H.M. Hyndman

Commercial Crises of the Nineteenth Century

Chapter VI
The Crisis of 1866

It is no easy matter for a society accustomed to certain definite arrangements, especially when those arrangements deal with such apparently complicated matters as currency, banking, bills of exchange, and the like, to understand how the present system has grown up or upon what it is really based. So natural to-day is it for all the well-to-do classes of this country to deposit their savings in a bank and to have an account there, that they can scarcely believe that in France, with all its civilisation, such a proceeding is even now the exception rather than the rule. Banks, in fact, were not originally established to take deposits, and if they had been they would not have got them. The Italian banks of the Middle Ages were established in order to make loans to the various Governments of the cities; the banks of Northern Europe were all set on foot to maintain an uniform currency with which to pay bills of exchange in good money; receiving the bad and debased coin at its intrinsic value, and, after making certain charges, crediting the merchant who thus transmuted his bad coin into good with the balance in the books of the bank. In the same way banks acted as the transmitters of payments for goods to long distances. Out of these necessities and the conveniences which they engendered, the banking system arose and was maintained. And, so soon as this banking system grew and extended, international trade began to assume its modern aspect; for the goods which were exchanged were estimated for the purpose of such exchange in gold or silver, and thus slowly the wider international price was substituted for the fluctuating price of the local markets.

By degrees, therefore, these banks, whether originating in the ways above-named or as goldsmiths and pawnbrokers, developed into the huge joint-stock shareholders’ banks of to-day. Private banks having been entrusted with remittances and bank money, or the money necessary to meet bills of exchange, were next entrusted with plate and funds deposited at call. To lend this would, at first, have been regarded as to the full as dishonest and dangerous as it would be to-day for a banker to borrow on his client’s securities. But gradually this, too, came to be a portion of the banker’s business in addition to his other businesses: to receive deposits of money for safe custody from his clients, and to lend out, what was learnt by experience to be a safe proportion of such deposits on the open market by discounting mercantile bills for other clients, or by lending upon securities realisable upon the market on arranged terms.

But the extension of the banker’s business in this direction tended rapidly to diminish the relative importance of his other business. Receiving money on deposit and lending it out again at a profit became so large a part of the banker’s daily business that a banker only considered that he entered fully upon his functions while he was doing this. Business with him is literally an affair of other people’s money: his own capital being only a sort of security for the proper conduct of the business, and a reserve in case of a run or of a period of continuous lack of confidence. But as savings greatly increased, and the profits to be gained by receiving them on deposit and lending the deposits out at interest became apparent, competition for them steadily grew. So profitable a branch of banking could not be left entirely in the hands of the old private bankers. Joint-stock banks were formed with great capitals, and, whereas the private bankers paid no interest and demanded that a balance of a stipulated amount should be kept, the new institutions all pay interest on deposits having stated terms of withdrawal – the rate of such interest being governed by the rate of discount exacted by the Bank of England; though they speedily surpassed that institution in the magnitude of their total and soon of even their separate operations, in spite of their having no issue of notes.

At the same time with these great joint-stock banks there grew up a whole series of discount houses and bill-brokers, in addition to the large mercantile and accepting houses whose bills had to be dealt with. It was and is the business of these establishments to deal specially in bills with their own and partly with others’ capital, rediscounting the bills at a very small profit with the great joint-stock banks. It is in no sense the business either of the banks or of the discount houses or of the bill-brokers, to foster trade or to develop new enterprises. They, in theory, deal only with the results of improved industrial conditions and the increased trade which springs from them. But in practice, as we have seen, the facilities given in times of inflation and high prices have the effect of enhancing both the one and the other. In some cases, means were found to start new enterprises by these financial firms themselves, and the circle of finance was thus not merely indirectly but directly involved in the risks of promotion; in the same way that many of the American banks and the great French Credit Companies were involved. If certain enterprises of a risky description required to be financed, that is to say, if labour and capital are ordered to be expended on undertakings which might never derive benefit from the community nor the community from them, and if the money to pay the labourers and to furnish the plant is advanced upon the shares of a Company, supplemented by its probably worthless bills, it is clear that when the inevitable crash comes it will take the shape of a financial crisis in the first instance, however clearly the failure is due to industrial causes at bottom. All this is simple enough. But so much stress is laid upon the details and complications of banking and finance that at periods of crisis men habitually talk as if the mischief lay wholly in the financial arrangements, and that the mechanical improvement of these arrangements would put everything right. And these remarks specially apply to the crisis now about to be considered.

The great crash of 1857 was not very speedily recovered from either in Great Britain or on the Continent; while even the United States, with their illimitable agricultural resources, suffered for some time from the stagnation, depression, and utter lack of confidence which followed upon the more acute stages of the panic. Scarcely, indeed, bad trade begun to resume its upward movements across the Atlantic, than the terrible Civil War, which originated in the slavery still prevalent in the Southern States, broke out. The war entailed terrible sacrifices on both sides, but the North being far richer to start with, and receiving, in spite of the civil struggle, crowds of immigrants each year, was certain to win in the long run. Being also preponderant at sea, the Northern navy was able to prevent the South from getting that support from Europe which might have been obtained from the sale of cotton and other slave-grown products. This inflicted a terrible blow upon Great Britain, where also the effects of the great panic of 1857 had only just worn off when the war begun in 1861; and the commercial treaty with France concluded in the previous year was a trifling make-weight against the depreciation of the raw material for the Lancashire cotton mills. There were, however, to the country at large, compensations in the general circumstances of the time for the calamity which fell so heavily upon the workpeople and manufacturers of Lancashire, nor can it be denied that over-production had produced glut before. For the war itself occasioned a demand for English goods up to a certain point, the Limited Liability Act of 1862 gave a great impulse to new ventures, and a supply of cotton from Egypt and India in that and successive years made amends in some degree for the loss of the superior American staple.

That there was plenty of capital seeking investment at this time was abundantly shown by the enormous sums paid into new companies, and the expenditure in the course of a few years on railways of £70,000,000. The close of the American War in 1865 gave a further impulse to new business, which the development of trade with China, India, and Australia likewise encouraged. The threatenings of war between Prussia and Italy on the one side, against Austria on the other, gave as little ground for uneasiness in Great Britain as the war between France and Austria had given in 1859. For, as at all such periods, a neutral power in the position of England gained both in the demands for the manufactures, and in the extension of her already enormous carrying trade. At this period, too, in the year 1865 that is, the total amount of wealth in Great Britain was put at £6,100,000,000. Of course, a capitalised value of this sort is in many respects purely imaginary, as, for instance, the capital value of land taken at a given number of years’ purchase of its rents; but on the same basis the capitalised value in 1814 was but £2,300,000,000, or little more than one-third of the amount, while the population in the meantime had increased only fifty per cent. There was again, therefore, nothing in the extent of wealth creation to justify an anticipation of a crash in 1866, nor was there any great evidence of inflation at the time. Some even go so far as to maintain that the crisis of 1866 was not an industrial crisis at all, and it is true that the ordinary symptoms of crisis were not apparent in the trade returns. But it is quite impossible that the downfall of a single house, however powerful, prepared for beforehand as it had been, could have given such a shake to credit and brought about as it did a stagnation in home trade, had there not been a good deal of foolish investment and wild speculation in the years immediately preceding.

At any rate, when on 10th May the great house of Overend, Gurney & Co. suddenly stopped payment, the panic occasioned throughout Great Britain was to the full as furious and unreasoning for the time, though happily for those who lived through it, not so disastrous in its ultimate effects, as the panic of 1857. The firm had only been converted into a Limited Company the year before, by which process a good deal of new capital was introduced into the business. They were at the time still considered by the world at large to be that which they had certainly been in 1856, if not in 1861 – the most powerful firm, as well as the most active and capably managed firm, in the city of London. They stood next to the Bank of England, and their name and influence extended to all parts of the civilised globe. Yet during the very years when their credit stood thus high, and in part for years before, they were encouraging and embarking in enterprises of a character which were so unsound in themselves, and so dangerous from the class of people connected with them, that the veriest tyro in finance would have instinctively shrunk from them, even if they had not been outside of the special business which it was the function of the firm to carry on.

Let us hear the late Mr. Bagehot on the matter, for, assuredly, he could not be accused of under-estimating the ability of English capitalists: “The partners had great estates which had mostly been made in the business. They still derive an immense income from it. Yet in six years they lost all their own wealth, sold the business to the company, and then lost a large part of the company’s capital. And these losses were made in a manner so reckless and so foolish that one would think a child who had lent money in the city of London would have lent it better.” Yet it was in the power of these sapient nincompoops to break the Bank of England, to occasion such a desperate panic throughout the country, and to injure the credit of Great Britain abroad to such an extent that positively the Foreign Secretary at the time was impelled to send a circular to all our ambassadors abroad, in order to assure foreigners that the bottom had not fallen out of our island – whose total wealth, according to Mr. Robert Giffen, then amounted, to £6,100,000,000.

What renders the whole thing more mysterious to those who do not look below the surface, and more absurd to those who do, is the fact that the Bank of England had, by common consent, an exceedingly good reserve when Messrs. Overend, Gurney & Co.’s suspension took place – that reserve being then, as it is to-day, the only real reserve retained by the greatest commercial city to carry on the greatest commercial transactions for the international business of the world. But the transactions of the firm of Overencl, Gurney & Co. were so extensive, bills drawn on them had such universal currency, that nobody knew what might be the end of their breakdown, and consequently, bankers, bill-brokers, merchants, rushed pell-mell to the Bank of England to secure to themselves the means of meeting their acceptances, and carrying on their business. Cash or notes were alone legal tender in discharge of debts, and those who wanted to keep their heads above water, as the tidal wave of general distrust swept on, were compelled, as usual, to obtain advances on the best securities they could get “Ma foi j’ai v4eu,” said the man who was asked what he had been doing during the French Revolution. “Ma foi j’ai vecu,” might have replied many a man of business who was still carrying on his daily round of duty a few days after that memorable 10th May, 1866.

The Bank of England did its best to check the panic, and advanced £4,000,000 in hot haste on stocks, bills, and any good security. But all to no purpose. The banking department ran down to £3,000,000, and then, for the third time in two-and-twenty years, the Bank Act was suspended, relief was given by degrees, and the panic rapidly subsided.

But those who contend that this was merely a currency crisis overlook what went before, and that which followed after. Overend, Gurney & Co.’s failure brought down with it many smaller firms. One hundred and eighty companies were wound up in a few months. And to take one trade only, the cotton trade, not until 1870 did the factories of Lancashire work on the same scale as they had worked ten years before in 1860; though at the time of the crisis a perceptible improvement had begun. The same phenomena of glut and stagnation were again to be noted, and the consequences to English credit on the Continent have already been spoken of.

It is a singular comment on this Overend & Gurney crisis of 1866 that the partner in the firm who was more than any other responsible for their ruin, but who retired before the firm was converted into a Limited Company, should only just (1891) have died worth £1,000,000 in personal property!

Last updated on 29.7.2007