Northern Ireland

Who invented the National Debt?

The Bank of England has been the government's banker since 1694
Image caption The Bank of England has been the government's banker since 1694

We hear about the National Debt on an almost daily basis. It's the amount the government owes and it is a matter of considerable anxiety for us all. If, like Greece, the government builds up so much debt it can't pay it back, then the country could be declared bankrupt, leading to financial turmoil.

The United Kingdom's National Debt currently runs at more than 60% of everything we produce as a nation in goods and services in a year, the measure of which is called the Gross Domestic Product (GDP).

This is by no means the worst ratio we've ever seen. Britain after the World War II had debts worth more than 230% of GDP. Some historians argue that the entire British empire was built on runaway government borrowing. Even so, it's clear we're not enjoying a particularly rosy outlook at present.

Monarchs and money

So whose government was the first to borrow money to finance itself? That honour falls to William of Orange, the Dutchman who was invited to seize the throne of England, Scotland and Ireland from James II in the Glorious Revolution of 1688.

Image caption Portrait of William of Orange by Sir Godfrey Kneller

William's subsequent victory at the Battle of the Boyne in 1690, which is commemorated on 12 July, put paid to James II's attempts to reclaim his kingdom and ended the Stuart dynasty.

For the Stuart monarchs, money had been a perpetual source of friction with Parliament. In the case of Charles I, it ended in his execution and the abolition of the monarchy. The Restoration saw his son, Charles II, return from exile in France as a believer in the divine right of kings, which meant raising taxes and spending cash exactly as he saw fit.

But Parliament attached conditions to the return of the king. Amongst other things, he was required to declare himself Protestant and agree that the raising of any new taxes would be approved by Parliament. The ever-pragmatic Charles agreed.

Money was the means by which Parliament sought to shackle him. In reality, it led to a series of tense stand-offs, with Charles adopting all sorts of secret stratagems to get the cash he needed, including asking Catholic France to service his debts.

Glorious Revolution to financial revolution

After Charles came his less pragmatic - and openly Catholic - brother, James II. James quickly succeeded in uniting the English establishment against him, partly through his attempt to stack Parliament with his supporters so he could raise taxes as he saw fit. It wasn't long before his situation became untenable. Shortly thereafter, a group of English nobles invited William of Orange to rule as co-regent with his wife, and James II's daughter, Mary. James fled and the Boyne followed.

The Stuarts were history, but the perennial issue of the monarch and his money was not.

The solution lay in William's need to cement his authority and secure the assets of England, Scotland and Ireland in his wars against the French king, Louis XIV. Keen to avoid a scrap with MPs, he quickly consented to a slew of weighty constitutional changes - the Bill of Rights - that handed over key kingly powers to Parliament.

In so doing, William paved the way for a financial revolution. Parliament now authorised taxes, audited how money was spent and directed revenue as it saw fit, including taking it away from the king. It also opened the way for the government to raise money by means other than taxation, namely, by borrowing. But borrowing from whom?

The government's banker

London's traders had long admired the Dutch, whose Wisselbank in Amsterdam provided the necessary supply of readily available cash that both government and commerce needed to extend trade and launch ambitious projects, including wars. It had played a major part in establishing the Dutch Republic as a European power and many in England saw huge potential for the same model at home.

Various ideas were put forward for some form of central bank, but it was Scottish entrepreneur William Paterson who carried the day with his proposal for a Bank of England and Fund for Perpetual Interest.

Paterson was backed by prominent business interests and the Chancellor of the Exchequer, Charles Montagu. In 1694, the Bank of England Act sailed through, establishing a new institution with a royal charter. It proved a popular innovation and private subscriptions of £1.2m formed the seed capital stock of the bank.

The creation of credit

Image caption Banknotes were first issued by the Bank of England in 1694

What really sped the plan through Parliament was the government's desperate need for money. It really couldn't afford to say no, especially given William's expensive European wars with the French. The Bank of England thus became the government's banker, arranging loans, often in return for renewal of its Charter. It was only in 1998 that responsibility for managing the government's debt was transferred from the bank to a department of the Treasury aptly called the Debt Management Office.

Another important innovation that would grow from William's financial revolution was the concept of "imaginary money". Money had always been seen as a solid and material thing. Now, investors began to raise money against assets like stocks, revenues and obligations, but without the tedious business of exchanging actual coins.

This "imaginary money" is better known today as credit, giving William of Orange the dubious honour of paving the way for not only the National Debt, but the credit crunch as well.

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