Scottish Banks and the Bank Restriction, 1797-1821, Part 1

free banking, Scottish free banking, banking regulation, Bank of England

From the beginning, there is one embarrassing and evident fact that Professor White has to cope with: that "free" Scottish banks suspended specie payment when England did, in 1797, and, like England, maintained that suspension until 1821. Free banks are not supposed to be able to, or want to, suspend specie payment, thereby violating the property rights of their depositors and noteholders, while they themselves are permitted to continue in business and force payment upon their debtors. …White correctly notes that the suspension was illegal under Scottish law, adding that it was 'curious' that their actions were not challenged in court. Not so curious, if we realize that the suspension obviously had the British government's tacit consent.

Murray Rothbard, "The Myth of Free Banking in Scotland"

Back in April, while Bob Murphy and I were debating whether fractional reserve banking poses a threat to market stability, Bob asked whether it was the case that, despite not having had Parliament's permission to do so, the Scottish banks joined the Bank of England in restricting specie payments between 1797 and 1821. The answer, I said, was that they had indeed done so. I also pointed out that, although the Scottish banks' decision was presumably illegal, the Scottish public appeared to go along with it.

In this and a subsequent post, I plan to delve more deeply into the story of the Scottish bank suspension, so as to offer more complete and accurate answers to Bob's questions, and to answer as well other important questions that the restriction episode raises. If the British government didn't authorize a Scottish suspension of payments, did it otherwise alter the rights of holders of claims against the Scottish banks? If those banks refused to pay their notes in specie despite being obliged to do so, why was no Scottish bank ever taken to court? To what extent, and in what fashion, were Scottish bank creditors harmed by the Scottish bankers' actions? Should those actions prevent us from regarding the pre-1845 Scottish banking system as an informative case study of free banking? Does the Scottish suspension suggest that fractional reserve banking is, inconsistent with genuine freedom in banking, including the consistent honoring of bank customers' property rights?

In this post, I'll first review the events leading to the passage of the Bank Restriction Act. Then I'll discuss how that act altered the legal rights of Scottish bank creditors. Finally I'll propose an explanation for the fact that no Scottish banks were sued for suspending payment. In Part 2 I'll consider the adverse effects of the Scottish suspension on the Scottish public. The restriction's main victims, I plan to argue, were tradespeople and others whose livelihood depended upon ready access to small change. But their plight, far from enduring throughout the full period of the restriction, was confined to its opening months. Finally, in Part 3, I'll argue that the Scottish restriction does not, after all, warrant any major revision of claims that Larry White and I and other members of the "modern free banking school" have made regarding the implications of  unrestricted freedom in banking. On the contrary: to the extent that Scottish bankers were guilty of "violating the property rights of their depositors and note holders," the fault lay mainly, not with freedom banking, but with provisions of the 1765 Scottish Bank Notes Act that placed unwise and unwarranted limits upon that freedom.

The Bank Restriction

The vast sums the Bank of England had been compelled to advance to the government from the outset of the Napoleonic Wars, together with persistent fears of a French invasion, had been draining it of reserves for some time when, in late February, 1797, news that a French fleet had landed in Wales threatened to carry it across the brink. Upon being so notified by the Bank's Directors, William Pitt prevailed upon the King to hold a meeting of the Privy Council, the result of which was an Order of Council prohibiting the Bank from issuing any more specie in exchange for its notes "until the sense of Parliament could be taken and measures adopted for maintaining the means of circulation." Parliament's "sense" was in turn taken and eventually embodied in legislation, known as the Bank Restriction Act, passed on May 3, 1797, exempting the Bank of England from the obligation to pay its notes in specie. Shortly afterwards a similar exemption was granted to the Bank of Ireland. These initial exemptions were to be repeatedly renewed throughout the courts of the Napoleonic wars, and for several years afterwards, until the two banks were at long last compelled to fully renew specie payments in 1821.

Because the Restriction Acts applied only to the Bank of England and the Bank of Ireland, they did not expressly contravene the obligation of other banks in the United Kingdom to pay their notes in specie. Nor did either law make Bank of England notes a legal tender. It's therefore tempting to suppose, as most commentators have done, that the Acts did not in any way relieve other banks, including those in Scotland, of their obligation to pay their own liabilities, and their circulating notes especially, in specie. But the truth isn't quite so simple.

As Frank Fetter explains in his very good 1950 article on the subject, although in drafting the English Restriction Act Parliament recoiled at the prospect of declaring Bank of England notes legal tender, it did provide that they "shall be deemed payments in cash if made and accepted as such." What's more, the act declared that anyone tendering such notes in payment, bankers included, "was to be protected from arrest for debt." Instead, "The creditor had the option of refusing to accept the notes and then taking legal action against the debtor to compel payment in legal tender." In other words, the creditor of a bank other than the Bank of England or Bank of Ireland might insist upon payment of a note in specie, but would in that case be obliged, as Pitt explained in justifying the clause in question to Parliament, to wait for the "process of law [to] take its course to the attainment of judgement."

No More Summary Diligence

So far as Scottish bank creditors were concerned, the effect of the Bank Restriction Act was to deprive them of the right to "summary diligence," a procedure in Scots law "whereby certain constituted obligations can be enforced without the need to apply to a court." Because the act also made the act of receiving Bank of England notes in lieu of specie tantamount to the extinction of the debt for which the notes were paid, it confronted anyone seeking to redeem a Scottish banknote with a relatively stark choice: either accept Bank of England notes in lieu of specie, or refuse payment and initiate a legal process that might at very least mean a considerable delay in payment. However, Parliament did not otherwise alter Scottish banks' legal obligations. That is, it did not supply any grounds for their clients to suppose that, if a suit were brought, it would only result in a verdict in the bankers' favor.

Because no Scottish banker was actually sued for refusing payment in specie during the course of the Bank Restriction, we don't know what verdict a Scottish court would have reached in the event of such a suit. However, in 1801 a suit was brought, by one Mr. Grigby, against an English country bank, Oakes and Co., and that suit resulted in a verdict for the plaintiff. As it plainly illustrates the court's refusal to bend the law in a bank's favor, by second-guessing the preferences of the British government or otherwise, the opinion in that case, as rendered by Chief Justice Lord Alvanley, at the Court of Common Pleas, with which all the other justices concurred, is worth quoting at length — and all the more so given Alvanley's evident lack of sympathy for the plaintiff:

Are we then to say [Alvanley asks], that the Legislature has enacted that which the provisions of the [Restriction] act do not warrant? If we were at liberty to refer to our own private knowledge of the language that was held in Parliament while this act was pending, no doubt could be entertained upon the subject. We know that it was very much canvassed by many persons at that time, whether or not the Legislature ought to go the length of declaring bank notes a good legal tender? If therefore it had been intended by the Legislature so to make them, that intention would have been expressed in such clear terms that no question could have arisen upon the subject. Indeed, it is expressly provided in the 2d section of the act, that if the Governor and Company of the Bank of England, shall be sued on any of their notes, or for any sum of money, payment of which in their notes the party suing refuses to accept, they [the Bank] may apply to the Court in which such proceedings are instituted to stay proceedings during such time as they are restricted from paying in cash. But with respect to individuals it was not intended to prevent any creditor who should be so disposed from captiously demanding a payment in money, though such a creditor is deprived of the benefit of arresting his debtor. Thank God few such creditors as the present Plaintiff have been found since the passing of the act! But yet whatever inconveniences may arise, and to whatever length they may go, Parliament, and not this Court, must be applied to for a remedy.[1]

If the British Government could not prevent England's Court of Common Pleas from rendering such a verdict, it's hardly likely to have held greater sway in any Scottish court. There seems to be no basis, therefore, for Rothbard's claim that the lack of legal actions in response to Scottish banks' suspension of specie payments was a reflection of creditors' belief that the suspension enjoyed "the British government's tacit consent." On the contrary: in refusing to make Bank of England notes legal tender, while explicitly absolving only the Bank of England and the Bank of Ireland from any obligation to pay their notes in specie, Parliament knowingly left all other British banks in the lurch. Their creditors had to sue for their gold and silver; but had any bank actually been sued, it would have found itself with no clear legal grounds by which to defend itself.

Why No Lawsuits?

If a Scottish bank might have been successfully sued for failing to pay its notes in specie, why were there no such suits? William Cobbett, a virulent critic of paper money generally, and of the Scottish banking system in particular, insisted that the Scottish public simply had no choice. Although the people of Scotland may not have been "compelled by law"  to accept Bank of England notes, he wrote, they were "compelled by circumstances … as powerful as if by law itself; and, in a way exactly similar as if the whole mass of paper-money had been made a legal tender ever since the year 1797."[2]

But what, precisely, were those "circumstances"? The trouble and delays that suing involved may well have deterred many. But it can't explain why some relatively well-heeled creditor didn't bother to press a claim, and especially so once gold commanded a substantial premium over paper, as it did after 1808.

I believe that the lack of lawsuits stems from the fact that many Scottish bank creditors were also debtors to their banks: although they held bank notes and deposit balances, they also depended on "cash credits" granted to them by their bankers — lines of credit, with interest charged only upon sums actually drawn. Most outstanding Scottish bank notes and deposit balances were the by-products of the banks' practice of granting such credits, so that almost all Scottish bank obligations to the money-holding public had as their counterpart like obligations of that public to the Scottish banks. Perhaps owing to his penchant for confusing banks with warehouses, Rothbard, in claiming that, by suspending specie payments, Scottish bankers systematically violated their patrons' property rights "while they themselves are permitted to continue in business and force payment upon their debtors," overlooks the fact that those patrons were as likely to be in debt to their bankers as vice versa, as well as the fact that the Scottish banks had always allowed their debtors to settle debts with them in either Scottish or Bank of England paper rather than gold or silver.

That so many Scottish citizens, including the vast majority of ordinary merchants and traders, relied upon cash credits, and that their banks could not possibly have continued to grant such credits were they systematically called upon to pay their notes in specie, gave the Scottish public a powerful motive for refraining from insisting upon such payments, and for otherwise accepting the Scottish banks' decision to suspend specie payments in good stride. For besides allowing the bankers to settle claims against them in Bank of England notes, it allowed them to settle their own debts to the banks with banknotes rather than gold. In short, Scotland's decision to join other parts of Great Britain in switching to a paper (Bank of England note) standard, instead of having simply been imposed upon the Scottish public against its will, is better understood as a cooperative solution to a problem — the absolute lack of specie — facing bankers and their creditors alike.

The suspension's cooperative nature was, indeed, made explicit shortly after the bankers announced their plans, when many of Edinburgh's prominent citizens gathered at a meeting convened by that city's  Lord Provost and attended by many other officials, including the Lord President of the Court of Session, the Lord Chief Baron of Exchequer, the Lord Advocate, and the Sheriff of Edinburgh. Those present "unanimously resolved to accept the notes of the Scotch banks as hitherto and to support their credit." Notice of this resolution was afterwards "inserted in all the newspapers and circulated throughout the country."[3]

That there was widespread support for the Scottish bank suspension did not, however, mean that the suspension left the Scottish public unscathed. Just how it harmed people, and whether its having done so constitutes a black mark either against the Scottish system or against fractional reserve banking, are questions I'll answer in the follow-ups.


[1] See Grigby v. Oakes et al., November 19th, 1801. In Reports of Cases Argued and Determined in the Courts of Common Pleas etc., Volume 2, pp. 526ff.

[2] Cobbett, it bears noting, is hardly an entirely objective observer. He had it in for all forms of paper money. "Ever since that hellish compound word, Paper-money was understood by me," he wrote, "I have wished for the destruction of the accursed thing; I have applauded every measure that tended to produce its destruction, and censured every measure having a tendency to preserve it." What's more he despised the Scottish banking system, observing that "There never was a thing under the sun to which a greater number of God's curses directly apply," that system having harbored "oppression, tyranny, fraud, monopoly, and every cursed art by which the avaricious take from the food and the raiment of the needy." See Cobbett's Political Register, June 14, 1828, p. 764.

[3] [Henry Dunning MacLeod], "History of Banking in Scotland," The Bankers' Magazine 37 (1) (January 1877), pp. 33-4. For further details see Sir William Forbes, Memoirs of a Banking House (London and Edinburgh: William and Robert Chambers, 1860), p. 83.