By John Steele Gordon
The Bank of England, the model for all subsequent central banks, was founded in 1694. But it did not come into existence in order to guard the money supply or to provide discipline for the banking system as a whole. Instead, it came into existence because of a series of naval disasters that revealed the deficiencies of the Royal Navy and the threat to the rapidly expanding English overseas commerce that it represented.
In 1667, during the Second Anglo-Dutch War, King Charles II had been forced by lack of money to lay up most of the navy at Medway, near where the River Thames meets the sea. The Dutch, while peace negotiations were already underway, decided to attack. They took the fort guarding the Medway and then broke the massive chain that had been placed across the river. Fifteen English ships were destroyed, either by being captured or by being scuttled in a vain attempt to bottle up the Dutch fleet. Three more English ships were then burned and the largest of them all, HMS Royal Charles, was towed back to the Netherlands in triumph. It was the greatest defeat in the long history of the Royal Navy.
In 1690, the French badly defeated a combined Anglo-Dutch fleet at the Battle of Beachy Head and, for awhile, had naval superiority in the Channel. Worse was to come.
On June 17, 1693, a huge English fleet of 400 merchant ships, headed for the Mediterranean, was attacked by the French off the southwest coast of Portugal. The small Royal Navy escort tried its best, but almost 100 ships were captured by the French and the rest driven into Spanish ports. The financial loss was over £1 million, a vast sum at the end of the 17th century, and a major financial panic ensued.
Clearly the Royal Navy needed to be both enlarged and better funded in order to ensure the success of both England’s political objectives and its mercantile interests. But how to find the money? Kings had long had very poor credit ratings and so were charged very high interest rates. King William III had found it impossible to raise the £1.2 million needed.
As people were unwilling to lend to the government, it was decided to get subscribers to the loan by making them shareholders in a corporation, called the Governor and Company of the Bank of England. It would then lend the money to the government at 8 percent, taking government bonds in exchange. These bonds could be sold to the public, raising additional funds. In addition, the corporation was put in charge of the governments balances and was allowed to issue banknotes, the only limited liability corporation allowed to do so.
The new corporation raised the £1.2 million in just 12 days. Half of that money was used to rebuild the navy, which soon became the largest in the world. It would remain the largest for more than two centuries, as Britain’s commercial interests and empire spread around the globe.
Building up the navy also stimulated British industry and agriculture. But the most important effect was the creation of the first modern national debt. Once people had faith in the soundness of government bonds, they were more than happy to use their surplus capital to buy the government bonds, bringing millions in capital out of hiding.
The ability of Britain to borrow large sums at low rates turned out to be the secret weapon behind its many victories in the endless wars of 18th century against France and Spain. It was the Bank of England and the British national debt that made Great Britain a superpower.
