Keepers of Running Cash

"What, then is the mystery of banking?"

  Centuries ago the Lombard goldsmiths made the discovery which is commemorated in London today by the title of Lombard Street, a first rate city address. In their days people who had a good deal of spare money, and were expected to protect it against robbers by their own hands and weapons behind bars and bolts and stanchions of their own houses, brought their spare money to the goldsmiths for specially fortified safe keeping, expecting naturally to have to pay for that accommodation. But as these rich people drew out only what they required for the moment, leaving "a balance" to their credit, the goldsmiths very soon found himself in permanent possession of much more money than he needed to pay out to the owners for their daily needs. By lending this surplus out at interest he could make more profit than by exercising his craft as a goldsmith. So he gave up goldsmithing and became a money lender.

  Later on he made another discovery. He found that if he printed bushels of promissory notes for £100, £10, £5, £1 or what not, his customers would find them much more convenient than bags of gold and silver when they had large sums to carry away or pay in or exchange with one another, and felt sure all the time that they represented gold in his safes. The notes would pass from one hand to another for a long time before they came back to him to be accepted by himself as so much gold. And as they never never all came back in on the same day, and there was always a mass of them floating round, he found that here too he need keep only a percentage in his till of the gold they represented, and could lend out the rest at interest. Here was a second Golconda for him. He had not only discovered the mystery of banking but invented paper money. He had found the philosopher’s stone." 

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George Bernard Shaw

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  The "first rate city address" of Lombard street was named after the Lombards who came from Italy to lend to the King and provide a service to transit money across Europe. Long before they reached England, Lombard Merchants had founded modern banking at the great trade fairs of medieval Europe. They would set up stall on their bancas which is Italian for bench but its corrupted form would enter the English language as 'bank'. They would write out bills of exchange that like bank notes were a promise to pay at a later date, normally at the end of the fair. If for any reason, they could not pay, their bench would be smashed and they would be declared bankrupt. The great banking houses of the Italian Renaissance the Bardi, the Medici, the San Giorgio grew from these humble origins.

  Edward III defaulted on his loans and bankrupted a few of these Italian bankers and English banking did not develop much further for hundreds of years. Until the early seventeenth  century most London merchants deposited their surplus cash in the Royal Mint then located at the Tower of London. Yet in the year of 1640, a series of events trundled into motion that would revolutionize every aspect of life in England including finance. Firstly, Charles I, desperately short of money due to his disputes with Parliament, seized the Mint and stole £200, 000 of deposits. The King turned thief sent commerce into a panic. Many merchants could not pay their debts and those that still had cash began to look for alternative security arrangements. They refused to trust the King with a penny and kept their money at their homes or their shops but then suffered a spate of robberies by apprentices absconding to join Parliament's army.

 A sensible solution was for merchants to place their cash with goldsmiths who kept secure safes. As Charles's dispute with Parliament turned to all out war, country gentlemen followed suit and deposited all their gold valuables. As their traditional crafts were not in demand during wartime, goldsmiths were more than happy to branch into new ventures. The cash left in their hands remained nominally available on call but during wartime nobody did, so it gave them plenty of ready money available to loan. A pamphlet of the day entitled ‘The mystery of the new fashioned goldsmiths or bankers" describes how "every of them that had friends and credit, aspired to this new Mystery to become Bankers or Cashers."

  Two years after Charles had raised the Mint, he fled London and declared war on Parliament that controlled the capital and the Royal Mint. There was a shortage of bullion and a Parliament inexperienced in these matters struck coins that were often mixed in weight. Uneven coins were a perenial problem of the age as many had been clipped by owners keen to keep tiny shavings of gold before they passed the coin on. These variations meant that goldsmiths originally kept customers deposits of coin separate and would have returned the customer the exact same coins with a receipt that could only be cashed by the original depositer. As there were allegations that goldsmiths engaged in clipping, a new fashion developed where goldsmiths weighed money when collected, then pooled it and guaranteed to redeem all deposits in good coin.

  With money safely in their vaults, the most enterprising goldsmiths took the opportunity to offer to transfer payments for their clients, both promissory notes and cheques date to this perid. A cheque is simply a cash receipt made out to a named third party. A promisory note is transferable cash receipt or as the legend says "a promise to pay the bearer". Both of these became popular amongst London merchants as the quality of the coin promised was guaranteed by the word of professional goldsmiths. Notes and cheques also offered better security than gold coin, they would not attract common thieves as they were only of use to merchants.

 Goldsmiths quickly learned to appreciate that the money entrusted to their care would not all be withdrawn simultaneously. As George Bernard Shaw testifies, they began to print excess promissory notes that weren't issued as a receipt for gold coin already deposited but in the expectation that it would be deposited in the future. Bizarrely, they were exchanging a promise for gold that didn't exist for another promise for gold that may or may not exist in the future. Again, this sounds odd but the purpose of this exchange was that one debt was believed to be surer than the other. Goldsmiths could never be entirely certain that their customers would always pay and to compensate for the risk they charged interest. In contrast, the public developed faith in the goldsmiths ability to perform their task, a borrower could always pass on a certificate that stated a goldsmith had promised to pay as everyone knew they had plenty of gold. Goldsmiths were lending their good name or more precisely what the public perceived to be a good name. As the circle of notes expanded, their ability to produce gold for their notes diminished but as long as customers pretended that it did it mattered little whether the gold existed or not. The enterprise was built entirely on the trust of customers accepting the goldsmiths word for as good as gold. This had to be built day by day, long term planning was extremely difficult in such a precarious enterprise. At first goldsmiths lent for a few weeks, then for months and then for years. As their network of customers increased so did the likelyhood that notes would not return quickly so they began to issue notes in amounts way beyond their reserves of gold. Instead, they learned to manage the risk that there would not be a sudden demand for cash, they kept enough at theri shops to meet demand and became known to their customers as the "keepers of running cash".

  They had not only convinced private merchants of the benefits of their new fashion. When Parliament had won the war and Cromwell assumed the title of Lord Protector, he went to leading goldsmiths like Edward Backwell to provide him with funds. After Cromwell's demise and the was monarchy restored, Charles II found they bore no grudges or political prejuduices and contracted similar deals. The new style of doing business had become engrained and royal patronage entrenched it further. However, canny eyes began to notice that the goldsmiths sums did not add up and began to question the sanity of a custom that effectively amounted to large amounts of people all pretending that goldsmiths had vast amounts of gold in vaults when clearly it was not the case. The strange operations of the goldsmith bankers must have been difficult to fathom, merchants may have used them reluctantly but each person who accepted a promissory note implicitly encouraged others to follow suit. Every time anyone did accept, the issuing goldsmith had effectively gained another customer. The logic became self reinforcing, every exchange with notes helped to swell their number but this snowball factor only exasperated the situation and the goldsmiths' critics who had calculated exactly how precarious the enterprise had become. The author of "The mystery of the new fashioned goldsmiths or bankers" was one who expected that the the public would see through the shenanighans and the goldsmiths would soon receive their comeuppance. He asked : “I suppose people will suddenly come to their wits, and begin to examine why a Goldsmith-banker should be better Security than another man, or fitter to be trusted for ten times more than he is worth”

  As the author would have known, there were times when people did 'come to their wits' and examine the security of goldsmiths . In 1667, a large Dutch fleet sailed up the Thames, firing upon the fort at Sheerness, burning English ships and the town of Chatham. Londoners were terrified and those who held goldsmiths notes instantly stopped pretending that the goldsmiths vaults were full of gold and ran to the bank. Samuel Pepys recorded on June 13th 1667 that his clerk "hath been at the banker's, and hath got £500 out of Backewell's hands of his own money; but they are so called upon that they will be all broke, hundreds coming to them for money". After the emergency was over (September 25th), Pepys discussed the success of bankers with his friend Lord Privy-Seale who "did mightily wonder at the reason of the growth of the credit of banquiers, since it is so ordinary a thing for citizens to break, out of knavery". Pepys agrees that it is remarkable but mentions that "to the honour of this City, that I have not heard of one citizen of London broke in all this war, this plague, this fire, and this coming up of the enemy among us"

   The comments again reflect the sense of mystery about the new fashioned goldsmiths and whether it was sensible to believe in imaginary gold. There is definite resentment from Lord Privy-Seale who takes the moral high ground. Aristocrats typically feared the power of lower born men whose sleight of hand appeared to conjure up money from nowhere. To his eye, the goldsmiths were complete fraudsters, it was plain as day that their excess issues of notes promised the same money to more than one customer at the same time. Pepys seems to take a more consolidated and practical view. This new fashioned goldsmithing was a peculiar practice but it oiled the wheels of trade at a time when silver and gold were still in short supply. There were clear social benefits to trade with promissory notes instead of gold. It was after all far simpler for a goldsmith to write out a promissory note than for an explorer to discover a new country and wrench gold from beneath the ground. Ultimately, the moral case is answered by the fact that customers went freely to the goldsmiths and after a while must have had some idea how the goldsmiths operated. After all, the term "running cash" implies that money was being juggled. Old fashioned goldsmiths may have sat over the gold under lock and key but the new fashion was to attempt the difficult task of investing it and making available at the same time. These new fashioned goldsmiths did not charge for services and some began to pay out interest on notes, which suggests that customers knew the risks but accepted the deal on offer. The public may have been confused about the precise operations but the fact that they ran to the goldsmiths so quickly when there was panic shows they knew they were playing a game of musical chairs with their finances.

  As Charles II relied on goldsmiths for finance as much as as any merchant in London, little was done by to regulate the Goldsmiths beyond his belief that the King did not actually have to pay his debts. In 1672, he conveniently remembered that the interest he was being charged was above the limit permitted by his own usury laws. He ordered the Exchequer to stop loan repayments on debts of over a million pounds. It left some of London’s most prominent goldsmiths bankrupt, major lenders like Edward Backwell were owed hundreds of thousand of pounds.  As the King could not pay the goldsmiths, the goldsmiths cound not pay their customers and thousands more were ruined by the crash. The moment of doom appeared to have arrived, a commentator at the time confidently predicted: "I believe it certain that the trade of the bankers is totally destroyed by this accident, for no man will ever hereafter run the like hazards when he shall consider upon what contingency he puts moneys into goldsmiths hands"

  Remarkably quickly, he was proved to be wrong, not even the spectacular crash caused people to come to their wits. Five years after the Stop of the Exchequer, ‘The List of Merchants of London' documented fifty eight Goldsmiths, thirty eight of them in Lombard street, evidence that the trade was in excellent health. Some of these had been clerks to the big names who had gone under. Also in that year, public indignation at a King confiscating his subjects assets and ruining the economy persuaded Charles to grant letters patent to each of the wronged goldsmiths covenanting to pay interest at 6%, although these ceased again in 1683. It may not have made perfect sense to trust goldsmith-bankers for ten times what they were worth or to believe in their imaginary gold but who else could be trusted? Certainly not the King. His attitude to business was that it was there to sporadically looted. In contrast, the new fashioned goldsmiths had the trust of large groups of people, even if their gold was make believe, the trade was real and whilst it grew people could live with the mystery.