IV. The Bank Act of 1844

The Act of 1844 put into effect these proposals of the currency school. But any expectations which may have been held that the provisions of the act were sufficient to insure protection against currency disturbances were destined to meet with early disappointment. The Bank of England took too seriously the freedom from statutory regulation of its banking department under the act, and proceeded immediately to reduce its discount rate from 4 to 2½ per cent, the lowest rate in its history up to that time, and to expand its commercial discounts.

Its reserves in the banking department soon began to fall. In 1847, the public, noting the decline in these reserves, and aware that under the Act of 1844 the Bank would be unable to meet the claims of its depositors with its own notes or with specie once the reserves of the banking department had been exhausted, took alarm, and proceeded to draw out their deposits. The Bank's attempts to check the drain by rationing, successive increases in the discount rate, sale of securities, and borrowing from the market, did not succeed. On October 22, 1847, the reserves in the banking department had fallen to £2,376,472, and a panic was in full sweep in the country. The Bank was still confident that it could continue to meet its payments, but the government, in order to allay the panic, stepped in, authorized the Bank to issue notes uncovered by gold in excess of the statutory maximum, and requested the Bank to discount freely, but at a high rate of interest. The panic ceased at once, gold began to flow back to the Bank, and no issue in excess of the statutory maximum was actually made. But it had been demonstrated that under the Act of 1844 gold could be withdrawn from the Bank by means of the deposits as well as by presentation of its notes for payment in specie, and that in a period of alarm knowledge that the power of the Bank to issue notes was legally restricted could operate to promote such withdrawal. In 1857 and 1866, suspension of the Bank Act was again invoked to prevent exhaustion of the reserves in the banking department. The Act of 1844 may have established an absolute guarantee of convertibility of the note issue, subject only to the condition that the amount of notes voluntarily remaining in the hands of the public did not fall below £14,000,000. It clearly failed to guarantee adequately good management of its credit operations on the part of the Bank of England.

The necessity of suspending the Bank Act three times within twenty-five years of its enactment was disappointing to its currency school advocates, but they denied that it justified the claims of the banking school that the currency school doctrines had been erroneous and that the act was injurious in its effects. Overstone even denied that the divergent fluctuations after 1844 in the note circulation of the Bank and in its bullion holdings disproved the contention of the currency school that the Act of 1844 would automatically enforce a correspondence between these fluctuations. He was able to show that when prior to the passage of the act he had supported the rule of forcing correspondence between the bullion holdings of the Bank and the note circulation in the hands of the public, instead of between the bullion holdings of the Bank and the notes outside the issue department, he had done so only because until 1844 information was not available as to the holdings of its own notes by the Bank as “till money.” Had such information been available, he would have included notes held by the Bank in the banking department in the “circulation” whose fluctuations should be made to correspond with the fluctuations of the bullion holdings of the Bank. The Act of 1844 did guarantee absolute correspondence between the variations in the amount of notes outstanding at the issue department and the amount of bullion held by the issue department.

The great fault of the currency school was the exaggerated importance which they encouraged the public to attribute to the automatic regulation of the issue department as contributing to a proper functioning of the Bank of England as a whole. In his speech introducing the Bank Act in the House of Commons, Sir Robert Peel had stated: “With respect to the banking business of the Bank, I propose that it should be governed on precisely the same principles as would regulate any other body dealing with Bank of England notes.” In his opinion regulation of the operations of the issue department would suffice—or perhaps more accurately, would be likely to suffice—to assure sound management of the currency. In this respect Peel went further than his currency school supporters, and he later admitted that he had been overoptimistic. Torrens and Overstone had never committed themselves to the doctrine that regulation of the note issues was a remedy for all banking ills, although this was often charged against them, both by contemporary and by later critics of the currency school. They had recognized that careful management by the Bank of its discounts would be necessary if its banking department reserves were not to be exhausted through drawing down of deposits. In their discussion of the Palmer rule, they had pointed out that suitable management of its discounts was an essential element in the proper functioning of the Bank. But they had believed that the Act of 1844, by requiring segregation of part of the bullion reserve as cover for the notes, beyond achieving its primary objective of assuring convertibility of the note issue, would force the Bank to give close attention to the fluctuations in the unsegregated or marginal reserve held in the banking department, and therefore to act more promptly to check a threatening drain of gold. They now held that the difficulties of 1847 were due to mismanagement of the Bank, not to the Act of 1844, and that had it not been for the Act of 1844 the Bank would have carried its imprudence even further:

It was a case of banking mismanagement on the part of the Bank of England acting upon the community, at that moment peculiarly susceptible of alarm under vague and ignorant apprehensions of the effect of the new law ... Danger from undue exhaustion of the bullion is the evil against which the Act undertakes to protect the community; against an improper exhaustion of the banking reserve, and the consequent inconveniences, it is the duty of the Bank of England to take timely and effectual measures of precaution.

But if the currency school were prepared to admit that proper functioning of the banking system required proper management by the Bank of England of its credit operations as a whole as well as of its note issues, why did they content themselves with proposals for the regulation of the note issue only? The answer lay partly in the fact that their primary objective was guarantee of convertibility of the note issue, and this the Act of 1844 substantially accomplished. As Overstone claimed: the Act of 1844 “has preserved the convertibility of the bank note; the purpose for which it was passed, and that which alone its authors promised that it should do.” The currency school tended also to minimize or to deny the importance of bank credit in other forms than notes as a factor influencing prices, or, as in the case of Torrens, to claim that the fluctuations in the deposits were governed closely by the fluctuations in the note issues. They had a hankering also for a simple, automatic rule, and could find none suitable for governing the general credit operations of the Bank. They also had laissez-faire objections to extending legislative control of the banking system any further than seemed absolutely necessary.

The currency school held that their critics exaggerated the significance of suspension of the Bank Act. Overstone had prior to passage of the act conceded that, in case of an internal panic, suspension of the act would be desirable. In such a case, resort must be had to “that power, which all governments must necessarily possess, of exercising special interference in cases of unforeseen emergency and great state necessity.” But an explicit provision in the act authorizing its suspension in an emergency would be objectionable, for it would tend to convert into a routine and anticipated procedure what should be regarded as only an emergency measure. Later he argued that the suspensions which had occurred were of small consequence. During a panic an interval would elapse before a contraction of the note circulation would be offset by an inflow of gold from abroad: “To meet this temporary difficulty, which was purely technical and not depending upon any principle, an important provision of the Act was for a short time suspended.”

The banking school objected to the Bank Act of 1844, both that it was no remedy against overexpansion of bank credit and that overexpansion of convertible bank notes was impossible. But they never supported any proposals for legislative control of the volume of bank credit, partly because they thought it impracticable, partly because, like the currency school, they objected to such control on general laissez-faire grounds. In spite of the past record of the English banking system, which they interpreted as unfavorably as did the currency school, they apparently saw no alternative but reliance on the hope that the English bankers would in time learn to do better:

If the country banks have erred at all, it has not been in their conduct as banks of issue, but in their conduct as banks for discounts and loans; a matter altogether different and distinct, with which the legislature has no more to do than with rash speculations in corn or cotton, or improvident shipments to China or Australia.

Were it possible, by any legislative proceeding, to restrain effectually the errors and extravagances of credit, that would be the true course to a really beneficial reform of our banking system. But these errors and extravagances are unfortunately rather beyond the pale of legislation, and can only be touched by it incidentally, or by a sort of interference which would be more vexatious and intolerable than even the evil which it sought to correct.

The banking school were not willing to concede any merit whatsoever to the Act of 1844. They either denied that it would force the Bank to contract its issues more promptly in case of an external drain, or, if they granted this, they denied that this was an advantage. John Stuart Mill took an intermediate position. While in general hostile to the Act of 1844, he conceded that when an external drain took place, the act forced upon the Bank a prompter contraction of credit than it might carry out in the absence of the act. But he held that where the drain was due to a temporary factor and would soon cease of its own accord, such contraction was undesirable. The act, moreover, hindered the Bank from taking the steps which would give relief when a crisis had already occurred.