The colonial origins of central banking: why every central bank is still paying for a 17th-century war

In July 1694, 1,268 Londoners put up £1.2 million in under a fortnight. The king needed money to fight a war. They gave it to him and received, in return, a Royal Charter granting a private bank — their bank — the right to issue paper notes backed by the debt they’d just purchased. The government got its war funding. The shareholders got an 8% annuity and the extraordinary privilege of creating money from a government IOU.

That was the deal. Everything else is commentary.

We now call the institution that emerged from this transaction the Bank of England, and we describe it as independent. Loan, charter, note issuance rights, interest, war finance — the terms of the original bargain — versus independence, technical institution, monetary policy mandate, price stability. Not synonyms. One set describes 1694; the other describes what has been built on top of it since.

The clean version

The textbook account runs roughly like this. Central banks exist to manage the money supply, maintain price stability, and act as lender of last resort to the financial system — all at arm’s length from political pressure. They are technical institutions staffed by economists, not politicians. When they work well, inflation stays low, credit flows, and panics are contained before they become collapses.

This account is not wrong. Central banks do these things. The problem is what it leaves out.

The account presents the public mandate — price stability, financial stability, lender of last resort — as the founding purpose, with the institutional design having evolved toward it over time. What actually happened was closer to the reverse. There was a private bargain in 1694. The public mandate was retrofitted over it. The Bank didn’t evolve from prior monetary institutions into something new; it broke from them. Christine Desan’s Making Money (Oxford University Press, 2014) makes the point precisely: the Bank of England invented a new kind of money as a direct consequence of the 1694 deal, money backed by government debt rather than metal or prior commercial convention. That wasn’t a refinement of existing arrangements. It was a rupture, driven by the fiscal emergency of a specific war.

The standard account also presents central bank independence as a structural feature — something that arises naturally from the function itself. The Bank manages money; political interference corrupts money management; therefore independence follows from competence. But independence wasn’t in the 1694 charter. It came, formally, in May 1997, when Gordon Brown announced rate-setting authority in his first week as Chancellor. The institution held up globally as the model of central bank independence operated for 303 years before this formal independence existed. That’s a strange thing to call a structural feature.

What the textbook account identifies correctly is the function. What it gets wrong is the origin. And origin matters because the founding political bargain is still embedded in the architecture of these institutions. The original deal determined what gets built in and what gets bolted on. Three centuries of accumulation haven’t buried that structure — they’ve built on top of it.

The transaction — anatomy of 1694

William III was, in the summer of 1694, having a miserable war.

Five years into the War of the Grand Alliance — the attempt by a coalition of European powers to contain Louis XIV’s expansion — England’s finances were in serious trouble. The king was borrowing on life annuities at implied rates of around 14%, a testament to how little confidence markets had in the crown’s ability to repay anything. Standard government debt instruments weren’t working. Previous expedients — lottery loans, tontines, assorted short-term credit mechanisms — had failed to plug the gap. What William needed was a large lump sum, reliably delivered, from creditors willing to accept the government’s promise of repayment.

William Paterson, a Scottish financier, had an idea. Pair a large government loan with a bank charter. The subscribers who lent the king £1.2 million would not merely be creditors; they’d be shareholders in a new institution empowered to issue paper banknotes backed by the same government debt they’d just purchased. The notes would circulate as money. The bank would earn seigniorage — the profit that comes from issuing money — on top of the 8% annuity on the original loan. The government would get its cash. The shareholders would get a private money-creation franchise underwritten by public debt.

Charles Montagu, Chancellor of the Exchequer, brought it through Parliament via the Tonnage Act of 1694, a piece of legislation that also imposed duties on ships and beer and other goods — duties tied directly to Atlantic and colonial trade circuits. The revenue foundation of the whole arrangement was inseparable from Britain’s maritime commercial position.

The subscription filled in eleven days. Roughly 1,268 investors signed up, drawn heavily from London’s merchant and financial community. On July 27, 1694, the Bank of England received its Royal Charter.

What this transaction produced, as Desan’s analysis demonstrates, was not merely a new bank but a new kind of money. Prior monetary arrangements in England had involved coins or instruments tied to specific commercial transactions. The Bank’s notes were backed by government debt — an IOU from a state — and circulated as a claim on the bank, which in turn held a claim on the state. The chain was: state promises to pay → bank holds that promise → bank issues notes → notes circulate as money. Money, in this arrangement, is the government’s debt obligation, laundered through a private institution’s balance sheet.

That’s still how it works.

The 1694 Charter and the 1708 monopoly

The 1694 Royal Charter established the Bank of England's right to issue banknotes. It did not immediately grant a monopoly. That came in stages. The Bank of England Act of 1708 extended the Bank's charter and established that no bank of more than six partners could issue banknotes in England — effectively prohibiting any competitor of meaningful size. The 14-year gap between founding and formalized near-monopoly is itself instructive. The monopoly wasn't in the original deal; it was extracted through subsequent political bargaining as the Bank demonstrated its value to the state. Each renewal of the charter became a negotiation. The Bank had leverage — the government owed it money and needed it to hold the debt — and used it. The monopoly, like the independence that followed much later, was not structural. It was political, achieved incrementally.

O’Brien and Palma, writing in the Economic History Review (2023, vol. 76, issue 1), argue the Bank functioned as a public institution from its founding — well before Bagehot’s later theorizing — and that the relationship between Bank, state, and economy grew tighter from 1793, becoming constitutive of Britain’s ability to project military and commercial power over the following century. The Bank’s credit extension, on this account, wasn’t merely convenient. It was structural.

The colonial dimension isn’t incidental to this. The War of the Grand Alliance had a North American theater — King William’s War (1689–97) — in which England and France contested control of the fur trade, the Newfoundland fisheries, and the Caribbean plantation economies. The Tonnage Act’s revenue base, the commercial interests of the merchant-subscriber community, and the war itself were all entangled with Atlantic imperial competition. The Bank didn’t cause British colonialism, but it was assembled from the same material.

The mutual dependency created at founding is worth naming precisely. The Bank needed the government to remain solvent — if the state defaulted, the debt backing its notes became worthless, and with it the notes. The government needed the Bank to hold its debt and maintain market confidence. Neither could survive the other’s failure. This wasn’t a bug. It was the design. The Bank was a machine for converting the state’s debt into money, and the state was the guarantor of the Bank’s money. Separating them, conceptually or practically, has always been more complicated than the subsequent doctrine of independence has let on.

What was not in the agreement

The Bank of England was not designed to be a lender of last resort. That function accreted through crises, slowly and reluctantly.

Walter Bagehot’s Lombard Street (1873) is usually cited as the founding text of lender-of-last-resort doctrine: in a crisis, the central bank should lend freely, at penalty rates, against good collateral. Bagehot was prescribing a reform he believed necessary, writing about what the Bank should do, against a backdrop of episodes in which it had repeatedly failed to do it. The 1797 crisis, when the Bank suspended gold payments under wartime pressure. The crisis of 1825, when the Bank’s own tightening helped precipitate the collapse it was then called upon to arrest. The 1847 railway mania aftermath. The 1866 collapse of Overend, Gurney & Co. — the largest British bank failure up to that point — which Bagehot watched unfold and which informed Lombard Street directly.

Henry Thornton had articulated the same principle 71 years earlier, in An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802). Thornton understood that the Bank’s notes were the system’s ultimate liquidity anchor and that in a panic the Bank had a responsibility to lend against them. The Bagehot attribution is a simplification — the concept had been available for decades before the Bank began consistently acting on it.

Thornton before Bagehot

Henry Thornton's Paper Credit (1802) is the earlier and in some respects more sophisticated articulation of the lender-of-last-resort concept. Thornton, a banker and evangelical reformer, understood that paper credit operated through confidence, and that a central institution bearing ultimate liquidity risk could stabilize a panic that private actors could only worsen. Bagehot refined and popularized the doctrine in 1873, but the intellectual groundwork was Thornton's. The standard citation practice attributes the whole thing to Bagehot, which tells you something about how institutional memory works: the version that arrived at the right political moment — when the Bank was finally willing to listen — gets the credit.

Stefano Ugolini’s The Evolution of Central Banking (Palgrave, 2017) puts this more systematically. The gap between what central banks are chartered to do and what they actually do, Ugolini shows, reflects the founding political bargain more reliably than any subsequent mandate. The gap was undeniable each time a crisis arrived — and each time, the public mandate expanded to cover what the founding document had left out.

This matters practically. When a central bank today “balances” its inflation mandate against financial stability objectives — the tension that has become almost chronic since 2008 — it’s choosing between a retrofitted public mandate and an architectural private one. The inflation mandate is the bolted-on part. The financial sector relationship is load-bearing. When they conflict, the architecture tends to win. The Bank doesn’t intervene in gilt markets to protect price stability; it does so to prevent the financial system — the heir to the 1694 arrangement — from seizing up. Understanding what’s actually being prioritized requires looking past the stated mandate to the founding design.

The template travels

The 1694 structure turned out to be reproducible. Not because anyone consciously exported it as a model — though sometimes they did — but because the political logic was available to any government facing the same problem: large financing need, inadequate fiscal revenue, merchant-commercial class capable of supplying credit, and a need to give those creditors something more durable than a promise.

France got there through catastrophe. After a decade of assignat hyperinflation — the Revolutionary government had printed paper money backed by confiscated church and noble land, and had comprehensively destroyed confidence in paper currency — Napoleon, as First Consul, needed to rebuild the monetary system fast. On January 18, 1800 (28 Nivôse, Year VIII of the Revolutionary calendar), the Banque de France was founded. Napoleon was among its founding shareholders — thirty shares personally. Parisian bankers formed the core of the initial ownership. The bank issued notes, held government debt, and operated as a private institution with a public mandate. In 1803, it secured the note issuance privilege for Paris. The national monopoly was extended in 1848. The political economy was essentially the same as 1694 in French dress: private shareholders, government debt as anchor, public mandate as justification.

The American case is the most self-conscious replication. The Panic of 1907 had made clear that the United States’ decentralized, nationally chartered banking system was structurally incapable of providing a lender of last resort. The system had no center. When trust companies began failing in New York, the contagion spread through correspondent banking with no mechanism to arrest it — until J.P. Morgan personally organized the private response, buying time at age 70 through sheer financial authority that no private citizen could reasonably be expected to provide again. Congress responded by establishing the National Monetary Commission in 1908, with Senator Nelson Aldrich leading a systematic study of European central banking.

Jekyll Island

In November 1910, six men traveled by private railroad car to the Jekyll Island Club, a private hunting resort off the coast of Georgia. The party — Senator Aldrich, A. Piatt Andrew (assistant secretary of the Treasury), Henry Davison (J.P. Morgan & Co.), Arthur Shelton (Aldrich's secretary), Frank Vanderlip (National City Bank), and Paul Warburg (Kuhn, Loeb & Co.) — agreed before departing that no surnames would be used during the stay. They referred to each other by first names only, ostensibly a duck hunt. What they were actually doing was drafting the Aldrich Plan: a privately controlled "National Reserve Association" that would function as a central bank. The secrecy was Aldrich's attempt to prevent the plan being labeled a bankers' bill — which it obviously was. The plan was not enacted in that form. Congressional Democrats, led by Carter Glass and Robert Owen, rewrote it significantly. The Federal Reserve Act, signed by Wilson on December 23, 1913, created 12 regional Federal Reserve Banks owned by member commercial banks, controlled by their boards, and overseen by a Federal Reserve Board appointed by the President. The Jekyll Island version: a private club runs the money. The Glass-Owen version: a hybrid, ownership private, oversight nominally public, the compromise made explicit in the congressional record. Nobody pretended otherwise.

What the private banks received in the Federal Reserve Act was a formal claim on the system’s liquidity — equity in the regional Fed banks, access to the discount window, membership benefits that made the system’s resources available in a crisis. What the federal government received was a lender of last resort that didn’t appear on the federal budget. It was the 1694 arrangement adapted for a republic suspicious of both central authority and private banking power, and the adaptation was, characteristically, a compromise that preserved the core while renegotiating the surface terms.

What “independence” actually means

The Bank of England became formally independent in May 1997. Gordon Brown’s announcement in his first week as Chancellor — rate-setting authority transferred to the Monetary Policy Committee — was treated globally as a culmination, a demonstration that central bank independence was the mature, modern arrangement. The institution that had existed since 1694 had finally arrived at its proper form. But the Bank had been operating for 303 years before this. Three centuries of monetary management without formal independence.

The Bundesbank’s independence has a different origin entirely, and it’s worth sitting with. The Bank deutscher Länder, the Bundesbank’s predecessor, was established in 1948 by Allied occupation authorities. The Deutsche Bundesbank Act followed in 1957. German central bank independence was not an expression of German democratic preference for sound money — or not only that. It was imposed by foreign governments on a defeated state, as part of a reconstruction architecture designed to prevent the Weimar-style monetary financing that had preceded Nazi political success. German independence was a foreign policy choice by the Allied powers, written into German institutional design. The famous German commitment to price stability, the institutional culture, the reputation — all of this is real. But the independence was not homegrown. It was transplanted, under political conditions of conquest.

The ECB’s independence is written into Article 130 of the Treaty on the Functioning of the European Union — the prohibition on ECB officials taking or seeking instructions from any EU or national government. The Treaty is a political document, negotiated by heads of government, binding only as long as political consensus supports it and subject to amendment by the same political processes. ECB independence is precisely as durable as Treaty consensus, which means it is precisely as durable as European political consensus on maintaining the current monetary architecture. The euro crisis demonstrated what happens when that consensus comes under strain: the ECB’s interventions — particularly the Outright Monetary Transactions program announced by Draghi in 2012 (“whatever it takes”) — pushed well past what Article 130 would seem to permit, and survived because political consensus barely held.

The Treasury-Federal Reserve Accord of March 1951 is the most clarifying American example. During World War II, the Fed had pegged Treasury yields — agreeing to buy whatever bonds were needed to keep long-term rates at 2.5%. This fiscal accommodation continued into the postwar period. By 1951, inflation was rising and the Fed, under Thomas McCabe and then William Martin, wanted to raise rates. Truman wanted to maintain the peg. The conflict was resolved not by the Fed’s statutory mandate — which would have settled nothing — but by explicit bilateral negotiation, culminating in the March 1951 Accord, which re-established Fed rate-setting freedom. Independence that required a formal agreement to exist is not structural. It is contractual. It can be renegotiated.

The fiscal theory of the price level

Christopher Sims (Princeton, Nobel 2011) and John Cochrane (The Fiscal Theory of the Price Level, Princeton University Press, 2022) argue that the price level is determined not by monetary policy alone but by the government's fiscal position. If public debt exceeds what markets believe can be repaid through future taxes or growth, prices rise — regardless of what the central bank does. The implication is that central bank independence is, in a deep sense, contingent on fiscal space. A central bank operating in a country where the debt trajectory is unsustainable is not independent in any meaningful sense; it is administering a monetary policy whose scope is bounded by the government's fiscal arithmetic. Sims made a version of this argument in "Origins of US Inflation" in AEA Papers and Proceedings (2024). The fiscal theory doesn't get much airtime in standard central banking discourse, partly because it implies that a central bank's independence is an artifact of the government's willingness to maintain fiscal credibility — which is, again, a political condition, not a structural one.

These four cases — the Bank of England, the Bundesbank, the ECB, the Fed — are the institutions most frequently cited as models of central bank independence. In each case, the independence is dateable, contingent on specific political decisions made by specific people, and revocable by the same political processes that created it. Ulrich Bindseil’s Monetary Policy Operations and the Financial System (Oxford University Press, 2014) makes the point at the operational level: central banks’ balance sheet positions constrain their operational independence regardless of what their statutes say. A central bank holding large amounts of government debt has a direct financial interest in sovereign solvency that shapes its room for maneuver. The gap between statutory independence and practical constraint is where central banking actually happens.

The bargain, live

The Federal Reserve holds Treasuries, the Bank of England holds gilts, the ECB holds euro-area sovereign bonds. Every major central bank today holds government debt as its primary asset — the 1694 bargain, reproduced at continental scale.

Quantitative easing since 2008 made the structure visible in ways it hadn’t been before. The Fed entered the 2008 crisis with a balance sheet of roughly $900 billion. By April 2022, that balance sheet had reached $8.95 trillion. The Bank of England’s Asset Purchase Facility reached £895 billion by the end of 2021. The ECB’s Eurosystem consolidated balance sheet peaked at around €8.56 trillion the same year. In each case: central bank purchases government debt, government receives cheap financing, central bank issues currency against that debt. Different vocabulary — quantitative easing, asset purchase facility, monetary accommodation — same machine.

Fiscal dominance is the 1694 dynamic becoming visible again under stress. It occurs when the government’s debt position is large enough that the central bank cannot raise interest rates without threatening sovereign solvency — at which point monetary policy decisions are effectively subordinated to the government’s financing needs. The form of independence remains; the substance narrows.

American net interest payments on federal debt rose from approximately $345 billion in FY2020 to approximately $659 billion in FY2023 — approximately a 91 percent increase in three years. The Congressional Budget Office projects net interest costs reaching $2.1 trillion annually by 2036. At that scale, rate decisions by the Federal Open Market Committee are no longer separable from questions about whether the federal government can service its debt. The FOMC can pretend otherwise, and the statutory independence remains intact, but the fiscal arithmetic constrains the policy space.

The UK provided a more acute demonstration in September 2022. The Truss government’s mini-budget — unfunded tax cuts worth roughly £45 billion — triggered a gilt market crisis that put pension funds using liability-driven investment strategies on the edge of forced liquidation. The Bank of England responded by intervening in the gilt market, buying long-dated gilts to suppress yields. This happened while the Bank was simultaneously raising interest rates. The Bank was tightening monetary policy and loosening it in the same month. The Monetary Policy Committee continued setting rates, the Financial Policy Committee continued its responsibilities — formal independence held; fiscal reality set the terms.

The ECB’s decade of near-zero rates was driven substantially by a problem the ECB would prefer not to name directly: Italian and Greek sovereign debt sustainability. With yields at normal levels, Italian debt service costs become existential. The ECB didn’t set policy to prevent an Italian fiscal crisis. It set policy according to its mandate. But the effect was the same, and the constraint was the same. The mandate and the fiscal reality pointed in the same direction — until they stopped, and the ECB had to improvise.

Former Treasury Secretary Janet Yellen, speaking at Brookings on January 6, 2026, put the American dynamic plainly: fiscal dominance occurs when “the government’s fiscal position—its deficits and debt—puts such pressure on its financing needs that monetary policy becomes subordinate.” She noted that while the US was not yet there, “the preconditions for fiscal dominance are clearly strengthening.” Trump administration pressure on the Fed in 2025 to reduce rates was explicitly linked in public commentary to the cost of servicing federal debt. This was not presented as fiscal dominance — it was presented as policy difference. But the mechanism is the same one Yellen was describing. The vocabulary has changed; the structure hasn’t.

OMFIF’s “Fiscal chickens are coming home to roost” (August 2025) warned that if fiscal pressures intensified, central banks could find themselves “under the gun to absolve governments of their responsibilities,” with yield curve control or quantitative easing to follow “under the guise of financial stability concerns.” The phrasing is tactful. What it describes is the government debt that the central bank already holds — the 1694 arrangement — becoming the instrument through which the independence is eroded. Not abolished. Eroded. The form remains; the substance adjusts.

The image and the argument

There’s a substitution at the center of how we talk about central banks. In 1694, the vocabulary was: loan, charter, note issuance rights, interest, war finance. In 2026, the vocabulary is: independence, technical institution, monetary policy mandate, price stability, lender of last resort. The second set is not a translation of the first. It’s a replacement. The original terms describe what happened — a political deal between a government and a commercial class that gave the latter a money-creation franchise in exchange for war funding. The later terms describe something that was retrofitted onto that deal over three centuries of crisis management, Bagehot, Thornton, congressional compromise, treaty negotiation, and political imposition.

The substitution is the concealment. If you accept the second vocabulary as the natural description of the institution, you lose the ability to see what’s actually there. You can’t understand why central bank independence is structurally contested — not merely politically attacked by populists or authoritarians, but contested at the level of architecture — without recovering the first vocabulary. Independence was never in the original design. It was added late, through different political processes in different countries, none of them inevitable, all of them reflecting the specific power relations of the moment. The question isn’t how do we protect independence. The question is what would it take to renegotiate the original bargain on different terms — who would have to give what up, who has a stake in the current arrangement, what the architecture would have to look like if the 1694 deal were being designed now, with different objectives and different beneficiaries. That’s a hard question because the answer requires acknowledging who benefits from the arrangement as it stands.

In July 1694, 1,268 people put up £1.2 million in eleven days to finance a king’s war, got a bank charter in return, and created — almost incidentally, almost by accident — the institutional template that every major economy on earth still operates. The deal was specific, contingent, and made by people with particular interests. What they built is still there. It’s been painted over, renovated, given new names, staffed by economists with doctorates, provided with statutory mandates about price stability. But the load-bearing walls are original.

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View of the Bank of England building in July 2022 – Wikipedia

Key Sources and References

Christine Desan, Making Money: Coin, Currency, and the Coming of Capitalism (Oxford University Press, 2014)

Patrick K. O’Brien and Nuno Palma, “Not an ordinary bank but a great engine of state: the Bank of England and the British economy, 1694–1844,” Economic History Review, vol. 76, issue 1, 2023, pp. 305–329

Walter Bagehot, Lombard Street: A Description of the Money Market (Henry S. King, 1873)

Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (J. Hatchard, 1802)

Stefano Ugolini, The Evolution of Central Banking: Theory and History (Palgrave Macmillan, 2017)

Ulrich Bindseil, Monetary Policy Operations and the Financial System (Oxford University Press, 2014)

John Cochrane, The Fiscal Theory of the Price Level (Princeton University Press, 2022)

Christopher Sims, “Origins of US Inflation,” AEA Papers and Proceedings, vol. 114, 2024, pp. 90–94

Janet Yellen, remarks at Brookings Institution on central bank independence and fiscal dominance, January 6, 2026. Available at brookings.edu

Federal Reserve, H.4.1 statistical release — total assets data. Peak of approximately $8.95 trillion, April 2022. federalreserve.gov

Bank of England, Asset Purchase Facility Annual Report 2021/22. APF peak £895 billion (December 2021). bankofengland.co.uk

European Central Bank, Eurosystem consolidated balance sheet data. Peak approximately €8.56 trillion (2021). ecb.europa.eu

Congressional Budget Office, The Budget and Economic Outlook: 2026 to 2036 (2026). Net interest data and projections. cbo.gov

Federal Reserve History, “The Meeting at Jekyll Island.” federalreservehistory.org

Banque de France, “The founding history of the Banque de France.” banque-france.fr

OMFIF, “Fiscal chickens are coming home to roost,” August 2025. omfif.org