Atanu Dey On India's Development

Keith Hudson on how the Western Economies Will be Saved


My friend Keith Hudson gave me permission to quote a recent piece of his in full. He presents an historical perspective to the present global financial conditions, thus helping our comprehension of what’s going on and what is needed to fix the broken bits. Read, enjoy, and pass it on.

Where are the rich London merchants?

by Keith Hudson

The likelihood is that the economies of Western Europe and America, now facing disaster, will be ultimately saved in a similar way to how the English economy was saved in 1694. Well . . . to be correct, it wasn’t so much that England’s economy was saved in 1694, but England’s very existence as an independent nation. At that time, the French government, fancying the wealth of England that was just beginning to industrialize, was massing troops on its side of the Channel and was imminently threatening to invade. Taxation being too slow to collect, King William’s government suddenly found itself needing money to raise an army and build more ships as quickly as possible.

However, there was a problem. Although there were two or three hundred extremely rich international merchant traders and goldsmiths in London with more than enough money to equip several armies they were unsure of the stability and probity of King William’s Government. In living memory (1672) they’d been bitten once before when King Charles II had reneged on his debts to some of them. However, they themselves faced being ruined if the dreaded French invaded so they had to devise a plan.

It was already the case that, for mutual everyday help, the London merchants were already grouped together in what can be called proto-banks (also known as bill brokers or discount houses). So long as they could trust one another, individuals within and between these groups could create and exchange credit by means of writing promissory notes to one another, balancing up with actual cash on clearing days. On this occasion, some of the groups coalesced (over 40 individuals altogether) and decided to form a ‘super-group’ which they called the Bank of England. They offered to lend £1,200,000 at 8% interest (quite a modest rate at that time) to William.

But they couldn’t necessarily trust King William’s Government (beyond being able to fight the French), and their offer depended on a few quid pro quos. The most important of these was that the new Bank wanted to monopolize all of the Government’s financial business. Because government taxation tended to come in as pulses on four ‘quarter days’ during the year, ownership of the accounts would mean that the directors of the Bank could get first-cut from the taxation moneys received in order to repay themselves with interest and also the opportunity to make short-term loans to others and receive additional interest. It was a wonderful way of saving the nation and making themselves even richer.

The second big concession they demanded, and received, was that their own promissory notes should become the official banknotes of England. Although there were many other varieties of promissory notes in use by private groups both then and in the following decades, this privilege ensured that the Bank of England’s banknotes could start to be used to pay taxation as alternatives to gold and silver. Thus everybody was encouraged to use the Bank’s banknotes.

Of course, the initial Bank loan to William’s Government was in gold and silver, the universal currency that was common throughout the world, from Ireland through to Japan, but after then the Bank of England’s banknotes could thus be used widely for domestic use (not for international trade, of course). In theory, the Bank’s proprietors could, at trivial cost, print as many of these as they liked and become as rich as Croesus. In fact, they didn’t. Being sensible people with a thorough knowledge of industry, trading and finance they only issued new banknotes by selling them for gold and silver. They knew that, like some sensible economists today (that is, those who consider ‘Quantitative Easing’ to be foolhardy), there is no such thing as a free lunch and they had make sure that they didn’t cheapen the value of their banknotes. If money is inflated by excessive printing then, sooner or later, the country that issues it is either defrauding its people (particularly those who save money) or ultimately faces disaster. Besides, the Bank’s proprietors wanted to make sure that they, and their descendants, besides being able to remain rich would also retain their high social status as being trustworthy.

In due course, the idea of a central bank with unique powers was copied by other countries which needed to raise large amounts of money to equip armies which, due to artillery innovations, had become very expensive. In modern times, however, governments have snatched back most of the powers that they were obliged to give to the central banks. All central banks, whether as powerful as the US Federal Reserve or the People’s Bank of China, are today not independent, as they are often claimed to be. That’s merely propaganda. In truth they are little more than departments of governments with most of their senior personnel appointed by their governments. They may seem to be independent sometimes when the cliques that run them are at variance with the cliques that run government treasury departments — as they often are — but, essentially, central banks print money and set interest rates for the political convenience of their governments.

Which now brings us to where we are today. The US Federal Reserve and almost all the central banks of Western Europe are now themselves effectively bankrupt. Strictly speaking, they and their governments are illiquid rather than classically bankrupt. In principle, they’ve no need to be bankrupt because the countries in which they reside are still wealthy with more than enough assets and human skills to keep their economies going. The problem is that those who have money — rich investors and, more importantly, pensions and investment funds — are becoming increasingly reluctant to lend it. Government bonds are not as secure as they used to be. The reason for this is that the methods that governments use — tinkering with interest rates or printing banknotes — are no longer having any effect at all on their economies.

Where, oh where, are the rich London merchants of yesteryear? Superficially they appear to be their modern equivalents — the high-street banks and the investment banks. But most of those are bankrupt or illiquid also. The reserves they have are either property collateral which they can’t sell at the price it used to be or government bonds which are now becoming increasingly difficult to sell with every passing day. Of the two principal government bonds in the world, the Eurobonds are fast becoming impossible to buy or sell, and the credibility of US Bonds now depend on what the US Congressional ‘Super-committee’ can conjure up in the next two weeks by way of rescuing the dollar from oblivion. The signs are — heavily — that it will fail and only come up with trivialities.

But we still have thousands of rich entities in the world. Not only are they rich, with swollen bank accounts at the present time, but they also know, unlike governments and central banks, exactly how to create wealth in detail — just as the London merchants used to (they had to know the details of industry as well as finance). I write, of course, of transnational corporations and hundreds of thousands of smaller businesses which depend on them. When the equivalent of the 1694 French troops are massed in sufficiently high numbers on the other side of the Bankruptcy Channel, then I think we can be reasonably sure that the transnationals (of the West and of China) will come forward with their plan. Of course, they will want their quid pro quos also. They’ll need to establish their own new brand of world currency and effectively monopolize, at least for a while, its supply in order to keep the world economic system going. Suitably re-sized governments and politicians who’ve learned some basic economics can emerge later.

  • tp

    I am sure total and per-capita energy usage increased substantially in the 50 years after 1694, whereas even if the total remains sort of steady, which is itself very unlikely, per-capita energy usage is guaranteed to drop away quite quickly between now and 2060. So this game is going to end quite differently from the historic game narrated here.

  • Prakash

    The lack of a clearly identifiable threat and the lack of a common culture may prevent the kind of coordinated response shown in the 17th century.

    But on the other hand, there are technologies like bitcoin which can replicate a limited currency to make sure that we never have to suffer the equivalent of fractional reserve banking.

  • RC

    The premise of Mr Hudson’s argument does not hold up in front of realities of the market. Mr Hudson surmises:

    Government bonds are not as secure as they used to be. The reason for this is that the methods that governments use — tinkering with interest rates or printing banknotes — are no longer having any effect at all on their economies.

    This could not be further from the truth as seen everyday in the bond market. Many cases effective yield on TIPS was negative!! People (or governments) the world over were handing over money to US treasury for safe keep and instead of expecting a return were willing to pay a fee… That is the reality of the bond market today (yields are not negative but are multi decade lows).

    Mr. Hundson seems to be one of those “lets return to a gold standard” folks.
    The first quantitative easing program was essential in my view, the number 2 version probably did more harm than good IMO.