Walter Bagehot (1826-1877) was the most famous editor of The Economist. (His last name, by the way, is pronounced “BADGE-it.”) For his wisdom on financial matters, he was dubbed “the spare chancellor,” a reference to the Chancellor of the Exchequer, the British minister of finance. His book Lombard Street (1873), named after the English equivalent of Wall Street, criticized the Bank of England for not using its powers to alleviate financial crises. Bagehot argued that the Bank’s monopoly position gave it both the responsibility and the ability to do so, and that the Bank should not conduct itself as if it were an ordinary commercial bank.
For its explanation of how the Bank of England should act, Lombard Street became the foundation document of modern central banking. As I explained in an earlier post, Henry Thornton had anticipated some of Bagehot’s ideas about 70 years earlier, but by the time of Lombard Street Thornton’s monetary thought had faded into obscurity, and would not be rediscovered for another half-century. The Bank of England followed Bagehot’s prescription during the worldwide financial crisis that occurred later in 1873, establishing a pattern that other central banks would imitate.
It is worth recalling, though, that Bagehot did not view central banking as the natural monetary system. Here are his words:
We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system—that which would have sprung up if Government had let banking alone—is that of many banks of equal or not altogether unequal size. In all other trades competition brings the traders to a rough approximate equality. In cotton spinning, no single firm far and permanently outstrips the others. There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either. In Manchester, in Liverpool, and all through England, we have a great number of banks, each with a business more or less good, but we have no single bank with any sort of predominance; nor is there any such bank in Scotland. In the new world of Joint Stock Banks outside the Bank of England, we see much the same phenomenon. One or more get for a time a better business than the others, but no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping. A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without.
I shall be at once asked—Do you propose a revolution? Do you propose to abandon the one-reserve system, and create anew a many-reserve system? My plain answer is that I do not propose it. I know it would be childish. Credit in business is like loyalty in Government. You must take what you can find of it, and work with it if possible. A theorist may easily map out a scheme of Government in which Queen Victoria could be dispensed with. He may make a theory that, since we admit and we know that the House of Commons is the real sovereign, any other sovereign is superfluous; but for practical purposes, it is not even worth while to examine these arguments. Queen Victoria is loyally obeyed—without doubt, and without reasoning—by millions of human beings. If those millions began to argue, it would not be easy to persuade them to obey Queen Victoria, or anything else.
Those who believe Bagehot thought that “there were responsibilities in emergent capitalism that only governments could assume, centralized control of the banking system chief among them” should be aware of this passage. And given that the Queen of England no longer reigns over millions of square miles teeming with hundreds of millions of subjects, but merely over the 80th largest country in the world plus some tiny outlying islands and a patch of frozen wasteland in Antarctica, we should consider that a return “the natural system” of free banking is likewise more possible than Bagehot imagined.
Concerning my last post, stating that central banking is a form of central planning, note that I did not state that it is the whole of central planning. As a commentator remarked, one of the ten key economic policy measures to implement communism that the Communist Manifesto proposed was “centralization of credit in the hands of the State, by means of a central bank with State capital and an exclusive monopoly.” Marx and Engels had in mind what was later called a monobank system, unifying central and commercial banking functions under one management. A central bank that is not also a monopoly commercial bank does not go nearly as far as Marx and Engels would have liked, but within its sphere, it is undoubtedly a form of central planning. And it is not like a government monopoly of, say, tobacco sales because monetary policy has effects that pervade throughout the economy, rather than being confined to a single industry.