Author: Paweł Kowalewski

Economist, works at NBP, specialises in monetary policy issues and FX markets

The history of the Bank of England

So far, no one had the courage to take a look at the times when the United Kingdom was trying to find its place in the post-imperial era, because of the difficulty of this task. Finally, however, it was taken on by Professor Harold James, who teaches economic history at Princeton University.
The history of the Bank of England

(David McKelvey, CC BY-NC-ND 2.0)

“Can you tell me where my country lies?” — asked Peter Gabriel in October 1973, dressed up as Britannia. His question was the introduction to one of the best albums in the history of progressive rock — “Selling England by the Pound”.

Of course, some may claim that the title of the album refers to the unit of mass, and not to the currency. This doesn’t really matter, because the title ultimately describes England’s struggle with a crisis caused, among other things, by a decrease in the value of the British pound. This crisis was not only an economic one as its scope went far beyond the economic realm.

The Sick Man of Europe

Four days after the release of the album, the proud Englishmen, the inventors of football, were knocked out of the World Cup by Polish Kazimierz Górski’s team. To make matters worse, Poles eliminated England without their biggest star on the pitch. Just three years later, the British empire was knocked down and required emergency assistance from the IMF. Could we imagine a greater humiliation for the English, who have always been so proud of their empire?

The answer, unfortunately, is yes. The next World Cup also took place without England’s participation. A few months later, the streets of London were drowning in garbage, while in Liverpool dead bodies were stored for weeks in plastic bags due to strikes of the gravediggers.

Peter Gabriel’s question began to take on a special significance. England was at a crossroads and had lost its way. This also applied to almost all public institutions. Governments were collapsing under the pressure of the wage demands of the trade unions, which resulted from the highest inflation in approximately 300 years, generated, among others, by a decrease in the value of the British pound.

At that time, it was being decided whether England would say goodbye to the status of a world power in a dignified manner, or whether it would share the fate of Spain and become a pariah of the western world. And what was happening with the famous Bank of England (BoE)? It was just as lost as the rest of the country. It’s no wonder, therefore, that at the time the United Kingdom was referred to as the “sick man of Europe”.

Both the crisis of the 1970s, and the attempts to overcome it, became the subject of interest for many specialists. Perhaps now, that the United Kingdom is at another turning point in its history, the British are looking for inspiration in their recent history (and not in the distant history of the empire)?

The details behind the IMF mission to the United Kingdom, which hurt the pride of the British, was described fairly well in the book “When Britain went bust” by the late Professor Richard Roberts. He also provided assistance to two reporters, William Keegan and David Marsh, in their highly accurate description of the British economy at the turn of the 1980s and 1990s. Both of these books are really good reads, but they only focus on one selected event. The first book describes the economic crisis of 1976, while the second is devoted to the crisis of 1992, when political dimension was much more significant than the economic one.

No one can hold a candle to Harold James

However, no one had the courage to take a look at the entire period in which the United Kingdom was trying to find its place in the post-imperial era. This is not surprising, because such a task has an almost instant paralyzing effect due to its sheer difficulty.

I’m fairly certain, however, that the abovementioned authors were aware that if anyone could do it, it could only be Professor Harold James, who has been teaching economic history at Princeton University for more than 36 years. The great master did not disappoint, and his new book entitled “Making a Modern Central Bank: The Bank of England 1979-2003” was finally released in September 2020. Reading it would be a good investment in knowledge about modern economic history for all of us, but it is simply a must-read for central bankers.

I’m sure the readers don’t need to be introduced to Prof. James. Therefore, I will shortly describe his work. He specializes in the economic history of Germany. However, over time he began to boldly venture outside the main area of expertise. It is difficult to identify his best book, but I’ll take a chance and chose the history of how the countries of Western Europe arrived at the creation of the euro zone, which was commissioned by the ECB and the BIS. Such experience made Mr. James the best candidate to deal with this exceptionally important period in the history of the Bank of England.

“Making a Modern Central Bank: The Bank of England 1979-2003” describes the complete transformation of the second oldest central bank in the world, from an institution that had lost its way, to once again become one of the most advanced and modern central banks in the world. The phenomenon of today’s BoE was perfectly described by the Nobel Prize winner Paul Krugman, who stated that the Bank of England has a much greater influence on the world than would be warranted by the strength of the British economy. This is due to its ability to take on new intellectual challenges. The primary role in this case is played by the strength of human capital. So why is this only happening now, and not earlier? Who was responsible for this change, and who contributed to it? Harold James answers all of these questions in his book.

This is not an easy book, but the author handsomely rewards those who decided to read it. Of course, even a minimal amount of knowledge about the contemporary economic history of the United Kingdom makes things easier. Still, the book is not exclusively addressed to lovers of economic history. Anyone interested in economics (including students) will learn a lot from it because of the author’s extensive knowledge. The book allows the reader to consolidate an existing, theoretical knowledge. This is made possible due to the detailed descriptions of the subsequent attempts at introducing various economic trends to the United Kingdom.

One thing that may be somewhat surprising, however, is the time period covered by the author. Above all, this concerns the choice of the year 1979, which was not a breakthrough year for either the British pound or the BoE, despite the changes in the government. The most likely reason is that it was the year which initiated a series of events leading to the globalization of the economy.

Besides Margaret Thatcher’s coming to power, many other important things happened in 1979: the beginning of the new economic program of the People’s Republic of China, the revolution in Iran (which generated the second oil crisis), as well as the extremely important decision taken by President Jimmy Carter: the nomination of Paul Volcker as the Chairman of the Federal Reserve. Volcker subsequently dealt with inflation, which was plaguing the Western world at the time, and as a result he accelerated the process of economic globalization.

It’s not just about inflation

Prof. James has no difficulty distinguishing how a given problem is perceived today and how it was perceived by people living in the described period. It is difficult to write about the modern history of the British economy without referencing the dramatic events of autumn 1976, when Denis Healey — the then Chancellor of the Exchequer — was forced to cancel (while already at the airport) his flight to Manila to the annual meeting of the IMF. The Chancellor had to stay in London in order to sort out another crisis resulting from yet another fall of the British pound. But is it really true that the British empire received a knockout blow?

The calm analysis presented by Harold James (as well as the previously mentioned Richard Roberts) indicates that the situation wasn’t really as bad as it seemed. The IMF assistance was only used as a precautionary measure, but the United Kingdom would have ultimately managed without it. Meanwhile, Chancellor Healey’s trip from Heathrow to Blackpool, where he had to face the hardline activists of his own Labour Party, was much more important than the IMF assistance.

Prof. James analysis of the BoE isn’t only limited to the fight with inflation, especially considering that it was difficult for the BoE to deal with inflation without an adequate amount of independence. Its difficult position was best described by one of the Chancellors of the Exchequer, who claimed that the role of the BoE was to carry out his instructions. The bank’s biggest problem, however, was not Chancellor Nigel Lawson, but above all, in the stubborn conservatives’ love of the idea of monetarism.

James skillfully identifies the reasons why the adventure with monetarism failed. Its fiasco forced the Brits to look at the exchange rate as yet another anti-inflationary anchor. Pegging the British pound to the German mark not only resulted in an economic disaster, but also started a series of events that ultimately led to Brexit (although Prof. James makes this argument in a much more cautious manner than Mr. Keegan, Mr. Marsh and Prof. Roberts). The British pound’s entry into the ERM (which happened almost exactly 30 years ago), and the subsequent withdrawal, were the key events in the recent history of the BoE. They allowed the central bank to recover its independence and the previously lost prestige. Almost everyone has heard of the crisis of the British pound in 1992, mainly because of George Soros. In the book, Prof. James presents the complete picture of the situation in an interesting way, describing the behavior of the BoE’s dealer, who was unsuccessfully struggling with the Quantum hedge funds.

Another important theme is the multitude of tasks that the BoE was responsible for. In 1979, there were so many of them that no one knew what the central bank’s main objective really was. Interestingly enough, the bank managed to carry out many of the tasks entrusted to it in a fairly effective way (this includes, among others, overcoming the debt crisis of the first half of the 1980s).

It’s also worth paying attention to the country’s financial stability. Of course, there were some mishaps (which the author describes in detail), but the bank never allowed a systemic crisis to break out. The book also has a very interesting chapter devoted to Hong Kong, and more specifically, the efforts of HSBC — which is now seen as a jewel in the crown of the United Kingdom’s banking industry — to become a British bank. Suffice to say that it took a lot of time before the BoE gave it the green light.

The importance of central bank governors

Prof. James writes a lot about BoE’s governors. In the critical period of the 1970s, the bank was governed by Gordon Richardson, who is not assessed in a positive way by James. The author offers a rather harsh criticism, pointing out that Mr. Richardson didn’t really understood the reality that was surrounding him. At the same time, however, Prof. James doesn’t blame Mr. Richardson for the fact that during his tenure (in the years 1973-1983) the United Kingdom was affected by inflation. Instead, the author points out that Mr. Richardson lacked the ability to find common language with the bank’s employees, which was perhaps due to the fact that he was a classic representative of the old world that was going down in history.

His successor, Robin Leigh Pemberton, represented an entirely different type of personality and largely contributed to the successful transformation of the BoE. His role also shows how the perception of the events changed over the years. Mr. Pemberton previously worked at the National Westminster Bank, and at the beginning of his term in the BoE was widely ridiculed for saying that inflation was not only a problem, but that it was even the greatest threat to the Western world. His statements that inflation was much more dangerous than communism perplexed the people in his immediate circles.

We should keep in mind that the beginning of the 1980s was a period when the Soviet Union was ostentatiously pulling its muscles, and effectively threatening the Western world. For this reason, hardly anyone took Mr. Pemberton seriously. But he who laughs last laughs longest. By 1990, the threat of communism in Europe was practically non-existent, while inflation in the United Kingdom reached peaks of 10 per cent. Mr. Pemberton, however, was only a harbinger of things to come. The whole weight of the transformation was carried by his successor, Edward George. And this is the figure that receives the most attention from Prof. James.

What I found most surprising, however, was the author’s statement made almost at the very beginning of the book. The successful transformation of the BoE represents the successful transformation of the whole United Kingdom into a modern country, fully adapted to the requirements of the global economy. The bank had changed, the country had changed, and the attitude of many British people had changed. The mixture of melancholy and desperation, which was best symbolized by the album “Selling England by the Pound”, was replaced by the spirit of Cool Britannia, which was based on pride of British origins.

There would be nothing surprising about this, if not for the fact that, according to James, this transformation came at a high price, which included, among others, the emergence of cynicism and self-interest. Even the main character of the book, Eddie George, was unable to avoid this path. In the book we learn some really interesting details about his life: who Mr. George tried to deceive (and who the first person he called after assuming his position was) and who stood in his way in the implementation of his very cunning plan. This does not change the fact that he was a man of great stature, however. The greatness of the late Governor of the BoE was based, among others, on the fact that he was able to face not only the unpredictability of the economic environment, but also the whims of fate.

As a result of a well-described chain of events, the BoE was assigned, as part of its de facto new mandate, a task with which it had so far fared really poorly. At the same time, it was deprived of the role in which it was doing really well (despite a few mishaps). This unexpected combination of events did not stop Mr. George (his caricature is on the cover of the book) from completing his life’s work and finishing the process of reforms started both by him and by his predecessor.

The process of globalization initiated in 1979 did not leave central banking unaffected, which is why it was not possible for Prof. James to limit the contents of his book solely to the description of the BoE. A photograph from the 1980s, taken somewhere over the Atlantic Ocean, with the governors of the major central banks leaning over a pile of documents, could be seen as a symbol of that process.

Descriptions of almost every important move by the BoE are accompanied by a comparative analysis — what other central banks did in similar circumstances. That is why the book about the BoE is in reality a book about the development of central banking at the turn of the centuries. The effects of globalization force us to ask: how should the central banks behave in the modern world? After all, there is no shortage of people claiming that central banks are no longer able to influence the course of events taking place in the economy. In response to the previously posed question, Prof. James compares the central bank to the conductor of an orchestra. While they often don’t have any influence over the selection of the repertoire, they can certainly influence the way in which it will be performed.

At the end of the book the author recommends that all employees of the BoE should use the London Underground. Such advice could be given to the employees of all central banks. And not only them. The idea is that each of us should be able to ride the underground towards Threadneedle Street, and to carefully listen to the messages when getting off at the Bank station.

At present, the spread of COVID-19 makes it somewhat difficult for us to follow the author’s recommendation. However, there is nothing stopping us from reading his book. It can be compared to a very demanding piece of music. Meanwhile, the author, who explains the details of central banking, could be compared to one of the world’s greatest, contemporary conductors.

The views expressed in this article are the private views of the author and are not an expression of the official position of the NBP.

(David McKelvey, CC BY-NC-ND 2.0)


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