BANKING CRISIS JUNE 1772 INTRODUCTION
Great Britain experienced an economic boom in the years building up to the financial crisis of 1772. Exports to America surged and London became an important network between provincial financial areas. This network was the catalyst for the lack of confidence that spread after the collapse of London banking house Neal, James, Fordyce and Down. The man held responsible for this collapse was banking partner Alexander Fordyce. Fordyce had speculated wildly, shorting East India Company shares while funding his losses using customers’ deposits. Once the news of the collapse hit Edinburgh the system of trust which had kept the credit structure afloat was gone.
The Douglas, Heron & Company, operating as the Ayr bank, was established in Scotland in 1769 based on the scheme championed by Scotsman John Law. Law believed that confidence was the basis of credit. Before this paper money had to be backed by gold, he felt banknotes would be just as valuable as coins of silver and gold. This made credit very risky as it now became dependent almost solely on confidence. Virtually overnight the bank handed out excessive loans to their privileged customers, with little or no collateral.
Several branches opened throughout Scotland, its main aim was to enhance and support the expansion of agriculture, trade and business. The bank brought with it a sense of optimism and confidence which led to customers overlooking the unlimited liabilities they faced on borrowings. Many of the banks customers were speculators involved in both American and West Indian trades, especially tobacco and sugar. A discovery after the bank collapse showed that many of the company’s directors were closely connected to these speculators and oversaw the transfer of funds, creating mutual credit agreements.
The bank spent a year after the collapse of Neal, James, Fordyce and Down trying to retain confidence but when the Bank of Scotland and the British Linen Company refused to accept Ayr Bank notes, the bank folded. The Ayr bank ‘traded beyond their means; divided control by permitting branches to act independently; forcing the circulation of their notes; giving credit too easily; ignorance of principles of business; and carelessness of officers’(Kerr 1908).
In scenes similar to the bank run in Frank Capra’s ‘It’s a wonderful life’ depositors rushed to the bank looking for repayments of their bills of exchange. Estate owners were forced to repay loans, which most were unable to do. The Ayr bank offered a £100 reward for anyone who turned in those spreading rumours about the sad state of the bank. This move went some way towards reassuring people but as more companies collapsed this confidence soon subsided.
Within months from June 1772, fifteen private banks in Edinburgh went bankrupt. Douglas, Heron & Company closed on 25 June with the intention of reopening in just three months. The Scottish aristocracy were now involved in an attempt to bail out the bank. The Bank of England offered to step in if the aristocrats supported its loan with bonds on numerous English lands. This agreement never went through as the aristocrats did not want to take on the full responsibility of the banks liabilities as co-partners and a cost of £300,000.
The report compiled following the 1772 crisis outlined how the bank was mismanaged and helped prepare a suitable regulatory framework for banking practises. Up to then rules and regulations were ignored and unsecured loans were the norm. The tide changed for some time in Scotland and bankers were given short rein on their consumption and private lifestyles.
Many of the loans were never collected and the repercussions reverberated throughout Scotland. Building works ceased through the summer of 1772 and many companies struggled to pay workers’ wages. Bank of Scotland and Royal Bank dominated Scotland post 1772 and were responsible for the rebuilding of Scottish banking in their supervisory roles. The managers of the Douglas, Heron & Company still insisted that the losses occurred in the normal operations of the bank.

QUESTIONS:
1. Expanding on the case study explain how confidence backed money compares to gold backed money. Which do you think is better? Explain your answer.
2. Can you discuss any similarities you see in this case study and the financial crisis experienced in Ireland since 2008?
3. The Ayr bank issued a reward for information regarding the spreading of rumours. Do you think this was a good idea? Would it work in today’s financial climate?
4. Discuss the aristocrats offer to support the Douglas, Heron & Company in comparison to the Irish Government supporting its banks with NAMA? In your opinion, are their similarities?
5. Briefly discuss the prominence of un-backed loans in the crisis of 1772. Name | ID | 1. Moges Asmare | GSR/2706/08 | 2. Israel Birhanu | GSR/3260/08 | 3. Henok Alemu | GSR/3259/08 | 4. Hussen Redi | GSR/2699/08 | 5. Seblewongel Arage | GSR/3265/08 |

1. Expanding on the case study explain how confidence backed money compares to gold backed money. Which do you think is better? Explain your answer.
Confidence backed money is better than the Gold backed money. One common misconception about money is that it has to be backed by a commodity such as gold or silver. Money is merely a representation of the perception of value. Instead of being backed solely by gold, money should only be backed by trust. Trust on which the note will be honored by a merchant in exchange for his merchandise or as payment for any debt. Another factor that backs the strength of money is confidence for those who use it. This confidence is imposed by governments through careful regulations preventing markets to surrender into irrationality which damages the value that money is supposed to physically represent.
Gold is subject to hoarding that could result in serious shortage. If the economy demands more money to represent the value created, it will result in a shortage and thus a liquidity crisis will emerge. The great depression is partly caused by the shortage of gold that supposed to back the enormous size the economy at that time has become after the First World War. Today's economic growth would never happen if credit is based on the gold available to satisfy it.
Money has to be anchored to a fixed commodity in order to prevent rampant inflation. Simply printing money without anything backing it is simply dangerous and could destroy the value of people's savings. It is true that economies expand and their value should increase as new products are created, a gold backed currency prevents asset bubbles as credit is limited based on the available gold or silver to back the printing of new bank notes. During an economic expansion, the limited amount of currency floating around the market prevents inflation by increasing how many more goods a single note can buy because it strengthened due to a limited supply of it. After the United States totally closed the gold window in 1971, the value of the dollar has steadily declined and it now takes more bank notes to buy the same items necessary for daily living.