#33 Finance, Banking and the Gold Standard: a Privatised National Money Market

Preface

Money was to become the lifeblood of the industrialised world. This lifeblood would require a heart to pump the money around. An understanding of money, finance and banking is at the very centre of understanding our capitalist world to this day. In the 19th century, the monetary system was the servant of industry, but over time the monetary system became the master of industry. This blog focuses on money, markets, and banking in the 19th century.

Finance and Banking

You can find accounts of the finance, banking, and the Gold Standard in all 19th century textbooks. Too often they are treated merely as a technical subject as part of the monetary system, which of course they were. But the Gold Standard was much more; it was the political ace of the dominant world power. The Gold Standard attached to the pound sterling was both the symbol of global power and the actual tool to control the world. Today, and since 1944, the US dollar has played a parallel role in world affairs.

Finance and banking are the essential prerequisites of all long-distance trade. Banking was a part of the early silk trade. Kings needed banks to lend them money to go to war. The problem for Europeans was that interest was outlawed before the Reformation. Monarchs, in Europe, had often invited Jewish bankers to their kingdoms when they needed money for war. After the Reformation, merchants trading in slaves, cotton and sugar were the new rich; some had set themselves up as bankers, hence the name ‘merchant banks’. By the beginning of the 19th century, Jewish and Protestant bankers dominated the scene in London, Paris, and Amsterdam, the centres of international commerce and trade.

A market in money was essential for an industrial society in the 19th century. Industrialisation required a financial infrastructure. Industrialisation would have been impossible without the parallel growth of the financial industry. Governments too needed the financial industry to lend them money for any overseas activity. This became the role of the ‘merchant banks’, who were able to determine what activity government could or could not do outside its shores. The digging of the Suez Canal in the middle of the 19th century was only possible with borrowed merchant bank money.

European industrialisation and global expansion came together during this century:

1.     First came the creation of national central Banks (1694 in Britain, 1800, the Banque de Franc, 1814 De Nederlandsche Bank NV (DNB)  The Federal Reserve in the USA 1913)

2.     Second, the growth of private banks and national money markets.

3.     Lastly, an international system of exchange, which came to be known under the rubric of the Gold Standard

The growth of banking and finance is best symbolised as a blood steam system. Industrialisation needed money: money to finance the factories, money for daily purposes to run the factory. The central banks became the heart of the system, pumping money around the private banks, which in turn lent money to factory owners around the country. From the earliest days of the first monopoly companies in the 16th century, finance had been crucial.

All the colonising states in the 17th century had developed central banks alongside Joint Stock Companies[i]. From their inception, the central banks were state banks, and the Joint Stock Company was the vehicle through which private individuals invested in ‘shares’, to finance the activities of the company.

Central banks have been the historical centre of all capitalist banking. The central bank from the beginning became the bank of the nation-state. Each of the colonising nations created similar national banking structures. The first to be created was the Netherlands central bank set up in 1609: the Bank of Amsterdam (which became De Netherlandsche Bank in 1814). Britain’s first central bank was set up in 1694; Frances, the Banque de France in 1716, and the USA in 1791. The State Bank of the Russian Empire was created by Emperor Peter III in 1762, modelled on the Bank of England, and implemented in 1768 to issue paper money. The first fully central banking body in Russia was established in1860: The State Bank (GosBank) of the Russian Empire (Russian: Государственный банк Российской Империи).

Each central bank was secured by its government, and each had several key functions:

1.     They had a monopoly over money creation and issued their own notes.

2.     Each government used its central bank at the same time as using it to borrow money.

3.     Historically they issued bullion, gold, and silver (the only common currency) for international trade until the creation of the Gold Standard.

4.     They provided loans to other private banks.

5.     The central bank was designed to create financial stability and structure to the system of money. Each country's central bank changed and was modified by its own nation’s circumstances.

A Privatised National Money Market

Alongside each country’s central bank arose a market to buy and sell money which provided short term and long-term loans. The idea of a free market in money was less controversial than it had been in terms of a labour market. The problem in the 19th century was then, as it is now, how best to control money flows.

These banks and their directors were powerful men. They sat on the boards of all the big companies and provided expertise on savings, insurance, and finance. They engineered amalgamations, reduced competition, and raised non-competitive prices wherever possible.

In Britain, much of industry was financed from private savings; but in the USA, Germany, and Italy new industries were financed through public bonds secured by these banks. They were investment banks for government and large-scale business. The stock exchanges in the 19th century bought and sold these bonds rather than securities, like today.

The money market developed into a complex system of institutions that provided long-term loans for capital projects at home and abroad, and short-term loans for every conceivable domestic project. Monetary instruments were created for diverse purposes, bills of exchange, mortgages and so on, from which loans could be created.

Throughout the 19th century, monetary markets in Europe were lending money for capital projects across the world. British banks lent money for the new railway companies in the USA. Both French and British companies lent money to build the Suez Canal in the 1860s; and when the Egyptians defaulted on their loan, they requested their nation’s navies to intervene and invade.

Germany developed local regional banks. Specialised mortgage banks lent money for housing, and both the French and British developed colonial banks which had monopolies in their colonial territories.

The banking system thus provided money in many different shapes and forms across the new industrialising system, for international trade and national industry. A subsidiary but important role of this structure was to provide avenues for the wealthy to invest. The old feudal lords and knights had from the earliest days in the 17th century bought shares in the new stock companies. New sources of money had arisen from the slave trade with all the surrounding activities such as boat building. As the money markets grew, so the wealthy increased their wealth. As the 19th century progressed, so the divergence between the rich and poor increased, becoming one of the chief characteristics of the 19th century.

The developing monetary system had created a circular mechanism for moving money around the entire industrialising global system.

The Gold Standard

Industrialisation and the financial structures had moved and grown side by side. Finance for international trade had always been problematic; every political domain had used its currency. As mentioned above, only gold or silver were global common currencies recognised across the world. Gold and silver offer traders of commodities security of exchange.

Traders, whether domestic or overseas, have always needed certain basics:

• They needed “security” to move their goods from A to B; that meant secure trade routes.

• They needed “partners” whom they could trust at either end; that normally meant family living in different parts of the world.

• They needed a “currency” that would hold its value.

Whether you examine traders 1000 years ago along the Silk route or today, these three maxims hold firm. The Gold Standard became the secure currency in the 19th century: the system of international monetary exchange. No trader has ever wished to carry gold or silver bullion, as it is heavy, bulky, and likely to be stolen. But if a trader had a paper currency that was as good as gold and could in extremis be exchanged for a given weight of gold, that became the Gold Standard. The paper currency - the pound sterling - became the world's international trading currency in exchange for a weight in gold. This is what The Bank of England offered traders in 1844, the date when they offered gold in lieu of their banknotes. The British central bank agreed to exchange a given weight of gold for a sterling note. The global Gold Standard became established in 1844, and Britain’s sterling was now the currency of choice for all international trade. The British central bank rapidly built up its stocks of gold and became the world’s banker throughout the 19th century.

But why the British? Carroll Quigley explains this succinctly:

Britain took the old disorganised and localised methods of handling money and credit and organised them into an integrated system on an International basis... The centre of that system was in London with offshoots in Paris and New York.... he asks why London? it had an integrated banking system... had the greatest volume of saving... an oligarchic social structure reflected in its concentrated landownership and limited access to educational opportunities which provided a very inequitable distribution of incomes, with surpluses coming to the control of a small energetic upper class... The upper class was aristocratic, not nobles, though based on tradition, was willing to recruit money and ability.... American heiresses and central European Jews to its ranks... lastly was the skill in financial manipulation on the international scene through a small group of merchant bankers.

- Tragedy and Hope as History of the World in Our Time, The MacMillan Company, New Millennium Edition 1966, page 37.

The Gold Standard was an enormous bonus for the British exchequer. So long as sterling was tied to gold, the volume of sterling in circulation at one time was limited by their stock of gold. As the exchequer was receiving gold from all over the world, the bank was able to print significantly more pound notes than any other country. The Gold Standard created a stable currency with limited inflation. It also required a world at Peace.  London, and particularly the City of London, during the 19th century, became the primary banking centre of the world. The edifice today, euphemistically called "The City", was given a huge boost in the 19th century with the creation of the Gold Standard. At the time, the City became the largest money market in the world.

The Gold Standard lasted until 1914 when Britain went to war. Then the demand for importing munitions grossly exceeded the volume of sterling at the Bank of England, limited by gold. Britain came off the Gold Standard to fight the war. At the beginning of the war, the Bank of England was replete with gold. But during the war, the gold was gone, used to buy armaments from the USA. By 1919, the British government’s highest priority was to get back to the Gold Standard: a priority higher than finding jobs for the men and women who had fought the war, and a clear reflection of class interests over the needs of their people.

The war broke the 19th century international monetary system. No-one realised this fact at the time, but a major cause of the economic turbulence of the 20 years between the two world wars was a failed international system of exchange.

The British central bank came back onto the Gold Standard in fits and starts but came off the Gold Standard again in 1939 forever.

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Suggested Reading

The Gold Standard:

You can find accounts of the Gold Standard in all 19th century textbooks. Too often it is treated merely as a technical subject as part of the monetary system, which of course it was. But the Gold Standard was much more; it was the political ace of the dominant world power. See Polanyi, The Great Transformation; in chapters 13 and 14, see the role of the Chancellor of the Bank England.

See Carroll Quigley: Tragedy and Hope as History of the World in Our Time, The MacMillan Company, New Millennium Edition 1966, who is very good on this complex subject.

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Maps

[i] A Joint Stock Company was an ingenious device that allowed wealthy people to buy shares created by the Company.  The value of the shares went up and down according to the demand for the shares and the success of the company to create profits.

Thumbnail Image: Bank of England Gold Vaults, CC BY-ND 2.0 Bank of England via Flickr.

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