Cross-Border Central Bank Operations (Part II - 1840-1900)

This is the second in a two-part series on cross-border actions by central banks in the 19th century. The first, covering the period 1800-1840, primarily addressed two episodes in which the Bank of England transacted with the Banque de France in order to replenish the former’s gold reserves. This allowed the Bank to avoid suspending convertibility of banknotes into gold and may have very well sustained the 19th century international gold standard when it could have just as easily become a short aberration in the history of money. In the period after 1840, it was the Banque de France’s turn to require foreign precious metals to maintain its monetary system.

**The Banque de France’s Predicament in 1846 …**

In 1846, there was a poor harvest in various parts of Europe; it was the same harvest that worsened the Irish potato famine. Wheat prices surged only to collapse later in 1847. Until then though, this posed a problem for affected countries’ note issuing banks because there was bound to be a surge of critical imports that must be paid for. If the imports could not be financed with foreign credit, this was likely to drain bank reserves and with it the supply of money. In short, importing grain from abroad, from unaffected countries such as Russia, risked draining affected countries like France of precious metal reserves. The strain resulted in failing French banks in all regions of the country.

The Banque de France too was in need of money. By contrast, the Bank of England had more silver than it needed; its reserves had recently risen by £1.5 million. Britain thus became a likely place to look for precious metal specie. So, when the French banking house Hottinguer was hired to acquire more reserves for the Banque de France, it is unsurprising that Hottinguer in turn coordinated with Barings which, in addition to being a British bank, was a firm which had gained experience in silver markets from its role financing trade with countries on silver-based monetary standards.

In 1846-47, the Banque de France borrowed twenty-five million francs (£1 million) in London from a syndicate organized by Barings. The loan was secured by 5% rentes, which were long-term bonds issued by the French government. The Bank of England itself participated in the syndicate, offering to provide thirty million francs for its part, which was ultimately more than the French took by means of this loan from the entire group of banks together.

The French also obtained fifty million francs from the Russian government, at least twenty-five million of this in the form of sales of gold in exchange for French government bonds; this gold was used to pay off the previous British financing. During the period of scarcity in Western Europe, the Russian government bought £6,600,000 of French and other countries’ securities for gold. This essentially provided a form of financing to countries importing Russian grain and it meant that the Banque de France was able to avoid any suspension in convertibility of its banknotes into gold or silver.

New Reading Room at the Bank of England (Illustrated London News, 1850)

And In 1855 …

In 1855, amidst high foreign spending during the Crimean War, the Banque de France was again in need of replenishing its reserves. Foreign military deployments have often led to drains on central bank reserves because the money spent abroad would typically be converted to gold, if not by the warring government to pay for things abroad then by the foreign suppliers or contractors of the army. The Banque de France did not choose to cooperate with the Bank of England on this occasion, perhaps because it was in need of gold rather than silver and thought it was unlikely to receive help on this front. Instead, it had French banks accumulate bills payable in London and to then use payments received thereunder to buy gold in the London market.

This was done in secret and, in any case, resulted in little incremental gold for the Banque de France. Complicating matters at the time, the Bank of England and Banque de France were both competing for gold. Thus, the Bank of England lifted its interest rate from 4.5% to 6% in October 1855, and the Banque de France in turn took its interest rate from 4% to 6%, as both sought to preserve gold and prevent outflows of capital. At the time, foreign central banks often feared scrambles for gold by means of increases in interest rates; the ‘follow-the-leader’ approach exhibited here is zero-sum, could be mutually damaging, and therefore should not be taken as evidence of productive cooperation but rather the opposite.

“In the present cordial good understanding between France and England, it becomes the duty of both, to unite their strength in every way, not to divide it. I have often thought that an intimate correspondence upon emergencies between the two Banks of France and England might be beneficial to both; and if the existing charters of either do not now admit it, an alteration or power to accomplish that object might be given for their mutual advantage.” – Walter Bagehot on the subject of gold purchases, 1855

And In 1860

Unfortunately, there was another crisis on the Banque de France’s hands by 1860. The coming civil war in the United States caused New York banks to search for gold or silver from wherever the metals could be found, putting pressure on the reserves of the European banks. In 1857, the Banque de France was given more latitude in setting interest rates by abolition of an interest rate cap. Still, it was not eager to lift its discount rate to offset the drop in reserves by means of making credit less available and withdrawing money from circulation.

The situation in 1860 was that the Banque de France possessed £13 million in silver, but silver was undervalued, in terms of the French franc, by the central bank in its bimetallist monetary standard, one backed by both gold and silver. The ratio in the value of gold and silver set by the bank no longer reflected the relative market value of these metals. The implication was that if the Banque de France had to resort to meeting redemptions of banknotes with silver at the official rate for conversion, people would rush to make redemptions because doing so allowed them to profit from the difference in the official and market price of silver. Thus, the more immediately relevant number was the Banque de France’s £4 million in gold reserves which the bank strongly preferred to use to honor redemptions, lest it cause a bank run.

To sustain its stockpile, the Banque de France was buying gold in London and drew on £2 million made available by Rothschild and Barings in London, money which it promptly converted into gold. This was not without negative consequences for Britain. The French were buying gold there, reducing the banking system’s reserves, and threatening the supply of credit in the United Kingdom.

Understandably, the Bank of England was keen to curb French gold purchases and was aware of France’s preference for gold over silver occasioned by its mispricing of silver. The Bank of England made an offer to resolve the problem. In December 1860, the Bank exchanged its own gold for Banque de France silver to help the French deal with brisk demands for conversion of banknotes into specie. Fifty million francs in French silver were swapped for fifty million francs of British gold through mid-1861.

The French made similar further swaps with other banks, one worth nine million francs with the Italian Banca Nazionale and a thirty-one-million-franc swap with the State Bank of Russia. Eventually, capital flight from the war-afflicted United States towards Europe arrested the shortage of reserves in Europe. However, French buying of gold continued to drain reserves in Britain for a few more years and this weakened the Bank of England’s own position when it was forced to deal with the 1866 failure of the bank Overend, Gurney and Company. In that episode, no help was sought by the Bank of England or proposed by the Banque de France.

Returning The Favor

There were few episodes of central bank cooperation after 1860. The next one of note came in 1890 when the ‘Baring Crisis’ struck with the financial difficulties of the storied British bank Barings. As it happens, Barings had previously played the role of intermediary in the sort of international central bank actions which its own troubles were now prompting. The bank’s problems were widely known but large-scale selling of securities by Barings in November 1890 made their troubles seem much more acute.

At the start of the crisis, the Bank of England’s reserves stood at £10.8 million. Still, various preemptive actions were taken before the full extent of the truly sorry state of Barings was made public knowledge. For one, the Bank of England lifted its discount rate to 6%. Further, the Bank of England borrowed £800,000 in gold from the State Bank of Russia. It also bought other gold from Russia; some £1.5 million was acquired from this country. In addition, the Bank of England borrowed £3 million of gold from the Banque de France.

The gold loan obtained from France, for a term of three months at 3% interest, was arranged this time by the Rothschilds, rather than Barings. Indeed, from beginning to end, central bank cooperation was mediated in the 19th century by private banks. In any case, the gold loan was renewed through February 1861 and was secured by short-term Treasury Bills which the Bank of England obtained from the British government by swapping them for long-term consols previously held by the Bank. In the end, this proved more than enough to see the Bank of England through the crisis. Ultimately, the extra reserves were not tapped into.

Despite the success, some were wary of relying on foreign cooperation, though that was a thought kept to the back of people’s minds when the financial system had been in the midst of the panic. Nonetheless, there was more regular contact between the Bank of England and the Banque de France hereafter. Still, no one will say that international financial cooperation would be any more successful in the first few decades of the 20th century than it was in the 19th century. Perhaps no other act by a central bank, or ministry of finance for that matter, is subject to as much scrutiny as its operations abroad.

Lesson

The history of the central banks of Britain and France in the 19th century makes clear that central bank coordination remained contentious even though they frequently needed to take actions that could be supported by cooperation. A technical reason for the lack of consistent coordination may have been that the Bank of England and Banque de France increasingly were in need of the same thing, gold, whereas in the first half of the 19th century they had a preference for different metals. Another explanation could very well be that cooperation simply seemed to make one institution dependent on the other and this was politically embarrassing. In the 20th century, coordination was not enough to save the international gold standard, but perhaps the difficulty here was already clear by the end of the prior century.

More from the Tontine Coffee-House

Read the first part of this two-part post and about the failure of the bank Overend, Gurney, and Company which caused a financial panic in 1866. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.

Cross-Border Central Bank Operations (Part II – 1840-1900)