TO MOST PEOPLE in the 1690s, paper money was an oxymoron, as ridiculous and self-contradictory as a wise fool or a cowardly lion. Paper could not be real money. But faced with the cost of the war and the fact of a debased coinage, the demand for something—anything—that could pass between buyers and sellers, debtors and creditors, forced the issue.
The idea behind the Bank of England was hardly new. Prototype national banks had been tried in London in 1682 and 1683, and the key founder of the Bank of England, William Paterson, had offered his first proposal for a loan-making company to the government in 1691. But the idea of a central lending bank remained suspect, viewed as a way for investors to enrich themselves at the country's expense. Paterson's proposed bank would have charged the government six percent on loan capital of a million pounds, a rate of interest that was rejected out of hand by the House of Commons.
But by 1694, King William was desperate. The Treasury had tried to raise its own loan in 1692, and was forced to offer first ten percent, and then a ruinous fourteen percent, to attract less than 900,000 pounds—well under half the total needed to support the army in the Low Countries, never mind the government's other expenditures. When Paterson renewed his offer in 1694, this time for a bank with a capitalization of 1.2 million pounds, the Chancellor of the Exchequer rammed it through a still hostile Parliament during an almost unpopulated session of the House of Commons—reports indicate that only forty-two members showed up to vote.
In its final form, the Bank was supposed to provide a very simple service. Wealthy men would subscribe money to supply the Bank's capital, and the Bank would then lend that money—and only that money—to the government. Depositors could get access to their funds in three ways. They could hold a "book or paper" in which their transactions were entered—the passbook in embryo. They could write their own promises of funds to be paid, which the Bank would accept up to the amount of their deposits—the prototype of the check. Or, crucially, they could hold their money as "running cash notes," which the Bank promised to accept on demand, redeeming the note, either in full or in part, in hard coin. (Clerks would list partial payments on the note itself.)
That's how it began: money, captured on a sheet of paper. It rapidly became something more. By lending the full sum of its deposits (and soon enough, even more) to the government, and by issuing notes against that same capitalization that depositors could spend, the Bank of England performed the essential economic miracle: it created capital out of thin air. This was the birth of what is known as fractional reserve banking, the foundation of the modern financial system. In a fractional reserve bank, working on the assumption that only a small percentage of depositors will demand their share back at any given time, the institution lends more than the sum total of its capital. How much more is the question. Banks that lend too great a multiple of their deposits risk running out of cash if too many depositors demand payment. If the banking system as a whole lends too little, credit tightens, loans become more costly, and economic life suffers. (Bank regulators can use the reserve requirement—how much cash as a percentage of loans a bank is required to keep on hand—as a tool to tighten or loosen credit, and thus, in theory, keep an economy from becoming either too sullen or too exuberant. The gap between that theory and actual practice is not, perhaps, as small as economists would wish.)
At the start, the Bank had no vision of global capitalism. It was just trying to get negotiable credit into the hands of William and his army in Flanders—all while making a profit for itself. The unintended but critical consequence of creating modern bank notes, however, was that for the first time, a nation in Europe had transformed its government obligations into a new, uniform—and most important, tradable—commodity. Previous attempts to raise cash for the war had relied on any expedient available—loans, annuities, exotic proto-bonds—but none of these had an agreed value that enabled holders of an annuity, for example, to trade that asset on a market for cash. Bank notes were a form of cash.
The uniform character of the notes also meant that, useful as bank notes might be, they carried a potentially ruinous risk: what one man could inscribe on paper, another could copy. The raw materials for paper money were easy to find, and with so many printers and engravers in London, surely some would sacrifice their honesty for a price. After all, William Chaloner had persuaded a few of them to risk the noose by printing Jacobite propaganda.
The Bank's owners understood the danger, and they did what they could to protect themselves. The first bank notes were never intended to be ready cash, replacements for the silver and gold coins that ordinary people used to do their business. The new currency was supposed to remain in the hands of financiers who needed to move major sums of money around. Although the Bank offered notes in amounts as little as five pounds, one hundred pounds—or roughly double a middle-class income—was the most common denomination. Such large sums made it harder to pass poorly copied bills. Few would or could accept them, and those who did were mostly sophisticated enough to protect themselves from amateur criminals. But greater sums of money also increased the temptation. So, two weeks after the Bank received its charter, the directors formally decided that "the Notes for Running Cash being considered liable to be counterfeited, for preventing thereof it was ordered that they be done on marbled paper Indented."
Thus decorated, Bank of England notes—in practical terms, the first bank-issued paper money in the world—entered circulation in June 1695. They were immediately popular. As early as 1697, almost 700,000 pounds circulated as running notes—and this pile of what passed as cash quickly took on a life of its own. The five pounds that Mr. Smith deposited on Tuesday became ten by Wednesday: the five lent to support the army in Flanders and the five Smith could hold as a running cash note. This simple trick was the first in the sequence of novel gyrations of money that was about to turn London into the financial center of Europe and, within a century or a little more, of the entire world.
For Chaloner, marbled paper did not present much of an obstacle. He knew at least one artisan capable of simulating it, and he or a confederate was skilled enough to forge the handwritten entries on each note. His fakes circulated for at least two months before the first was detected, on August 14, 1695. If that was not enough time to match the haul of his early coining triumphs, with the house in Knightsbridge and his service of plate, it was still long enough to pass a serious amount of money.
But then, of course, he had a serious problem. The Bank's men traced that first detected dud note back to the printer who had copied the marbling. The printer informed on Chaloner, who then performed a magnificent two-step. Of course, he had to surrender his as yet uncirculated stock of false bank notes, but he forestalled prosecution with his usual expedient of trading information for freedom. He told the Bank's investigators of another scheme, one he had almost certainly also masterminded. The Bank had been fooled into accepting stolen checks from the City of London's Orphans' Fund, a fraud that had cost it at least a thousand pounds. Chaloner named names, and the infamous John Gibbons, porter at Whitehall, arrested those unfortunate enough to have been of use in this Chaloner enterprise.
It was a vintage performance. Chaloner played the boundaries between official London and its criminal shadow city better than anyone else in his day. For his services to the Bank—a double robbery, admitted and betrayed only after the profits had been booked—Chaloner received grateful thanks and, unbelievably, a reward of a further two hundred pounds. Encouraged—and why not?—Chaloner kept playing what must have seemed like an exceptionally gullible and rich mark, extending "his old Trick of Trumping up his Services." In November 1695, he sent the Bank a list of suggestions for dealing with the threat of counterfeit bank paper. His ideas impressed his readers. Sir John Houblon, the governor of the Bank, became an active supporter, to the point of seeking Chaloner's release from Newgate on his next brush with the turnkeys.
It was that same November that King William finally commanded Parliament to act in the face of the ever deeper crisis of England's coinage. To Chaloner, the decisions made in response to the King's demands only widened the field of opportunities. His experience in stealing from and then "funning" the Bank had confirmed for him that any turmoil in the money system created opportunities for him to get rich. Sixteen ninety-five had turned out to be a highly profitable year. It looked as if 1696 would be even better.