By John Steele Gordon
In the endless wars between Britain and France in the 18th century, Britain had a secret weapon: It was a bank.
The concept of a national debt did not exist before the end of the 17th century. Instead, kings, in effect, borrowed money from bankers and private citizens and were personally responsible for both the interest and principal. But kings, of course, could not be dragged into court when they were in arrears, and not infrequently they simply defaulted and even repudiated the debt entirely. Being lousy credit risks, at best, kings were always charged high interest rates.
In 1672, for instance, the government of the notoriously extravagant King Charles II announced that it would not repay any principal due on a debt amounting to over £1.2 million that year but would continue to pay the interest at the rate of 6 percent. This decree, known in British history as the “Great Stop of the Exchequer,” devastated the nascent British banking community, and several went bankrupt as a result.
Even payment of interest did not begin until 1675 and soon became erratic, or worse. Despite a protracted lawsuit against the Exchequer, neither the principal nor much of the interest was ever repaid.
Eighteen years later, in 1690, France, which then had the largest navy in Europe, badly beat up a combined British and Dutch fleet at the Battle of Beachy Head. As a result, King William III wanted to radically increase the size of the Royal Navy but needed £1.5 million pounds for the task. The bankers, not surprisingly, were not interested in lending the necessary funds.
In 1691, a Scottish banker named Sir William Paterson had suggested that the government should charter a bank to handle the debts of the government, issuing negotiable bonds, both short and long term, to fund the borrowing needs of the government. As a privately owned bank, it would be much more subject to legal process than the sovereign. And the owners, putting their own capital at risk, would be much more prudent managers of the bank’s affairs.
Some historians also think that the New Englander William Phips’ success at treasure hunting made the creation of the Bank of England much easier to achieve by providing a sudden infusion of capital into the London financial market. In 1686, he had brought up from a Spanish galleon wrecked off Hispaniola in the 1640s no less than £205,536.
In 1694, Parliament passed the necessary legislation, and the Bank of England was established. It was to raise £1.2 million to fund the new navy, with no one investing more than £10,000 each. The investors ranged from merchants, to titled aristocrats, to the joint sovereigns William and Mary. The government, its credit still suspect, agreed to pay 8 percent interest, well above what today would be called the prime rate.
As the Bank of England always scrupulously met its obligation on time, the interest rate on government debt soon declined to a level far below what France had to pay as it continued to borrow the old-fashioned way. Before long, Britain had far surpassed France in naval tonnage and the Royal Navy would dominate the seas for more than the next two centuries as it built the British Empire.
By the end of the Napoleonic wars in 1815, Britain’s national debt stood at an awesome £1 billion, about twice the annual GDP of the United Kingdom. But it had won almost all the wars with France and emerged as the world’s foremost military and commercial power, thanks to its secret weapon. The reason was simple enough: As Cicero had explained two thousand years earlier, “The sinews of war are infinite money.”
