Financial Crisis (1667) avoided by Charles II, via London Goldsmiths’ Loans


Background

After a brief hiatus of experimentation with a pseudo-republican government under Oliver Cromwell, the English monarchy was reinstated in 1660 but Charles II began his reign with vastly reduced powers, especially in the realm of taxation – responsibility for which had been transferred to Parliament.

This was a major restriction on Charles II and his extended family. Prior to this, all tax was paid to the King who used it for his personal expenses, his family’s expenses and to finance his army and navy. These were the days before free education, a free health service and a social welfare. Many of the jobs in the royal institutions (what we would now call a ‘civil service’) were poorly paid, or unpaid – but highly lucrative for the often corrupt job holders. If a king wanted to do something above the ordinary, like building castles, expanding the army or navy, or going to war, he just had to increase taxes.

  • This option was now taken from him
  • The Great Plague (1663) and the Great Fire of London (1666) further weakened the King’s finances
  • In early 1667, the British crown ran out of money, and could not afford to re-fit the fleet and pay ships’ crews.
    • When the crown asked parliament for the necessary £1.5m it replied that first it wanted to know how the £5m it had previously allocated to the exchequer had been spent.
      • No answer was forthcoming.
      • According to Samuel Pepys at the navy board, £2.3m was unaccounted for.
      • It was rumoured that the king had lavished much of this on his mistresses.
    • With no money forthcoming, Charles decided to lay up the bulk of the fleet in the Medway river.
    • When the Dutch discovered this, they decided to finish the war in a decisive knockout blow.
      • In June, the Dutch fleet was spotted massing off the Thames Estuary.
      • Charles didn’t act.
      • Two days later the Dutch sailed into the river Medway and burnt or captured the pride of the British fleet, even towing away the flagship, the Royal Charles
Arrival of the English Flagship Royal Charles, painting by Jeronymus van Diest II from the Rijksmuseum Amsterdam (note the Dutch flag at the rear and English flag flying upside down from the main mast)

Arrival of the English Flagship Royal Charles, painting by Jeronymus van Diest II from the Rijksmuseum Amsterdam (note the Dutch flag at the rear and English flag flying upside down from the main mast)

The Treaty of Breda

The Treaty of Breda was signed at the Dutch city of Breda, 31 July 1667, by England, the United Provinces (Netherlands), France, and Denmark–Norway.

  • It brought a hasty end to the Second Anglo-Dutch War (1665–1667) in favour of the Dutch, as Louis XIV’s forces began invading the Spanish Netherlands as part of the War of Devolution, but left many territorial disputes unresolved.
  • It was thus a typical quick uti possidetis treaty.
  • In the latter stages of the war, the Dutch had prevailed. Lieutenant-Admiral Michiel de Ruyter virtually controlled the seas around the south coast of England, following his successful Raid on the Medway, and his presence encouraged English commissioners to sue for peace quickly.
  • Negotiations, which had been long protracted, and had actually begun in Breda before the raid, took only ten days to conclude after resumption of talks.

During the negotiations, the English commissioners (Denzil Holles and Henry Coventry) offered to return New Netherland (now part of the Mid-Atlantic States of New York, New Jersey, Delaware, and Connecticut, with small outposts in Pennsylvania and Rhode Island) in exchange for their sugar factories on the coast of Surinam, that had been taken by Abraham Crijnssenearlier in 1667.

  • The Dutch side declined.
  • In the East Indies, the Dutch secured a worldwide monopoly on nutmeg by forcing England to give up their claim on Run, the most remote of the Banda Islands.
  • The Act of Navigation was moderated in that the Dutch were now allowed to ship German goods, if imported over the Rhine, to England.
NETHERLANDS, The Dutch Republic. Breda. Plaquettepenning, or Hollow medal (Silver, 82mm, 77.46 g 12), on the Peace of Breda between Great Britain and the Dutch Republic, by Wouter Muller, 1667. HET OUD BREDAAS KASTEEL, DOOR MULLERS VOND EN WERK, VERTOONT VAN BINNEN EEN GEWENSTE VREEDE KERK (=Old Breda’s castle, by the ingenuity and art of Muller, exhibits within it a wished-for Temple of Peace) View of the city of Breda, with angels flying above, one carrying a banner inscribed SOLI DEO GLORIA. Rev. HIER ZEIHLT HET VREDESCHIP, OP ‘T ZILUER IN DE ZEE MET BLIIDE WIMPELS, VAN EEN VIER GEKNOOPTE VREE (=Here sails the ship of Peace in silver on the sea, and bears the happy pennants of a quadruple peace) Ship sailing to right, bearing the arms of France, the United Provences, England and Ireland, and Denmark; below, A°1667. MI, I, pp. 531-532, 180. PiN 263. Van Loon II, pp. 538-539, v. An attractive and impressive piece. Usual blow hole on the edge, obverse fields polished, some polishing and minor casting fault on the reverse, otherwise, about extremely fine.

NETHERLANDS, The Dutch Republic. Breda. Plaquettepenning, or Hollow medal (Silver, 82mm, 77.46 g 12), on the Peace of Breda between Great Britain and the Dutch Republic, by Wouter Muller, 1667. HET OUD BREDAAS KASTEEL, DOOR MULLERS VOND EN WERK, VERTOONT VAN BINNEN EEN GEWENSTE VREEDE KERK (=Old Breda’s castle, by the ingenuity and art of Muller, exhibits within it a wished-for Temple of Peace) View of the city of Breda, with angels flying above, one carrying a banner inscribed SOLI DEO GLORIA. Rev. HIER ZEIHLT HET VREDESCHIP, OP ‘T ZILUER IN DE ZEE MET BLIIDE WIMPELS, VAN EEN VIER GEKNOOPTE VREE (=Here sails the ship of Peace in silver on the sea, and bears the happy pennants of a quadruple peace) Ship sailing to right, bearing the arms of France, the United Provences, England and Ireland, and Denmark; below, A°1667. MI, I, pp. 531-532, 180. PiN 263. Van Loon II, pp. 538-539, v. An attractive and impressive piece. Usual blow hole on the edge, obverse fields polished, some polishing and minor casting fault on the reverse, otherwise, about extremely fine.

The Development of Banking in London 

In 1609, the money changers in the Netherlands established the the first central bank in history, in Amsterdam.

  • When Oliver Cromwell was financed by the money changers, his victory allowed them to take re-gain control of the money system – for a short while.

The ‘Divine Right of Kings’ had taken a bit of a setback when Charles I was beheaded in 1649 but Charles II’s power was still based on a Divine mandate. His government and institutions — and indeed he himself — saw the king as the Chosen One. This bound him to the laws of Christendom and Christianity (at the time) still forbade lending or borrowing with usury (interest). This restricted the development of banking in England and the Puritan Parliament with its Protestant zealots had put Britain way behind its European counterparts when it clamped down on all forms of usury.

Prior to this, during the reign of Charles I, the London Goldsmiths Company had pioneered the concept of ‘fractional reserve banking’ in the 1620’s when they used the specie (gold and silver) deposits lodged in their vaults to issue of “bearer receipts” instead of issuing individual receipts tied to specific deposits.

  • These ‘bearer receipts’ soon began to circulate as the first ‘banknotes’
  • This has obvious advantages, and since one gold coin is as good as any other of the same weight and fineness, there is obviously no need for the strict allocation of deposits.

The convenience of carrying and using these banknotes instead of lugging around bags of gold and silver soon made them popular, and it didn’t take long for the goldsmiths to realize that the actual coin deposits were rarely withdrawn in great quantities. Instead, the receipts would remain in circulation, being regarded as perfect money substitutes. It followed from this that one could temporarily lend deposits out and collect interest on such loans. This was problematic from a legal perspective, as demand deposits should be available at all times.

Moreover, since the originally issued receipts remained in circulation, the total money supply actually increased once these deposits were lent out. In fact, many goldsmiths simply issued additional receipts for gold, even if they were not actually backed by deposits (with a similar effect on the broadly defined money supply).

This was an early form of fractional reserve banking, namely lending out far more receipts for money than one actually holds in one’s vaults.

  • Obviously, this methodology was highly innovative (although some might say “fraudulent”) but it worked because a situation whereby all of the depositors demanding their deposits was highly unlikely to ever happen

As a result of this, the London Goldsmiths became very wealthy and powerful. They loaned money to the king, the aristocracy, landed gentry and large merchant traders. As such, they became an indispensable asset to both sides during the civil war … but they still had to be careful … and prudent.

  • Their bank notes were still backed (at least partially) by specie on deposit
  • Money supply did expand but the expansion of this money substitute was held in check by the fear of a ‘run’ on their deposits, i.e. a bank run

Charles II & the Goldsmith’s Tally Sticks

They also made money by their ability to buy ‘foreign’ gold and silver coins and re-sell them to the Royal Mint (and the Parliamentary Mint during the Interregnum) so they could be turned into coins of the realm. When Charles II returned in 1660, they seemingly re-gained their appetite for risk, as they considered him to be what we would now call a ‘Triple A’ rating.

Since Charles had to beg the parliament for money, he struggled with paying his vast pile of bills. Whenever Charles wrangled permission to raise taxes from parliament, he immediately went to cash in these future tax receipts by selling ‘tally sticks’ to London’s goldsmiths at a discount.

  • Since the austere Parliament had banned usury (charging interest), Charles II sold his ‘future taxable income’ at a discount to the Goldsmiths, hence they could make a profit without charging interest.
  • Such debt was payable to the bearer, which allowed the goldsmiths to sell it in the secondary market to raise yet more funds that could be lent to the king.
  • They also began to pay interest to depositors, in order to attract still more funds.

At that stage of the game, the goldsmiths figured they had a good thing going for them, since the king was widely regarded as someone who could always be relied upon to cover his debts with future tax receipts.

  • No one thought it problematic that the vaults soon contained far more ‘wooden sticks’ than gold.
  • An active market in this government debt developed, and the goldsmiths profited handsomely.

The medieval origins of the Tally Sticks

The use of ‘tally sticks’ was a medieval royal perogative (started by King Henry I in the 1100’s for the purpose of recording tax payments. By the time of Henry II’s reign, taxes were paid twice a year, and a secondary market for tally sticks recording the partial tax payment made at Easter developed. Tally sticks were circulating in the secondary market at a discount to their face value and were accepted as payment for goods and services, since they could be later presented to the exchequer as proof of taxes paid.

A wooden stick for recording transactions. Made in England in the third quarter of the thirteenth century, the first stick reads “£9.4s.4d. from Fulk Basset for the farm of Wycombe“; probably Fulco Basset, bishop of London, who died of the plague in 1259. The second one reads: “£4. 8p. from Robert of Curclington for an injustice.”

A wooden stick for recording transactions. Made in England in the third quarter of the thirteenth century, the first stick reads “£9.4s.4d. from Fulk Basset for the farm of Wycombe“; probably Fulco Basset, bishop of London, who died of the plague in 1259. The second one reads: “£4. 8p. from Robert of Curclington for an injustice.”

Charles II restores his Financial Independence

It didn’t take long for the king and his treasurer to realize that they could actually issue tally sticks in advance, in order to finance “emergency spending” (such emergencies often involved war). The sale of these claims to future tax revenue created the market for government debt – which is an essential part of today’s fiat money system as well.

  • The king meanwhile decided to circumvent parliament completely via these ‘tally sticks’

Charles II began to issue tally sticks as he pleased (as an aside, one half of such a stick, which was given to the party advancing funds, had a handle and was called the “stock”, while the other half was called the “foil”.

  • The term “stock” has evolved to describe shares in publicly listed corporations today).
  • Not surprisingly, Charles was more than happy to exchange sticks of wood for gold and soon kicked off a sizable credit boom by vastly increasing his production of wooden sticks.

During his 25 year reign, Charles II waged three wars, all of which he lost (two against the Dutch, one against France); he survived 4 different parliaments (only the first of which wasn’t hostile to him); he helped to establish the East India Company, made numerous shady deals with Louis XIV of France (his cousin), sired a horde of illegitimate children of which he acknowledged 14, and was roundly condemned for his hedonistic court.

His Parliament quickly discovered they could not control his spending.

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