Part III of IV—A Brief History of World Credit & Interest Rates
by Martin A. Armstrong
1690 – 1774 AD
The eighteenth century was a period of strong economic and political growth for Britain. Constitutional parliamentary government, which had replaced the monarchy, appeared to foster great national expansion. The currency of Britain remained very stabled during the eighteenth century. There were no debasements and gold was made officially legal tender in 1717. By 1774, payments in silver were limited to 25 pounds, which effectively created a gold standard by defacto.
Nonetheless, the British government was indeed the biggest primary borrower. The national debt grew always due to war efforts. A usury limitation on interest was finally established at 6% but was later reduced to 5% in 1714. Private debt was set according to government rates and maturities. Because of this limitation of interest, private borrowings could be funded only when government demand for borrowings declined. This often created small credit crunches particularly during periods of war. The English national debt rose from 1 million pounds in 1689 to 900 million by 1800. Interest rates tended to decline on government debt from an 8% high down to 3% by the mid-1730’s. However, as government debt escalated, rates began to rise. The steepest advances came after the government floated the famous 3% consols of 1751. From 1754 onward, rates tended to rise. By the end of the eighteenth century, consols fell by 50% in price and the government was forced to pay rates as high as 6.5%.
Eighteenth century Britain was also a period of inflation and speculation. As capital concentrated once again and prosperity blossomed, speculation took the form of many strange circumstances. Insurance companies prospered during this period and the policies that they issued were the target of speculators. Life insurance was bought when one wished to gamble on another’s life. Insurance on ships was another commonplace speculation.
More organized speculation was also present. A large and liquid market had sprung up in the trade of company shares. Government often floated debt through the means of attaching lotteries. Of course, the famous South Sea Bubble took place in 1720. This was actually promoted by a government scheme to convince holders of government debt to convert it into the shares of an official trading company known as the South Sea Company. In theory, this government-sponsored company would hold the government debt as an asset. The problem was that the share prices rose from 128 pounds to 1000 pounds per share that year. Holders of debt were enticed to swap their debt for shares as they stood by and watched share prices soar. When the bubble burst, share prices collapsed back to the 135 level. The outrage was so indignant that the Chancellor of the Exchequer was imprisoned and Parliament passed the “Bubble Act” which greatly restricted the formation of any new companies.
A similar speculation, but less known, was the Mississippi Bubble. This was of French origin also involving a government sponsored trading company intended to promote trade between New Orleans and France. The venture failed to attract reputable emigrants and New Orleans remained no more than a dismal collection of wooden shacks. The entire affair turned out to be yet another stock speculation that sent many French investors into financial ruin.
Although history would like to classify these two incidents as unusual, the truth is that investors were eager for speculation of any kind. Commodities were also the target of speculation as were many shares of private companies. Both the Mississippi and South Sea stocks received the greatest attention because they were the leading speculative issues of the time. But it is important to keep in mind that speculation was not restricted to these issues and was widespread showing up even in the Americas. In fact, speculation was also widespread in Japan, which had no financial connection with that of Western Europe or America. The shogun Yoshimune banned all expensive clothing, furniture, cakes, candies, and other extravagances in an austerity decree in hopes of controlling inflation.
The words “Stock Exchange” first appeared in 1773 over the door of New Jonathan’s Coffee House when a fee was levied on admittance. Stock trading was traditionally done on the “curb” outside. Often, traders would congregate in coffeehouses. Jonathan’s was a central meeting place and served as the cradle for the London Stock Exchange which eventually moved into its own building in 1802.
Industrialization was flourishing in Britain while in France the guilds fought hard to retain their monopolies and refused to accept any new ideas. This closed mind approach in France eventually set the stage for its economic decline and British dominance. France had lost most of its colonial empire but gained somewhat as a military power in Europe. The Italians had never recovered from the defaults of France and Spain and Germany was still a group of small states restricting trade and imposing tariffs against one another.
French defaults to some extent still occurred during the eighteenth century. The previous debt issues that paid 7% to 8.5% were simply reduced by force in 1710. By this it is meant that the government simply stated that it would no longer pay the higher rates of interest. Government debt tended to yield higher rates of interest in general by 1-2% over that of good quality private issues. Therefore, in 1720 when the Mississippi Bubble arose, a similar scheme to exchange government debt for stock was fairly well received particularly since the same scheme was in effect in Britain.
The Dutch lost most of their trade as nations expanded ports. Their alliance with Britain increasingly made them the smaller partner in the pact and eventually, the Dutch gravitated more toward a center of finance than trade.
In the United States, the colonists had brought with them the English laws regarding usury that for the most part set the legal maximum rate at 6%. But this limitation on interest rates was not uniform throughout all the colonies. Massachusetts had established the maximum rate at 8% in 1661. Virginia set the legal usury rate at 5% while Pennsylvania established its rates ranging from 6% to 10%.
The invention of paper money within the western world is largely credited to the American Colonies. Although Marco Polo during the 1300’s brought back news of how the Emperors of China circulated mulberry bark paper as money, the news had little more effect upon Western minds than to serve as a humorous joke. But one of the early paper money issues in Europe came in 1661 and was issued by Stockholm’s Banco to avoid a constant movement of payments in Swedish copper plate money which was heavy and bulky to say the least.
In the Americas, paper money began as an emergency measure in 1685 in Canada when the French military payroll failed to arrive. In order to pay the troops, the intendent, Jacques Demuelles took normal playing cards and cut them into quarter sections. He then inscribed denominations, signed the scraps of paper and declared them to be legal tender as well as redeemable when the “ship came in” – which gave rise to that memorable phase. After a while, this seemed to be a fool’s game and sooner than expected, additional playing card issues emerged as money in 1686, 1690, 1691 and 1692. Payment of course was deferred from one year to the next and the scheme was suppressed for a while in 1701. However, card money continued until eventually a collapse of the monetary system in Canada took place in 1757.
The first official governmental issue of paper money began in the Province of Massachusetts Bay before the Bank of England attempted it in 1694 followed by the Bank of Scotland in 1696. But by far, America would become the greatest experiment for paper money economics.
England had adopted the policy of extracting gold and silver coin from the American Colonies and most transactions during the 17th and 18th centuries were accomplished with paper money or drafts for goods from British merchants.
The real start of this paper money experiment came in 1690 when Massachusetts Bay paid for a military expedition to Canada during King William’s War with paper money referred to as Bills of Credit. To encourage circulation, the Bills of Credit would gain you a 5% discount when used to pay your taxes. From this point on, most other Colonies followed the lead and issued paper money in payment largely for military expenses. This form of paper money was called specifically “Bills of Credit” since the Crown did not extend the right to any Colony to issue “money.” Money was a term reserved to mean a unit of circulating medium of exchange whereas the “Bills of Credit” were borrowed for a public expenditure following in the European tradition.
Of course, inflation had long since been a problem within the Colonies even before paper money came into general circulation. An example of this inflation can be seen by studying the official valuations of the coins in circulation at the time. Specifically, in 1645 Virginia had placed an official value on the Spanish dollar from 6 shillings, then down to 5sh and later back to 6sh when just in 1642 it had been circulating at the rate of 4sh. Inflation and the constant revaluation of silver Spanish dollars resulted in complaints from British merchants that culminated in the Act of Parliament in 1707 which effectively set a limit of 6sh as a maximum value that Spanish dollar could be used for in trade.
At first, paper money was generally being issued for war expenditures that came about as the result of King George’s War (1741-1748) and the French and Indian War (1754-1763). At times, the Crown itself virtually ordered the New England Colonies to cover the expenses of these wars by issuing paper money thereby avoiding the need to use gold and silver.
But during 1733, paper money began to be issued for such things as the building of courthouses, jails, lighthouses, harbors, forts and many other forms of public expenditures. In 1769, Pennsylvania issued paper money for the relief of the poor in Philadelphia.
The early part of colonial economic history began to take a much more volatile path with the invention of quasi-banks. The “loan office” was a scheme for economic manipulation as well as corruption. Commissioners supervising the loan offices were designated by the Colonial Assembly. Paper money was then issued and lent to private individuals who in turn placed their land or silver belongings up for collateral. The first loan office was set up in 1712 by South Carolina and by 1737, all other Colonies had followed with the exception of Georgia. Many loans were repayable with the notes, however, the interest was in some cases payable only in coin (hard currency). In 1741 Parliament required the immediate redemption of all such private paper money since the economy had become quite flooded with various forms of paper currency.
This period in history was filled with frequent financial panics. Of course the earliest recorded economic panic took place in 1683 but strangely enough, it was worldwide. In Japan the Prime Minister Hotta Masstoshi was assassinated and the shogun Sunayoshi was left with no able counselors. Inspired by Buddhism, Sunayoshi issued an edict that prohibited the killing of any living creature. He extended special protection and privileges to dogs and in the process sent the Japanese economy into ruin.
In 1683 Charles II compelled the City of London to surrender its charter and injected his own various aldermen and officers by royal appointment. Municipal charters throughout England were revoked in an effort to give the Tories control over municipal governments and their officers. Some defeated Whigs conspired to assassinate the king in what became known as the “Rye House” plot. The conspirators, and some falsely accused political adversaries, were put to death but the affair aided in creating a severe economic panic at the time.
Again speculation was bursting forth in many areas around the world. The first commodity futures trading actually had its humble beginnings not in Europe or America but in Japan as merchants banned together to trade rice receipts in 1690. Numerous financial panics followed the period in 1711, 1720, 1731 and in 1745. Utilizing the exchange rate for paper currency from the Massachusetts Colony, we can achieve some sense of how inflation was taking place in America which was contributing to wild speculations and the eventual economic panics.
Looking at the exchange rate for only Massachusetts, we find that accumulative inflation during this period had reached 752%. Paper money had been issued at an uncontrollable rate that had caused inflation to move in leaps and bounds.
In 1740, England had become so concerned with the depreciation of the American Colonial paper money, that each Colony was required to prepare a completely detailed report on the status of their currency. In 1749, England had actually sent sufficient English silver and copper coins to redeem the paper currency at the rate of 7.5 to 1 shilling sterling. This action aided in bringing about a temporary end to runaway inflation that had inflicted the Colonies in America. It was formalized by an act of Parliament that became effective September 29th, 1751 with the following provisions.
- No extensions, reissue or deferment in the redemption dates or amounts of existing paper money issues within the New England Colonies.
- No change in the legal tender status of existing issues.
- No relaxed enforcement or extensions of mortgage loans that were used to secure paper money issues.
- No new legal tender issues of any kind.
- No new issues of paper money for emergency expenses unless redeemable from taxes at face value plus legal interest to be paid within 5 years.
- No new issues of paper money for normal expenses unless it would be redeemable from taxes within 2 years.
The stringent controls on paper currency provided by the Act of Parliament in 1751 began to be ignored by the Colonial Assemblies. Each colony was ruled technically by a governor who had to sign the laws passed by the Assemblies. Growing resentment towards England and the Crown was building up over the 1751 Act which virtually transferred control of the currency to the Crown. Despite the fact that the Crown was just stepping into a situation that had become intolerable, this transfer of control to the Crown was not appreciated to put it mildly. The Colonial Assemblies had grown dependent upon their habit of printing money whenever they chose. Therefore, the Assemblies began to ignore the Act of 1751. When a Colonial Governor would refuse to sign their decrees to issue more money, the Assemblies were not without means of forcing him to comply. In New York, the Governor’s salary, which was paid by the Assembly, was simply not paid for over 1 year until he finally signed their bill allowing the Colony to issue more paper money. Other Colonies used the same tactics to win over their Colonial Governor’s approval for paper money issues.