles’ heir, in the Glorious Revolution of 1687.
To ingratiate the newly crowned monarchs with the conquered people, and ‘to erect a lasting monument of their Majesties’ goodness in every hearth in the kingdom’, Parliament repealed the loathed hearth tax. But it left the new monarchs with a problem. Their largest source of revenue was gone – and the King had wars to fight, against France this time and in Ireland and Scotland, not to mention that £1.2 million cost of the Royal Household.
Charles approached the goldsmiths of London, who said no. But, in 1691, a Scottish businessman by the name of William Paterson came up with a plan for a new type of bank. Members of the public could lend the crown £1.2 million in exchange for 8% interest. A royal charter would enable the bank to operate as a joint-stock company with limited liability, and those who signed up to the scheme become shareholders. No other joint-stock banks would be permitted to issue bank notes, so the bank would have special status and considerable competitive advantage.
The company was called ‘The Governor and the Company of the Bank of England’. In 1694 Charles Montagu, 1st Earl of Halifax, enacted Paterson’s plan. That £1.2 million was raised in just 11 days from 1,268 different people.
The bank was established in an old Roman temple in Walbrook, a street in the City of London, where Mithras was worshipped. Mithras was, among other things, the Roman god of contracts.
And central banking was born.
*Dominic Frisby is the author of Daylight Robbery – How Tax Shaped The Past And Will Change The Future, out now at Amazon and all good bookstores with the audiobook, read by Dominic, on Audible and elsewhere.