The result of the bidding gave the necessary stimulus to the South Sea Company's stock, and, seeing it going up, the public at once rushed in, when the stock rose faster than ever. In a very short space of time the fever for speculation infused itself into the blood of the whole nation. The pace became so furious that the more thoughtful among the gamblers began to see the end and to sell, with the result that, upon a memorable morning, everybody wanted to dispose of his stock--and then the bubble burst.
In June, 1720, the £100 stock of the South Sea Company was rushed up to £890, and a little later it touched £1000. Then the tide turned, and, as is invariably the case, all were as anxious to sell as a few days before they had been eager to buy. Every hour intensified the panic, until at length the stock fell to £175, and the difference between the highest and lowest quotations is eloquent of the loss inflicted upon the community, for everybody who had money to invest was interested in this gigantic gamble.
Widespread misery and ruin followed. Suicide was of daily occurrence, and, after a momentary lull in the storm, popular indignation lashed itself into fury against the directors, for whom, it was openly declared, hanging was too good a fate. The Government, thoroughly alarmed, turned to the one strong man who had consistently opposed the scheme, and who, in consequence, was at that moment the most popular man in England; so Sir Robert Walpole stepped into the breach, and stemmed the tide of popular indignation and national disaster.
At first Walpole was disposed to resort to half-measures, but when it became apparent that the South Sea Company was rotten to the core and that it must go at any price, he devised a scheme by which the East India Company and the Bank of England took over £18,000,000 of South Sea stock. The Bank directors, throughout this trying period, acted with a strange lack of caution, and the situation was only saved by Walpole's better judgment.
The period was one of mad speculation, and no venture was too absurd to foist upon a public, which, until the crash came, did not display a gleam of intelligence or discernment, so blinded was it by greed. Naturally, those bankers who had advanced against South Sea stock did not escape loss, and many of the goldsmiths and private bankers were ruined by the reaction, while the Bank of England itself barely escaped. It is interesting to notice that, even in 1720, the public could only be tempted by a rising market; and it has remained true to this instinct, as, for some unaccountable reason, the "bear" is always looked upon as an undesirable kind of person.
The next disturbance of credit occurred in 1745, when the Young Pretender, "Bonnie Prince Charlie," after defeating Sir John Cope at Prestonpans, resolved to march on London, and penetrated as far as Derby. The news of his arrival there reached London on the 4th December (Black Friday), and the City was seized with so severe a panic that business was suspended. Some of the citizens actually left the country, and even the King made preparations for flight. Everybody then wished to possess himself of gold, and a run at once began upon the Bank of England, which was taken completely by surprise, and only saved the situation by resorting to the expedient of paying its notes in sixpences--a somewhat lengthy proceeding, but one which enabled it to gain time. Nobody, however, would trust a Stuart, and the panic very quickly subsided.
Learning that the Duke of Cumberland was advancing to meet him, Charles was compelled by his followers to beat a hasty retreat towards Scotland, and by the 23rd December the Highlanders had crossed the border again. In January, 1746, they defeated General Hawley at Falkirk, but in the following April the Prince lost the battle of Culloden, which dealt the final blow to the hopes of the House of Stuart.
The panics and crises between 1745 and 1857 have been discussed in Chapters I. and II. of this book--principally in Chapter II.
The Crimean War, through which this country muddled, was brought to a close in 1856, at a cost to the nation of £33,000,000; and it may perhaps be interesting to compare this sum with the £230,000,000 which has been expended in the South African struggle. Even for a Balaclava £33,000,000 seems a dear price to pay. But £230,000,000 for a Colenso! Glory makes a poor national asset.
In 1848 Lord Dalhousie carried out a policy of annexation in India in a ruthless manner, and the native princes, thirsting for revenge, insidiously propagated a rumour among the native soldiery of the East India Company to the effect that the British Government was anxious to Christianise them, knowing that the unsophisticated Hindu preferred his sacred cow to the God of his conquerors, though he had probably little faith in either.
At any rate, the princes appealed to the patriotism of the native soldiers, who, in May, 1857, replied by refusing to accept the famous "greased" cartridges, and in a few days the insurrectionary movement was ablaze in India. The massacre at Cawnpore sent a thrill of horror and indignation through the country, and Sir Colin Campbell (afterwards Lord Clyde) was ordered post haste from England to take command of the British troops. Naturally, our trade with India was disorganised; and, speculation having exceeded all bounds in America, the grave news from that country, combined with the outbreak in India, hastened on the crisis of 1857.
Quite an epidemic of crime swept through England about the middle of the nineteenth century, and many names well known in the City were smirched, whilst even the firm of Overend and Gurney, whose credit was then at its zenith, were said to have compounded a felony in order to avoid a bad debt. Financial morality, which is at all times peculiar, was at this period at its lowest ebb. So small wonder that when the American banks failed by the dozen in 1857, a feeling of distrust should make itself felt in this country, which was then engaged in a fierce struggle in India.
Merchants and houses engaged in trade with India and America began to fail, and in a very little while there was a run upon some of the banks. Then followed the collapse of the Borough Bank, and Dennistoun's of Liverpool. In Scotland the Western Bank and the City of Glasgow Bank put up their shutters; and the failure in London of Sanderson & Co., the well-known bill brokers, accentuated the grave condition of credit, forcibly reminded the public that the rotten state of the American railroads had ruined thousands of speculators in this country, and generated in the public mind a feeling of positive alarm. The result was a panic, which by 12th November culminated in a crisis. The country then looked to the Government and to the Bank of England.
Both 1855 and 1856 were years of unusually high Bank rates, and during 1857 the demand for loanable capital became so pronounced that the Bank of England, in order to protect its dwindling store of bullion, had to raise its rate still further. The year opened with six per cent. In July it fell to five-and-a-half per cent., but by 19th October it had reached eight per cent. On 5th November nine per cent. was recorded; and upon the 9th of the same month it was hurriedly raised to ten per cent. Lombard Street had then practically arrived at the end of its available resources; and demand, of course, centred itself upon the bank which held the bankers' cash balances.
The Bank of England, as usual in those days, was quite unprepared to meet a crisis, and made application for assistance to the Government. Had help then been refused, it must inevitably have closed its doors, for the reserve in its Banking Department on 13th November, 1857, had fallen to £957,000, while it was rumoured that, at the close of a particular day, the reduction was appreciably greater. In plain English, the Bank of England was practically broken.
On 12th November the Government consented, for the second time since 1844, to the suspension of the Bank Charter Act; and when it became known that the Bank of England was in a position to increase its circulation to an unlimited extent, and to advance notes against the better-class securities, the nervous tension created by the numerous failures throughout the country instantly relaxed, and in a few days a comparative calm followed the storm. Indeed, before the close of 1858 the Bank rate was down to two-and-a-half per cent.
The suspension of the Act during a crisis creates a market for securities at the Bank of England. Furthermore, at so critical a moment the Bank is the only market in existence; consequently those securities in which it decides to deal are alone saleable, and we know that it confines its advances solely to the so-called gilt-edged securities and to good bills. Of course, if the public only thought, it would instantly perceive that the more notes the Bank issues in excess of its authorised amount the less secure is its position, because the smaller is the proportion of gold in the Issue Department to its liabilities. But the British public is led; it does not think. If it did we should speedily be in the throes of a revolution.
The public thinks the Government lends its credit to the Bank, but in reality it does nothing of the kind. It simply authorises the Bank of England to break the law, and to advance notes at its discretion. However, the credit of the Bank is so good that the public, seeing that it has the "moral" support of the Government, possesses absolute confidence in its stability; and though it trusts the Bank blindly and unreasonably, that institution has earned its gratitude upon more than one occasion, and its history, if full of mistakes, certainly entitles it to this confidence.
Mention has been made of the failure of the Western Bank of Scotland in 1857. This institution, besides advancing indiscreetly at home, helped to finance the gamble in American securities; consequently, when the crisis occurred in the United States, the bank found itself saddled with huge blocks of unsaleable stocks and shares. Subsequent investigation disclosed a most discreditable state of affairs.
In 1856 the Royal British Bank, after a short life of continual fraud, came to the ground; and in 1857 the public learned that the notorious Colonel Waugh had fled to Spain with considerable sums belonging to the Eastern Banking Company. A little later, when it was discovered that bank directors and auditors who, for a consideration, would attest such statements as those issued by the Western Bank, could be found in Scotland, the public came to the conclusion that a balance sheet is worth little more than the paper upon which it is printed; and a run at once began upon the rest of the Scotch banks, which promptly arrested the panic by guaranteeing the notes of the insolvent Western Bank of Scotland. The City of Glasgow Bank, though it closed its doors temporarily during this period of fraud and distrust, succeeded in weathering the storm, only to fail badly in 1878.
The relations between England and France were severely strained in 1859. A plot was hatched in London by an Italian secret society against the life of Napoleon III., whose publication of a denunciation of British hospitality sent a thrill of passionate resentment through this country, which replied to his threat of invasion by the inception of the volunteer movement. The call met with immediate response, for nothing kindles enthusiasm so quickly as hate, and England, for the first time in her history, created an army of citizen soldiers. At the height of the frenzy there were ominous rumours, and for a little while a state of panic prevailed; but the alarm soon subsided, and the next year a commercial treaty was enacted with France.
During 1862 loanable capital was cheap, and in July that year the Bank rate sank to two per cent., whilst at no time did it exceed three per cent. With money abundant, the promoter was soon in evidence, and the speculation fever once more took possession of the public, hundreds of companies being registered under the Companies Act of 1862 within the space of a few months, until dear money began to lessen the output of limited liability concerns and the energies of that arch-enemy, the promoter. In 1861 the United States was convulsed by civil war, which caused a cessation of production there on a large scale, and produced a cotton famine in this country. Lancashire, the centre of the industry, could not obtain fresh supplies of the raw material when the ports of the Southern States were blockaded, and early in January, 1863, hundreds of thousands of operatives were out of employment. Speculation instantly received a check, and the energies of the country were concentrated upon raising huge sums for the alleviation of the distress in Lancashire--for 500,000 unemployed workers might at any moment, should their attitude become menacing, prove a danger to the State.
From 1863 to 1865 the Bank of England was undoubtedly face to face with a serious situation, and, for the first time in its history, its directors grasped the simple fact that only by maintaining a good reserve can the country be saved from panics and crises. The year 1863 was one of high Bank rates, and during the autumn of 1864 pressure upon the Bank's resources became so severe that a crisis was narrowly averted. Supplies of cotton from America having practically ceased, demand centred upon India, and the Bank of England, early in August, had to support a drain of silver thither to help pay for the cotton crop. On 4th August the Bank rate was raised to eight per cent., and again on 8th September to nine per cent., at which figure it remained until the 10th November, when it fell to eight again. The strain upon the Bank was severe, but the crises of 1847 and 1857 had taught their lesson, and by using the "Bank rate" with effect, the directors succeeded in keeping a sufficient reserve in the Banking Department.
By about the middle of 1865 capital was cheap, but, towards the end of that year, a decided stringency manifested itself, and at the beginning of 1866 many companies which had been registered under the Act of 1862 failed. The banks, whose reserves were then much smaller than now, came in for their share of distrust, and the failure of a Liverpool firm for a large amount made the public uneasy; but when it was known on the 11th May that Overend, Gurney & Co. had closed their doors, the City was seized with panic, and streams of depositors rushed to Lombard Street to withdraw their money from the banks, which, in a very short time, were paying out at a rate it was impossible to maintain; and it soon became evident that unless confidence were speedily restored the banks must break.
The Bank of England had to meet large demands from the provincial banks, for distrust was general throughout the country; consequently at such a moment the country bankers required their reserves of cash in their safes, so that they could immediately meet the demands of the more nervous of their customers should necessity arise. The Bank advanced its rate to seven per cent. on the 3rd May; to eight per cent. on the 8th of the same month; and to nine per cent. on the 11th; and, the pressure becoming more intense, application was made to the Chancellor of the Exchequer, with the result that the Bank of England was authorised to break the Act if necessary, the Government's condition being that the rate of discount should be ten per cent. while the Act was in abeyance; so, on the 12th May, the Bank rate was raised to ten per cent., where it remained until the 16th August following.
By the 16th May the reserve was reduced to £731,000, but directly it became known that the Bank was in a position to advance notes against approved securities the tension relaxed, thereby proving that the public understood the cure as little as it did the disease--for it was an act of madness to make the run, and equally as stupid not to perceive that the issuing of unconvertible notes is at the best only a quack remedy. However, the remedy proved effective, and the result enables one to realise that a nation, like an individual, is the slave of habit.
The history of the firm of Overend, Gurney & Co. makes sorry reading. Between this old-established discount house and the Bank of England there had always existed a spirit of rivalry; and when, after the crisis of 1857, the Bank stated its intention not to again assist the bill brokers during a time of panic, and only to make advances to them at those periods when the Government takes large sums off the market, a very bitter feeling sprang up between the discount houses and the Bank.
Overends, determined to show the Bank that it was not omnipotent, allowed their account at the Bank of England to run largely into credit, and one day suddenly demanded three millions in cash. Their ruse failed. Indeed it was as stupid as the resolution which goaded them into making the effort; for, of course, were the Bank to refuse to assist the bill brokers during a panic, it would only be adding fuel to the flames and increasing its own difficulties. Small wonder then that so absurd a decree created intense irritation, for, upon examination, it is evident that the Bank of England is as dependent upon the bankers' balances in a time of panic as are the bill brokers upon the institution which holds them. Then what folly to advertise such a decision!
Naturally, the Bank is not pleased at the thought that it must help its rivals over the stile, but the peculiarities of our banking system compel it to, whether it like the task or not. Therefore, it was an error of judgment on the part of the directors of the Bank to pose as the champions of the banking community, and to declare that the bill brokers must, in future, accumulate reserves of their own, when they knew quite well that the nature of their business utterly precluded such an attempt.
During a panic the Bank of England can only save itself by advancing freely against certain securities and good bills. The credit so created, however, swells the bankers' balances in its own books, and consequently the amount standing to the credit of the bankers increases appreciably. But, at such a moment, the bankers call in large sums from the bill brokers, and, unless the brokers can obtain advances from the Bank of England against good bills and gilt-edged securities, they will be unable to satisfy the demands of Lombard Street. By declining to advance to the bill brokers, the Bank, in reality, would be refusing credit to Lombard Street (bankers' balances); and, as the Bank itself could not live were Lombard Street to withdraw its balances at so critical a time, it follows that it must lend to the bill brokers in order to enable them to repay the bankers. It simply dare not refuse to assist them, for, if it did, the banks might decline to support the Bank which left them in the lurch just at the height of the storm. The bill brokers (the outside market) come within our present credit system, and if, when a state of panic prevails, they were left to their fate, in every probability the system of which they form a part would collapse with them. The brokers may not be essential to the system, but it is always dangerous to "swop horses whilst crossing a stream."
In 1865 Overend, Gurney & Co. converted their business into a joint stock company for the same reason that some private firms adopt the procedure--because their profits were decreasing--though this was not known until after the crash of 1866. During the panic of 1857 the Bank of England made large advances to Overends; but when, early in May, 1866, the firm again applied to the Bank for assistance, the request was refused. It has been suggested that the Bank's decision was prompted by malevolence, but at so crucial a moment the directors of the Bank would have hesitated to make a rod for their own backs, and, had they believed in the genuineness of Overends' application, they would have gladly granted the accommodation in order to spare themselves the panic which they knew must follow their refusal to assist a firm with liabilities of over £19,000,000. Moreover, subsequent events confirmed the judgment of the directors of the Bank of England.
When the partners of Overend, Gurney & Co. discovered that their books were full of possible bad debts, they promptly converted the firm into a company, guaranteed the book debts, and appointed directors. Shortly afterwards it was noticed that the Gurneys were realising their property, and suspicion was at once aroused, for it was naturally assumed that they had incurred heavy losses. When, therefore, the company appealed to the Bank the next year, the directors were sceptical, for though Overends still retained the entire confidence of their country customers, there undoubtedly existed a feeling of distrust in the City, and the directors of the Bank of England shared in the opinion there prevailing.
When the rash speculations of the partners were disclosed the public was loud in its abuse, and nothing short of a prosecution would satisfy it; and when, early in January, 1869, the directors of Overends were committed for trial on the gravest of charges, the crowd manifested its delight. But the comedy followed. The trial took place at the end of the year, by which time public opinion had completely veered round, and when it became known that the accused were acquitted, this same crowd cheered lustily. Small wonder that a Government, which must be well aware of the vagaries of crowds, should hesitate to conduct a public prosecution.
The panic of 1866, though the suspension of the Bank Act immediately brought relief, dealt a fearful blow to credit, and the country recovered from the shock with painful slowness. Foreigners, alarmed by the disorganisation of the London money market, began to withdraw their capital, and the Bank, in order to check this drain of gold outwards, was compelled to keep its discount rate at ten per cent. for three weary months.
By the middle of 1867 the Bank rate was at two per cent.; but even the company promoter had not the audacity to show himself, so depressed was the public spirit by the disasters of the previous year. The great railway companies, too, began to find themselves in financial straits, and their credit was so bad that they could only raise money on debenture stocks at high rates of interest, for the public then looked upon their ordinary shares as distinctly speculative holdings. As the railway directors neglected to borrow with the option of redemption at certain figures at a future date, it followed that, when their credit greatly improved at a later period, the companies were saddled with a huge drain in the shape of high interest on their debenture issues, whereas, had their directors exercised ordinary prudence, they would now be paying very much less upon their prior stocks, and consequently the dividends on their ordinary shares would be proportionately greater. Evidently, then, the interests of the shareholders were sacrificed to the holders of the debenture and preferred stocks.
As the prior stocks absorb so large a share of the profits, and, moreover, as the amount so absorbed is practically always the same, whereas the revenue is variable, it follows that the distributions on the ordinary shares fluctuate considerably. This fact, of course, has not escaped speculators, who work out the ratio of ordinary share capital to total capital; and the smaller the ratio the more inconstant will be the dividends, and the greater the movement in prices. Investors know that, should the trade of the country be improving rapidly, a certain railway will earn more; and if its share capital ratio be small, then the increase in revenue will largely swell the ordinary dividends thereupon--so they speculate for a rise.
The Franco-German war, which broke out in 1870 did not at first exercise any very great effect on the English money market, for though the Bank raised its rate to six per cent. on the 4th August that year, it was at two and a half before the end of September. Indeed, after the panic of 1866 down to the middle of 1870, scarcely a ripple disturbed the unusual calm of the money market, but the three crises since 1844 were largely accountable for that. They taught both Lombard Street and the Bank of England that caution is essential to the successful working of our banking system, and that fair reserves, however great the loss of interest incurred thereupon, are indispensable to a banker. The result of these bitter lessons may be read in the comparatively peaceful history of English banking since 1866.
In 1870 specie payments were temporarily suspended by the Bank of France, and the European demand for the precious metals had to be met by the Bank of England. A much larger amount of foreign capital, consequently, was deposited in London, which then became the Clearing House of Europe, and the accumulation of so much foreign money unquestionably made the money market more sensitive, and increased the responsibilities of the Bank, whose store in the Issue Department was then peculiarly exposed to the danger of a drain outwards.
The Franco-German war ended disastrously for France in 1871, and the vanquished had to pay a huge indemnity to the victor. France paid considerable sums to Germany by bills on England, and although Germany employed a certain proportion of the capital so obtained in the London money market, it withdrew large sums in gold, which were required for purposes of currency reform. During the latter part of 1872 the Bank rates were decidedly high, and in November, 1873, nine per cent. was recorded for about two weeks, but by December it was down to four and a half again. The Bank, no doubt, had its anxious moments during this period, for the larger the drain outwards the more dependent would be the bill brokers upon it, and the directors could not refuse to increase their advances to the brokers, because, had they done so, there would have been a panic at once.
We can now see distinctly how our system works. First, we get the bill brokers or middlemen, who, from the nature of their business, cannot afford to keep reserves, because their margin of profit is so small; and secondly there are the bankers, who keep their reserves with the Bank of England, which is thereby placed, so to speak, in the centre of the money market.
The Bank, after it was stripped of its monopoly of joint stock banking, failed for a time to understand its new environment, and it would have closed its doors three times since 1844 but for Government intervention, viz., in 1847, 1857, and 1866. However, when we remember that its directors were merchants, not trained bankers, and that the Bank had to adapt itself to entirely changed surroundings, this result is not remarkable. So little acquainted were the directors with the laws of banking that they actually believed the Act of 1844 would prove a panacea for all kinds of financial troubles; but their eyes were opened very widely indeed in 1847, and they gradually came to the common-sense conclusion that "the higher the ratio of reserve in the Banking Department the smaller is the danger of disaster to the Bank and to the country."
During 1866 the Bank was fairly well prepared, and, for the first time in its history, it met a panic in a scientific or common-sense manner, and advanced without hesitation to all would-be borrowers whose securities were good. The greatest danger the Bank has to face is the suspension or stoppage of the credit machine of which it is the heart, for if the progress of that machine be arrested, then the trade of the country must also stop, and England will be bankrupt.
So long as the machine can be kept in motion a catastrophe is impossible, and experience has taught the Bank that, during a period of pronounced distrust, this can only be done by advancing liberally against certain securities, and by a skilful use of the "Bank rate." The whole credit machine must work smoothly, and it would be madness, at such a moment, for the Bank to attempt to leave any part of the machine (the bill brokers for instance) to its fate. This is now fully recognised, and consequently a better feeling exists between the various divisions of the money market.
The credit machine is kept in motion by the workshops; therefore, during a panic money has to be advanced to discount good trade bills in order to support the workshops, for if a rumour got about that the banks were refusing the acceptances of strong firms, the pressure to borrow would immediately increase, thereby adding a fresh danger to the situation, and causing nervous depositors to rush in a body to the banks for their money.
It follows, therefore, that in order to arrest a panic, and to prevent a dangerous run upon their resources, the banks must lend freely to strong clients. In a time of financial stress the weak go to the wall, for finance is no exception to the rule that only the strong can live when a storm bursts and causes a struggle for existence. There is no room for sentiment at such a moment. The fight is bitter and to the finish. Sentiment comes in afterwards. This state of affairs is one of the curious products of modern civilisation, and, if you want to alter it, you must first alter human nature, which changes strangely little as the centuries roll on.