Rather disingenuously, on the first page of Lombard Street — in the first paragraph, in fact — Bagehot declared that he would not be taking part in the controversies surrounding Sir Robert Peel's Bank Charter Act of 1844. This was more than a little hypocritical, for he then proceeded to speak of the Act in favorable terms, and to base his entire analysis on the presumption that the Act was permanently valid and a sound expression of guidelines for the regulation of money, credit, and banking.
The framers of the act, faithful adherents of the inelastic currency faction of the British Currency School of finance, considered gold the only "real" money. Banknotes were considered, at best, a substitute for gold. Under the Currency School, then, a commercial bank's power to create demand deposits backed by bills of exchange drawn by private sector individuals and businesses was not affected — or even considered, as John Fullarton and N. G. Pierson noted. (Moulton, Principles of Money and Banking, op. cit., II.234.)
Some authorities consider the Act the beginning of the gold standard in Great Britain, but this had already effectively been implemented with the "New Coinage" of 1816, which made silver subsidiary to gold, although paradoxically the official unit of value remained the Roman pound of silver, the "pound sterling," divided into 240 pennyweights. By 1816, of course, the so-called pound sterling was worth nowhere near the value of an actual Roman pound of silver. Attempts to maintain bimetallism (that is, a fixed rate of exchange between gold and silver) had virtually destroyed the British currency in the 18th century.
British banks that had previously issued bank notes were permitted to maintain those already in circulation, but the Act was intended to discourage further issues and force withdrawal of existing notes. The government was permitted to issue up to £14 million worth of notes backed by State securities, euphemistically referred to as "government stock." By the time Bagehot wrote in 1873, the statutory amount had been adjusted a number of times in response to recurring financial crises brought on by reliance on an inelastic currency. The ruling assumption was that any increase in the currency was to come from an increase in the gold supply; all new issues of notes by the Bank of England were to be subject to a 100% reserve requirement in gold.
The Bank Charter Act of 1844 (consistent with the view that the State and not the people is sovereign) was not absolute. The government retained the power to suspend the Act in cases of financial emergency, and to have the Bank of England issue additional notes backed by government securities, thus granting the State the power to impose an elastic, debt-backed currency at will, despite the official commitment to an inelastic, gold-backed currency. Not surprisingly, this happened regularly, almost every ten years: 1847, 1857, and 1866, incidents that Bagehot made a great effort to justify.
Thus, while the Act was considered a victory for the inelastic currency faction of the British Currency School and its doctrine that the issue of new banknotes was in and of itself a major cause of price inflation, the Act was only allowed to function when it suited the government — meaning (according to Bagehot) the propertied classes who controlled the House of Commons, who used their protected monopoly on existing accumulations of savings to great advantage.
Further (as we have seen), because of the naiveté over money, credit, and banking embodied in the Act, demand deposits were not considered part of the money supply. This is understandable, for if gold is the only "real" money, everything else is either a substitute or replacement for gold. Consistent with divine right, however, the State, in the person of the king or queen (or, for Bagehot, the House of Commons), can declare that State debt is as "good as gold." If anyone else attempted this same operation it would be theft, for no one other than a divine right sovereign can have the same God-given power of financial transubstantiation to turn government debt paper into bars of gold, having the outward appearance of paper, but which in reality is precious metal.
Demand deposits as well as bills of exchange fall outside this rather limited understanding of the institution of money. Demand deposits — "checking accounts" — ultimately involve exchanges and contracts between private individuals, not the State, and a check is not legal tender currency. Nevertheless, as Harold Moulton was to observe in his 1935 classic work on the science of finance, The Formation of Capital, extension of bank credit supplied the primary financing for capital formation in the United States during the 19th century. Obviously, given the similar dramatic increase in demand deposits in Great Britain during the same period, economic growth and development may have been hampered somewhat by the Bank Charter Act of 1844 and the antics of the government, but it was not halted.
What was hampered by the Act and other factors (such as the lack of limited liability for corporations in the United Kingdom until 1855) was widespread access to the means of acquiring and possessing property. While bank credit was supplying the primary financing for economic growth, the universal requirement that commercial loans be adequately collateralized (a requirement based, in part, on the belief that only accumulated savings could be used to finance capital formation) restricted ownership of most new capital to the already wealthy. At the same time, new conceptions of property that dismissed its roots in the natural law allowed control over the capital to pass to a new rising management class that, in many cases, did not own: Pius XI's "economic dictatorship." (See Kelso and Adler, The Capitalist Manifesto, op. cit., 117-129, esp., 119-120 in the discussion on Milovan Djilas's book, The New Class (1957).)