Bank Bargains and Entangled Political Economy:

The Evolution of the Bank of England

Pablo Paniagua*
King’s College London

Abstract

This paper examines the evolution of the Bank of England under a framework of entangled political
economy that originates in a process of bank bargains. The theory explains the process by which the
political economy order becomes increasingly entangled in the banking system, leading to a
banker’s bank to emerge. The theory suggests that the entanglement allows the polity organization
to transmit some of it features to the economic organization. The transmission of non-market
characteristics was an essential part of the bargains, leading to the Bank’s transformation. This
paper contributes to a public choice rationale for the emergence of central banks and to political
entanglement theory by providing an additional source for its dynamic development.

JEL Codes: E6, H1, P1

Key Words: Bank of England; Central banking; Entangled Political Economy; Political Bargains.

* Ph.D. Candidate King’s College London, U.K. Author contact: pablo.paniagua_prieto@kcl.ac.uk

The Author would like to thank Victoria Finn for editorial support and suggestions.

1
1. Introduction

Since the publication of Goodhart’s locus classicus The Evolution of Central Banks, there has been

little work in understanding central banks’ nature, fundamental roles and evolution (Broz, 1998;

Giannini, 2011; Selgin, 1993). The lack of this critical understanding and evaluation of central

banks’ evolution has been more acute in the post-crisis literature.1 Goodhart’s general overview of

early central banks evolution is well characterized by his account on the Bank of England

(Goodhart, 1988, pp. 15-19; 45-46; 104; Selgin, 1993). The Bank seems to be a solid historical

interpretation of central banks’ plausible natural evolution, characterized by the natural transition

from a for-profit competitive bank towards a non-profit central bank. Goodhart’s evolutionary

account has been questioned (Dowd, 1990; Selgin, 1993). Selgin (1993) argues that the Bank of

England’s evolution cannot be explained in a ‘natural’ competitive way and that its evolution was

severely distorted by government favors and regulation. While we agree with the general criticisms

in Goodhart’s evolutionary account, we believe that the dynamics that enhanced and led to the

Bank’s non-profit structure in addition to its hegemony as a banker’s bank have not been accurately

explored. In this paper, we seek to use an alternative framework to make the Bank’s evolution

comprehensible. We will use a public choice framework of bank bargains and entangled political

economy pioneered by Calomiris and Haber (2014) and Wagner (2010; 2012), respectively.2 This

framework enables us to understand the Bank’s role and how it evolved from for-profit to a non-

profit structure. The framework of bank bargains will sustain the dynamics of political economic

entanglement. Our account will set us apart from Goodhart and his critics by showing that the

evolution of the Bank is conditioned through a process of political entanglement rather than from

the natural evolution of the English banking system.

1
Calomiris and Haber (2014) deal with the evolution of banking systems. Giannini (2011) addresses central bank
evolution through a perspective of endogenous responses to crisis. For a classical account of the evolution of
banking systems, see Clapham (1944).
2
On political entanglement see Patrick and Wagner (2015) and Smith, Wagner and Yandle (2011). To read about
charter renewals as bargains, see Broz and Grossman (2004). For a general view of public choice analysis on
central banking, see Toma (2001, chapter 21).
2
The bank bargain framework establishes that the variation in political institutions and legal

frameworks affects the nature and incentives of possible government-banking partnerships

(Calomiris and Haber, 2014, p. 4). It then shows how those partnerships affect the structure and

efficiency of banking systems. Different political powers and institutions arrange incentives that

lead different entities and policy makers in a social network to seek to form coalitions through

bargains. Coalitions are formed in order to alter legislation and policies in their favor, externalizing

the cost of those policies (Calomiris and Haber, 2014, pp. 4; 13-15). In addition, entangled political

economy is an alternative framework to understand social and political relationships. Entangled

political economy differs from the ‘normal approach’ (Wagner, 2010) of political economy in

understanding social relationships. For example the most common approach, illustrated in the work

of Besley (2006) and Persson and Tabellini (2000), models the relationships between political and

economic organizations as unidirectional relationships stemming from the political entity as a

unified whole into economic organizations. This sequential relationship seemingly arises from

entirely distinct divisible institutional frameworks, modeled as single point-mass systems (Smith et

al., 2011). This unidirectional linear relationship limits the analysis of socio-economic interactions

towards treating relationships as static equilibrated ones, in a one action one outcome setting

(Wagner, 2010). The government sees a space for improvement and the political entity acts upon

the economic system to move it towards the objective equilibrium (see Fig. 1). This view treats

cause and effect linear relationships as an exercise of comparative static analysis (Wagner, 2010;

2012). Implicitly this approach models the outcomes and consequences of these relationships as if

they are on the same complexity level in which actors make their choices. Since the relationship

choices are linear and with pre-reconcile objectives, the social relationship’s outcome is therefore

derived from the agent’s choices. Hence it is conceptualized at the same level of complexity (Salter,

2014; Wagner, 2012). This approach’s shortcoming is that it misses the open-ended nature of choice

along with the unintended institutional consequences arising from the relationships (Wagner, 2010).

Relationships are social elements of a higher complexity level, irreducible to agent’s choice under
3
an equilibrium framework (Wagner, 2012). These are precisely the elements that entangled political

economy seeks to illuminate.

The scope of this paper is to understand the evolution of the Bank of England, through entangled

political economy.3 Public choice analysis has modeled central banks mainly as institutional

responses to crises and other public goods following the logic of collective action (Olson, 1965).

Their evolution is seen as a convergence, or ‘joint production’ (Olson, 1965), between financial

stability and lower public credit. This provides disperse collective benefits and establishes a

bureaucratic entity providing concentrated benefits to interest groups (Broz, 1998; Toma, 2001).

Whereas Broz’s (1998) public choice concept of ‘joint-production’ is able to explain the micro-

foundations for the original Bank charter, it implicitly assumes that the ‘joint-production’ original

Bank was permanent and created as a full central bank. Therefore neglects the subsequent recharter

bargains in which the bank gained extra market characteristics. Treating the Bank as an institutional

equilibrium ignores the dynamic process of entanglement that led the Bank to become the banker’s

bank concentrator of reserves. We extend Broz (1998) and Broz and Grossman’s (2004) account

with an unintended institutional evolution of a banker’s bank that can be explained through

entanglement based on the process of bank bargains. The theory explains the process by which the

political-economy order becomes increasingly entangled. The entanglement allows a polity

organization to transmit some of its extra-market features to the economy organization with which it

establishes relationships (Salter, 2014). In the case of the Bank of England, the transmission of

political characteristics was an essential part of bank bargains between the Bank and the

government. The dynamic entanglement’s end result was the full transition of the Bank into a non-

profit central bank (Goodhart, 1988, pp. 45–46). We contribute to the entangled framework by

3
Entangled political economy unveils the dynamics of overlapping interactions among “individual entities and
participants” (Patrick and Wagner, 2015, p. 104). For tractability of the bargain dynamics, we focus on analyzing
entanglement of entities such as banks and Parliament rather than single actors. Propositions can be made at the
level of interacting entities despite the fact that acting individuals form them (Patrick and Wagner, 2015).
4
suggesting that the “continuum of entanglement” (Salter, 2014) can also be nurtured through

processes of flexible bank bargains arising to renegotiate incomplete contracts under uncertainty

between polity and economic entities (Broz and Grossman, 2004). This paper contributes by

suggesting a possible path of the entanglement generalization, via repeated but infrequent bank

bargains. This extends the theory away from its dependence on the channel of repeated regulatory

interactions during crisis as the only entanglement facilitator (Salter, 2014; Smith et al., 2011). This

paper then builds on Broz (1998) and Calomiris and Haber’s (2014) conceptualization of the

political factors that shape coalitions and banking bargains but emphasizes the unintended

institutional shifts and entanglement dynamics arising under those repetitive bargains.

The paper proceeds as follows: Section 2 examines the theory of political bargains and political

economy entanglement, pointing out how they differ with the “additive” concept. We contribute to

political entanglement by associating its emergence and dynamics, as stemming from a ‘bank

bargain game’ (Calomiris and Haber, 2014). This enlarges the entanglement framework by

suggesting a wider explanatory dynamic for its emergence and growth, sustained by incomplete

contracts and charter bargains. In Section 3 we present the arguments exposed by Goodhart (1988),

which sustain the natural evolvement of central banks. We also explore the historical account of the

Bank of England’s establishment, as well as how the continuous charter renewals exacerbated

entanglement. Section 4 reviews the Bank’s evolutionary account based on the concentration of

reserves enhanced by legal precedents. Section 5 concludes.

2. Bank Bargains and Entangled Political Economy

We will briefly conceptualize Wagner’s (2010) “additive political economy” concept. Additive

political economy refers to “a scheme of thought where economic equilibrium is conceptualized

prior to political activity, with political activity then modifying that equilibrium” (Wagner, 2012, p.
5
9). The concept starts with the assumption that the economy as a whole is in a state of equilibrium

that might not be desirable. From there the political organization as a single entity comes as an

exogenous unit into the system to apply a specific action to move the equilibrium to a new state

(Figure 1 displays this relationship). The political entity therefore acts as a whole mass into the

economic organization to direct the system towards a preferred set of equilibrium. This entire

concept possesses shortcomings. First, it assumes that both the economy and the polity are single

divisible entities or solid unities of equilibrated relationships (Wagner, 2010, Chapter 8). In reality

the economic and political world are formed by myriads of actors and decentralize entities. Under

that heterogeneous setting, objectives and incentives of actors might differ but interact. Second, the

assumption that the political entity is detached both socially and economically from the economic

sphere is unfounded since the polity’s foundation and survival requires support from the economic

order (Buchanan, 1990; Tullock, 1965). Here is where the concepts of political bargains and

entangled political economy might be useful to fully understand the relationships between

economy-polity nodes.

The Great Recession in 2008 has evidenced that banking systems are institutional arrangements

which possess severe embodiments of national and political systems leading to triadic exchanges

(Calomiris and Haber, 2014, chapter 7 and 8; Congleton, 2009). The crisis and bank bailouts have

also shown the severe degree of institutional entanglement between banks and regulators, which

suggests a higher level of complexity in their relationships, inexplicable from an additive

perspective (Congleton, 2009; Smith et al., 2011). Government policies in banking therefore cannot

be seen as outcomes of policymakers’ decisions leading the economy to a new desired equilibrium.4

They are rather the outcome of a more complex interaction in the form of political exchanges or

game of bargains. The process of “Game of Bank Bargains” (Calomiris and Haber, 2014, chapter

4
For essays on the complex relationships between bureaucratic networks and monetary policy in a Public Choice
framework, see Mayer (1993 [1990]) and Toma (2001).
6
2), is a process that considers government policies and legislations as the outcome of dynamic

partnerships of interests groups or coalitions that control regulation, definitions of property rights,

and banking policy.5 The institutional, legal, and political framework shapes the partnerships and

determines the current distribution of political and economic powers that might influence

negotiations. The bank bargain players are entities or actors who have a stake in the banking

system’s performance and credit allocation. Coalitions might form among the possible players,

affecting the banking industry rules and its market properties.

Calomiris and Haber (2014, pp. 32–34) recognize that governments possess the power to regulate

banks and the power to enforce credit contracts through altering the structure of property rights via

bank charters. From charters, governments might affect or seek to influence the system so that

banking responds institutionally to political and pressure groups’ objectives rather than to market

efficiencies. When polity entities leverage the property rights system through processes of political

deal making, they can potentially generate a propitious environment in the chartering negotiations

that entangles the polity and banking sector. The property rights system and the framework

established by the government of enforcing contracts through charters affects the potential

relationships between them and banks through time (Broz and Grossman, 2004; Calomiris and

Haber, 2014). When the bank bargains determine the outcome of property rights under which banks

operate, banks and government actors that gain from bargains would be interested in perpetuating or

enhancing those bargains to renegotiate contracts in their favor by altering legal and property right

structures in subsequent charters. This could generate a flexibly adjusted long-term bargaining

relationship, opening the possibility of dynamic entanglement among the involved entities. Bank

bargains through time could be a plausible starting point of an entanglement process. Banks that are

affected by these assignments of property rights or legal constraints will no longer be considered

5
The process of bank bargains builds on Olson (1965) and Stigler (1971), which modeled government policy and
regulation as reflecting conflict dynamics among interests groups and existing partnerships. For more on the
dynamics of bank bargains, see Calomiris and Haber (2014, pp. 13–15 and pp. 38–41).
7
private in the full meaning of the term. Banks formed under chartering arrangements as such are

founded on systems of partnerships with government, importing non-market characteristics through

time that reflect negotiation bargaining power among the entities that negotiate charters renewals

(Calomiris and Haber, p. 13). The fundamental point of bargains is that a polity or political actors in

the network, which has certain enforcement and legal powers, might seek to form partnerships with

other actors. Through a partnership, the political entity wants to gain from political trades while in

exchange it gives a certain property rights and regulatory structure to banks. The structure severely

affects the banking sector’s economic and market boundaries, which blurs their boundaries via the

structure of charter rights. Bank bargains therefore could potentially start the process of political

entanglement and moreover advance its own expansion through a dynamic negotiating process.

Within the political entanglement, Calomiris and Haber (2014, Chapter 2) implicitly reflect on how

the political entity exports extra market characteristics onto the economic organizations through the

bargains. In order to make this gradual process more comprehensible we complement their account

with entangled political economy. According to the authors it is due to the inherent nature of

banking, which needs defined and enforced property rights, that banks seek a mutually beneficial

partnership with governments. Partnerships are formally codified in the form of bank charters in

which the government grants special privileges along with legal enforcement of limited liability and

certain extra market benefits. In exchange, banks agree to provide certain economic and financial

assistance to some interest groups. Bank charters can therefore be seen as institutional and legal

formalizations of exchanges between polity and economic entities in which these bargains are

executed. They generate political-economy novelty in the social order, affecting the network of

relationships and their market boundaries (Wagner, 2010). The process of bank bargains can then

explain how the process of political entanglement originates and expands across banking systems.

Entanglement can be carried forward with bank bargains based on flexible incomplete contracts

‘under uncertainty’ that allow for future renegotiations (Broz and Grossman, 2004). The nexus
8
between bank bargains under uncertainty and entanglement has not been addressed in the political

entanglement literature. The nexus can also contribute to enlarging a public choice understanding of

central banks’ evolution and explain the Bank of England’s evolution. Bank bargains can be at the

core of the process that initiates entanglements and add constant novelty to social relationships,

since “entangled political economy is centered on networks and evolutionary process of

development, where that development is kept in motion by individual [or entity] efforts to seek gain

by putting together deals that often are triadic” (Patrick and Wagner, 2015, p. 105). Chartering

systems under incomplete contract that define property rights appear to be a propitious setting for

entanglement to arise.

The entanglement process then could originate in these bank bargains relationships. A key aspect of

bank bargains resides in the ongoing negotiations in which the involved parties settle deals that

often externalize pecuniary and non-pecuniary costs to third parties (Calomiris and Haber, 2014, pp.

37–38). This happens to also be at the core of triadic relationships typical of entangled systems

(Podemska-Mikluch and Wagner, 2013). Here the process is a dynamic economic and political

exchange in the form of bidirectional relationships between the entities involved in bargaining

under unfolding uncertainties. Entanglement can create the institutional effects of these

relationships.6 In this framework, the economy and the polity are considered as non-hierarchical

nodes that establish bidirectional relationships in a complex unfolding network. The polity is no

longer a single entity but a constellation of nodes with different political and economic powers

within a type of loose hierarchy of bureaucracies (Tullock, 1965), (see Figure 2 for an illustration of

such).7 Entanglement dynamics originate from the conscious actions of the parties and actors

involved in the bank bargains, who are also entrenched in a network of relationships. The emergent

6
Entangled political economy differs from the dynamics of intervention in the mixed economy (Ikeda, 1997) since it
treats polity and markets as overlapping emergent participations of entities, in a formulation of networks (for more
details, see Patrick and Wagner, 2015).
7
This framework treats governments as polycentric orders and not organizations, similar to a bureaucratic free
enterprise (Tullock, 1965). It assumes that polity is not a unified source of power but rather a loose network of
bureaucratic entities. The figures used here are based on Wagner (2010) and Salter (2014).
9
institutional effects that arise from the entanglement dynamics are not part of the conscious plans of

the actors involved (Wagner, 2012). Like in bank bargains, the entities enter into contracts since

they expect gains from bargaining. In their rational maximizing behavior, however, neither of the

parties have knowledge as to where the relationships might lead to, institutionally speaking.

Nevertheless the unintended outcome of the bargain leads to a process of entanglement that can be

perpetuated and enhanced through the coalitions’ dynamics severely affecting the institutional and

market setting in which economic actors operate. The bargain process has dynamic synergy that

further feeds the process of entanglement in the banking industry. Unlike what has been stressed in

the literature (Salter, 2014), the dynamics of entanglement do not solely arise from regular

interactions from a polity ‘big player’ entity overseeing economic entities. The dynamics can also

be found in the process of political bargains and coalitions arising naturally within the network of

interactions, given an original set of political and economic powers. The repeated interaction in our

account is the consequence of the negotiations’ adjustments among parties that re-negotiate

bargains and not from a regulatory supervisory position. Through rearranging property rights

naturally, the bargains initiate the entanglement process, which unintentionally affects the polity-

banking order. The bargains’ effects might dissipate beyond the individual entities’ borders,

potentially affecting the banking order at large. When the banking entity involved in the bargain

reaps the benefits of the exchange, it starts to import extra market characteristics from the polity.

The privileged position granted to a bank through the bargain overshadows the relevance of the

market process’ economic and competitive discipline (Smith et al., 2011).

The bank involved shifts away from generating value to its customers through voluntary consent,

towards perpetuating extra market properties through renegotiating bargains according to the

parties’ dynamic bargaining powers . These allow parties to engage in potential long-term triadic

parasitic behavior over the rest of the social order (Podemska-Mikluch and Wagner, 2013). The

bank acts not merely on market signals and market discipline, but its focus shifts towards securing
10
special revenues by maintaining bargains. Through bargains the bank is “no longer purely a private

ordering, since the terms on which it operates are now a mixture of the logic of private orderings

and common orderings” (Salter, 2014, p. 9). Furthermore, when entanglement is visible to other

banks, they will also seek to be part of it in order to reap extra market benefits (Baumol, 1990).

Bank bargains in the form of incomplete contracts not only jump start the entanglement dynamics

but further advance its growth to a progressive accumulative entanglement among other entities in

the network. The crucial aspect is that gradual entanglement leads to further exporting polity

characteristics to the banks involved. This is important since these strategic interactions do not lead

necessarily to the growth of the bureaucratic apparatus but rather to the degradation of the

boundaries and the shifting economic roles of the organizations in the banking system.

3. Political Entanglement and Charter Renewals

Goodhart’s (1988) account of the natural evolution of central banks resides mainly on recognizing

banks’ competitive tendencies to concentrate reserves throughout the banking network (Goodhart,

1988, Chapter 3; Selgin, 1993). Due to economic considerations such as economies of scale,

simplification of interbank lending and reducing the overall need to accumulate reserves, banks

have a natural tendency to centralize reserves (Dowd, 1993; Selgin, 1993). Goodhart claims that

these tendencies will inevitably lead to the centralization of reserves in a single or a few important

banks (Goodhart, 1988, p. 34). He suggests that this tendency to concentrate reserves mostly in a

single dominating bank naturally leads to that bank becoming a banker’s bank and a controller of

reserves of the system. Goodhart’s generalized account of the ‘centripetal forces’ of the

concentration of reserves leads him to assume that competitive banking is inherently hierarchical.

Bank competition leads to gradual domination of a single bank that handles high reserves and

borrowing in time of distress to other competitors (Goodhart, 1988, p. 37). The banker’s bank then,

by gradually accumulating and managing the system’s reserves, adopts regulatory and supervisory
11
roles over competitive banks that established relationships with. Unfortunately, according to

Goodhart, due to inherent conflicts of interest between its for-profit maximization and its new role

as interbank coordinator and regulator, a banker’s bank will have to become a noncompetitive

central bank to better play the new role reflecting public interest. A noncompetitive central bank

then is a natural and necessary evolution from banks’ natural tendencies to concentrate reserves in a

single for-profit entity. We will analyze this account by seeing the key historical events that led the

Bank of England to become the banker’s bank. We will show that what Goodhart believes to be a

natural evolution of central banking is in reality an unintended institutional effect of a political

economy entanglement process. The process led the Bank in the bargain to adopt and accumulate

non-market characteristics and therefore become a polity-economy hybrid through a dynamic

process of bank charter bargains (Broz and Grossman, 2004).8

The bank charter model began from monarchs needing to finance the creation of their international

expansionary domains. Most of successful empires used charter monopolies on different business

activities as a way to subcontract the process of colonization (Calomiris and Haber, 2014, chapter

3). The bank charter allowed the bank involved to benefit from unique legal privileges during

financial activities, while furthering the goals of the state. In the case of England, after the Glorious

Revolution of 1688, King William III needed resources to finance the war against Louis XIV of

France (Dowd, 1993). To do so, while constrained by Parliament, he had to rely on corporate

entities as an important part of the new funded long-term debt. Chartering a bank improved the

government’s ability to issue long term debt and reduce credit transaction costs (Broz and

Grossman, 2004, p. 54). This process of ‘incorporation of the public debt’ established a series of

monopoly charter schemes by which companies were founded to provide credit to the English

monarchs in exchange for monopoly deals. One of them was with the Governor and Company of

8
Due to length constraints we review only the earliest rechartering bargains, which granted the major non-market
characteristics to the Bank. In section 4, we review the period between 1797–1819, characterized with the
suspensions of gold payments and legal tender status.
12
the Bank of England in 1694, proposed by entrepreneur William Patterson (Broz, 1998).9 In

between 1694 and 1844 the Bank’s charter was renewed nine times. The renegotiations that

perpetuated and enlarged the Bank’s entanglement in the economy reflected economic and political

uncertainties unfolding through time (Broz and Grossman, 2004). We will study the evolution of

the Bank in line with the dynamics of bank bargains and political entanglement as defined in section

2.

A parliamentary act initially established the Bank with an expiration date. The Bank was founded

only for 11 years with initial capital of £1,200,000 which was immediately lent back to the

government. As part of the initial bargain exchange, the government authorized the Bank to issue

notes in the same amount (Smith, 1990 [1936]). The original charter and the subsequent ones had

explicit expirations by which after the guaranteed life Parliament could dissolve the Bank through

exercising an ‘option’ with a one-year notice by repaying its loan. Each renewal extended the

lifespan of the Bank for a limited time. These renewals occurred at irregular intervals and always

earlier than the expiration date, reflecting the necessity of both parties to bargain and enhance the

entanglement (Broz and Grossman, 2004, p. 50). The original bargain culminated in the creation of

the 1694 Bank charter as an ‘incomplete contract’ that originally reflected the relative bargaining

power of each party. This is the initial relationship that created a link between the two types of

organizations. The first charter established flexibility in a “contracting under uncertainty” outlook,

opening the path for further interactions. Future bargains then allowed both parties the flexibility to

incorporate unfolding uncertainties into the exchange, both from market competitive forces and

international political pressure. A substantial part of the bargain was then the flexibility to increase

entanglement by eroding market pressures via renegotiating the charter at their discretion. The first

charter allowed the government better capacity to borrow, smoothing the cost of long-term higher

9
For a more thorough account of how the Bank of England was established, see Clapham (1944). For the legal and
financial details of the charters, see Broz and Grossman (2004).
13
expenditures and allowed the bank coalition of shareholders to profit from government extra-market

rents (Broz, 1998). The first charter had no intentions of establishing a central bank in any form

(Goodhart, 1988); neither did it intend to substantially affect the English banking system. However,

the charter established a flexible bargain that set in motion the dynamic process of renegotiating

renewals among the involved parties, enabling the entanglement process which did in fact impact

the English banking system. This established the path between the polity and the economic

organizations by which the polity’s characteristics could be further transmitted through future

renegotiations. This altered the structure of property rights and gradually eroded the Bank’s market

order. The two subsequent charter renewals resulted in further entanglement. They were mainly

driven first by the increases on the budget deficit due to war financing and second due to

competitive pressures from the market ordering (Broz and Grossman, 2004, p. 54–55). In the first

1694 charter, the Bank was granted the following extra-market (non-exclusive) characteristics: the

right to form a joint-stock company with limited liability, the rights by Parliament to conduct a

banking business (in the first charter, this was not an exclusive right) and the right to issue notes in

the amount of the Bank’s capital (Broz, 1998). The Bank was formed as a corporation with regular

shareholders entitled to dividends from the profits earned through the legal benefits granted by the

charter.

The major extension of monopolistic extra-market characteristics mainly came from two

rechartering processes: first in 1697 and then in 1708. We have seen how the first charter in 1694

began the entanglement process. The exchange can be seen as a bargain in which a political and

economic entity (rent-seeking group), are in a contractual agreement with uncertainty in the form of

an incomplete contract (Broz and Grossman, 2004).10 The scheme had the possibility of

renegotiating the bargain to incorporate unfolding uncertainty in the government’s fiscal position

10
Broz and Grossman (2004) provide quantitative evidence showing that through the years, renewal timing reflected
increasing necessities of each party to renegotiate the bargain and incorporate unfolding market and political fiscal
uncertainty. The residual aspect of these bargains was increased entanglement.
14
and shifts in the bargaining powers. The charter was designed as such that the parties became

mutual hostages (the core of continued entanglement) to the incomplete contract (Broz and

Grossman, 2004, p. 58). This situation led the parties in the original bargain to subsequently

collaborate in 1697 with the first Continuance Act, when the government extended further

privileges. The renewal was part of the ongoing relationship that the monarchs needed since war

pressures had increased the budget deficit (Broz, 1998). Moreover there were further market

pressures from the Land Bank charter, which pushed the Bank to pursue further entanglement in

order to seek protection from new potential charter banks.11 The first 1697 rechartering ended with

increasing their note issuance capacity and giving the Bank a monopoly over managing government

account and balances; this was “a provision that added considerably to its prestige” (Smith, 1990

[1936], p. 12). Even more importantly, that renewal stated that no other bank could ever be

established through an Act of Parliament, that its profits were exempt from taxation, and also gave

the Bank the monopoly on the limited liability in banking in England. This was a special privilege

that was legally denied to competitor banks for one and a half centuries (Broz, 1998; Smith, 1990

[1936]).

The first 1697 rechartering process allows us to understand the entanglement that the first Bank

bargain started. When market forces threatened the Bank’s position and expected profitability, its

managers sought possibilities to rearrange the incomplete original contract sooner through a new

bargain in order to dodge the threat of other potential competing bank charters. Only after three

years, the Bank renegotiated the charter in order to incorporate these unfolding market threats. The

Bank wanted to move away from competitive market characteristics (the private economic

ordering) through renegotiating, which further degraded their market boundaries. A second example

of how the incomplete contract was ‘improved’ by increasing entanglement came along with the

11
In 1695 Parliament chartered the Land Bank, which never started operations. The legal precedent challenged the
Bank’s preferred position. This pushed them to seek a renegotiation of the bargain earlier than expected in order to
obtain legal exclusivity in the recharter and thus impede future ‘Land Banks’ cases (Clapham, 1944, p. 47).
15
second recharter in 1708. During that time the joint-stock company business model was spreading

through different markets (Smith, 1990 [1936]). This new business model clearly challenged the

Bank’s position. During the War of the Spanish Succession the government was simultaneously

looking to extend its loans. In exchange, the government offered the possibility for a second

recharter in 1708. Due to the potential pressure from the joint-stock business model, the Bank

sought to move further away from the competitive market order since they realized that the 1697

recharter had failed to foresee the rise of unincorporated private competitors. The second recharter

gave the Bank a monopoly through legally prohibiting other firms to form associations of more than

six partners to carry out banking businesses, as well as reaffirmed previous prohibitions (Broz,

1998). The monopoly over joint-stock note issuance restricted banks to partnerships of no more

than six partners (this was reaffirmed and strengthened in 1742). The main goal was to exclude

newly founded joint-stock firms from issuing notes, which severely restricted competition. In

practice this almost entirely excluded businesses from banking activities (White, 1984). The second

rechartering fits the pattern predicted by political entanglement. Once the bank bargain starts, it is in

the involved parties’ interest to seek further entanglement. The Bank saw the potential monopoly of

joint-stock note issuance as critical for its long term source of profitability. Hence it was willing to

give large financial concessions to increase entanglement. The government on the other hand

needed assistance to finance the war at the time. Parliament then willingly exported more key polity

features to the Bank by altering property rights in exchange for credit. This benefited the Bank

through a monopoly over notes and paper currency by externalizing the cost and fragility of a

restricted, undercapitalized and overregulated system to other competitors and bank customers in

the form of a triadic bargaining exchange (Dowd, 1993).

In the case of the Bank of England, the entanglement did not occur during specific times of

economic crisis or from a strictly formal regulatory interaction (Salter, 2014). The entanglement

process can perfectly originate through the dynamics of banking bargains in the form of open-ended
16
charter renewals based on incomplete contracts. As long as competitive market developments

threaten the Bank’s market profitability, it will lead to renegotiations at irregular intervals, allowing

the Bank to escape from the market ordering, moving towards a dynamic entanglement of common

polity ordering. The Bank managers in the second renewal saw the monopoly over the joint-stock

business model of issuing notes as a critical non-market characteristic. This eroded the market

discipline typical of any private ordering. The Bank’s profits were no longer solely a function of

good business practices; as the theory of entanglement predicts, its boundaries changed towards a

dynamic relationship of parasitic behavior between the bargain players and the rest of society

(Podemska-Mikluch and Wagner, 2013).12 This behavior among entities continued through charter

renewals, allowing the involved parties to be dynamically entangled (Salter, 2014), as depicted in

Figure 3a. The three chartering processes reviewed in this paper were the major drivers by which

the bargain process allowed the polity organization to exchange non-market ordering properties to

the Bank in exchange for financing, placing the Bank in a unique position in the banking system.

Moreover the extra market properties granted to the Bank via the bargains were contextually

dependent on the market order that was evolving around it, which indicates that the Bank had

incentives to seek extra market characteristics. The unintended consequence of this is that other

private ordering banks saw and understood the entanglement, attributing a special prestige and new

roles to the Bank (Smith, 1990 [1936]). Hence without foresight the Bank became an entangled

banker’s bank that extended the entanglement to the rest of the banking system.

4. Evolution as the Unintended Consequence of Entanglement

Through time the Bank’s legal restrictions and privileges changed, nevertheless the monopoly over

London’s note issuance remained almost unaltered (Selgin, 1993). The key for understanding the

12
Parasitic behavior is the situation in which the entities of the bargain reap extra market benefits from the relationship
with respect to the rest of the social order (see Wagner, 2012).
17
Bank’s evolution resides in how the entanglement, embodied in charter privileges and legal

precedents, incentivized the dynamics of the banking system’s concentration of reserves. This led to

the Bank’s notes becoming the principal reserve medium. Through entanglement the Bank

involuntarily came to possess a unique intangible asset: other banks’ recognition of holding unique

extra-market order properties. This recognition added to the Bank’s prestige, security and value,

which lowered its cost of funding and its perceived riskiness (Broz, 1998; Smith, 1936 [1990]). The

entanglement allowed for extracting long-term additional extra-market revenue and a strong

ongoing polity relationship; it also gave the Bank a unique superior credit and lower market

riskiness. This key financial and political position incentivized the smaller banks’ practice to keep

balances and reserves with the Bank, which gradually accumulated the banking system’s reserves.

As the monopolistic London issuer, the Bank came to possess a unique hegemony over the English

currency system. The extra-market sphere gave the Bank the possibility to expand its business,

increasing in size and security. This added an extra-market competitive advantage to the Bank’s

notes over private ordering banks’ competitive notes (Dowd, 1993, p. 222). Competitive banks saw

the Bank’s new politicized extra-market structure and started treating the Bank’s notes as their

reserve medium instead of gold (Broz, 1998). These activities were more convenient and safer for

competitive banks since leaving part of their cash and gold reserves with a single entangled entity,

isolated from market pressure, reduced business risk and economized the use of reserves at a low

cost and political risk.13 This is because after rechartering, the Bank laid somewhat outside the

market ordering. Normal banks were certain that the special bank holding their reserves would,

under any circumstance, be able to provide those reserves either in money or a reserve medium that

would be accepted by the public and other banks (Goodhart, 1988). The competitive banks’

rationale of recognizing the Bank’s entanglement and hegemony is crucial in understanding the

13
Since bank notes were less costly to store and move compared to gold reserves, customers also preferred Bank notes.
Moreover due to the Bank’s extra market capacities, it was the only bank that could offer notes as secure as gold as
redemption for liabilities, even at times of crisis (Dowd, 1993, p. 224).
18
entanglement’s unintended effects: It affected the competitive banks’ decisions of their

concentration of reserves and therefore affected the Bank becoming a central bank. The process of

reserve convergence into the Bank was further reinforced with the key episodes between 1797 and

1819 (Fetter, 1950). When the Bank suspended gold payments, it established legal precedents of the

de facto legal tender status of its notes. The gradual and natural accumulation of reserves in the

banking system directed towards the banker’s bank was mainly incentivized by the entanglement

signaling process. This allowed the accumulation of political and legal precedents that encouraged

and secured bankers’ banknotes (the Bank) could be guaranteed and accepted throughout the

country. Hence the entanglement via charter monopoly powers and through the suspension period

led the Bank to increase in size, security, and competitive powers that set it drastically apart from

the competitive market ordering (see Figure 3a). This severely undermined competitor banks and

incentivized them to accept the Bank’s polity-economic ordering hegemony through using its notes

as reserve medium to reissue their own notes, which of course furthered entanglement.

The events between 1797 and 1821 played a role in the entanglement process since government

actions beyond the bargains also affected the entanglement.14 This period is important in

understanding how the Bank became the banker’s bank by accumulating reserves. In 1797, due to

excessive government borrowing, the Bank was under pressure regarding its reserves’ positions.

During the Napoleonic Wars the government pressured and prohibited the Bank to redeem notes in

gold in order to finance the war (Broz, 1998). This led Parliament to pass an act to suspend

payments of the Bank’s notes. The 1797 Act allowed the suspension of payment in cash and gold of

the Bank’s notes, de facto legalizing the capacity of the Bank bankruptcy (Dowd, 1993). The Act

created a crucial legal precedent in which the public and competitive banks started to expect that the

government would continue acting this way, giving a special status to Bank of England notes. This

14
This was known as the Restriction Period, during which the Bank operated on inconvertible currency (see Fetter,
1950).
19
gave the Bank the de facto partial legal tender status (Dowd, 1993, chapter 11). After a severe

depreciation of Bank notes, the government declared them legal tender in 1811 through the

Stanhope’s Act, which further reinforced the entanglement process (Smith, 1990 [1936]). This had

severe institutional implications since it changed the legal and economic status of the Bank’s notes

in the country and therefore “country banks began to look on them [Bank of England notes] as

backing their own note issues” (Smith, 1990 [1936], p. 16).15 These two cases further exported non-

market characteristics to the Bank and gradually to the whole system. The suspensions and legal

tender status released the Bank from any competitive banking pressure and obligation to redeem

their notes in gold, which increased its outside market sources of profitability. The government’s

credible commitment that the Bank’s notes would be good for legal payments and accepted by the

public also assured the competitive banks of those notes’ superior status, again furthering the

entanglement to the rest of the system. The combination of monopoly powers from the charters and

the legal restrictions increased the Bank’s hegemony, size, security, and market power, making it

the dominant banker’s bank in the system. The entanglement conditioned the centripetal forces of

the concentration of reserves of the entire system towards the entangled entity.

Banks had the incentive and a safety commitment of the monopoly bank that they could provide

reserve medium at any time. This incentivized banks to economize gold reserves and treat the

Bank’s notes as good as gold to issue their notes, hence to park their gold and (cash) reserves under

the banker’s bank.16 Since the Bank was the only entity outside the market ordering unconstrained

to supply notes and suspend payments in gold if needed, it exacerbated the process of concentration

15
The Resumption Act eliminated Bank notes’ formal legal tender status in 1819. However, the precedents had
generated expectations that the government would behave again in this manner (in 1833 the notes again became
legal tender). This increased the system’s entanglement and commercial banks started to see it as customary to treat
the Bank’s notes as their reserves in lieu of gold even after the Restriction ended. This further encouraged the Bank
to hold concentrations of reserves and adopting a special banker’s bank role.
16
As Dowd (1993, chapter 11) points out, it would have been economically inefficient for a competitive bank to redeem
liabilities in gold if they could by law use the Bank’s notes of the same nominal value, which were sold at a
discount against gold. The Restriction Period led to a severe depreciation of Bank notes against gold, but their legal
tender status led to a process of “Gresham’s law,” driving gold out of the English system (Dowd, 1993, p. 341).
20
of reserves within it. The entanglement’s natural outcome was that commercial banks gradually

accepted the Bank’s liabilities as their reserves, which led the Bank (unintendedly) to gain control

over the total level of reserves throughout the entire system (Dowd, 1993). This made competitive

banks dependent on the entangled Bank in case they needed extra of the Bank’s notes to expand

their reserves. This by necessity forced them to acknowledge the Bank’s hegemony while

incentivizing banks to lower their provisions for higher levels of reserves and also further

promoting the entanglement’s moral hazard to the whole banking system (see Figure 3b). The

banking system then depended on the Bank’s actions to adjust reserves to expand credit; this

process eroded market discipline and the market-banking signals throughout society (Calomiris,

1990). The process of accumulating reserves, in which competitive banks started to use the Bank’s

notes as reserves, is a crucial aspect of how the entanglement process spread throughout the rest of

the banking system. The spreading, introduced polity characteristics, eroding market and credit

signals to control the supply of money and created moral hazard problems while managing

commercial banks’ reserves. The extension of the entanglement, generated benefits for competitive

banks at the cost of increasing the network’s fragility in the form of a triadic fragile banking system

(White, 1984).

The cost of the fragility of lowering reserves by relying on the issuance of Bank notes, is

involuntary transmitted to involved third parties—a common characteristic of entangled systems

(Podemska-Mikluch and Wagner, 2013). The renewal charters and the Restriction Period

incentivized competitive banks to become entangled with the Bank of England and accept the notes

as their own reserve medium. The entanglement gave economic incentives to lead competitive for-

profit banks to rely on banker’s bank interbanking lending and lowering their reserves at the

expectation that the banker’s bank would use its monopoly powers and legal tender status to

increase the money supply. The fact that the whole English banking system gradually started using

the Bank’s liabilities as reserves implied that the Bank had assumed a central position in the
21
entanglement. This unintentionally allowed the Bank to control the total level of reserves and guide

the money supply of the system. The fact that commercial banks became economically linked with

the Bank through using its notes as reserves exacerbated the entanglement across the network,

prolonging private and common ordering blurriness as graphically shown in Figure 3b. This degree

of entanglement forced the Bank to (unwillingly) accept its new central banking role and

responsibility of managing the entire system’s reserves, at the expense of profitability (Dowd,

1993). Political entanglement explains how the Bank evolution can be characterized by the

emergent phenomena of a dynamic entanglement process through the gradual transmission of non-

market characteristics, leading to accumulating reserves. This encouraged the transition of

commercial banks to use the Bank’s notes as their reserves and finally for the Bank to become the

sole lender of last resort to the English system. Central banking functions are not the natural and

evolutionary development of the banking system, unlike what Goodhart assumes (1988). The

evolution of central banks arises as a condition during the entanglement process, initiated under a

process of bank bargains allowing commercial banks to identify the entangled banker’s bank,

leading them to concentrate reserves with it. This entanglement process undermines Goodhart’s

generalization of the natural evolution of central banks; instead it supports Bagehot’s intuition

(Bagehot, 1873).

Both the market’s indistinctness and the Bank of England’s political boundaries unintentionally led

it to become a political entity, placing the Bank into an unwanted position of a hybrid between a

commercial and central bank at the center of the English banking system (see Figure 3b). This

hybrid position created severe problems for the Bank since managing the system’s reserves and

supervising other commercial banks cannot be effectively provided within a for-profit bank

structure due to severe conflicts of interest (Bagehot, 1873; Goodhart, 1988). The dynamic

entanglement process allowed the Bank to accumulate several benefits and reap extra-market

profits, but had the unintended consequence of increasing entanglement towards the network,
22
transforming the Bank into a political extra-market institution by which other banks saw it as a

source of banking reserves and for interbanking support. Without seeking it, the Bank gradually

became a quasi-central bank that had to assume the role of maintaining overall financial discipline

and provide support to competitors in time of crisis and thus disregard its private ordering. This

created conflicts of interest during banking crises between the Bank’s shareholders and overall

banking stability (Bagehot, 1873; Dowd, 1993; Goodhart, 1988).

To the extent that the Bank remained a for-profit bank, its private activities were not compatible

with the roles that a central bank should assume. This contradiction between the private ordering

and common ordering within the Bank consequently led to fully recognizing its lender of last resort

role and the transition towards a non-competitive non-profit central bank between 1858 and 1890

(Bagehot, 1873; Dowd, 1993; Goodhart, 1988). This was unlike other cases in which economic

crises and regulatory supervisory relationships are the usual dynamics that feed the process of

political economic entanglement (Salter, 2014; Smith et al., 2011). Here bargains and chartering

renewals instead initiated the dynamic process. As Podemska-Mikluch and Wagner (2013)

recognized, these dynamics lead to each subsequent interaction (bargain) to further the

entanglement and generate a process of obscuring the political and economic ordering limits to a

point that division becomes vague. This is exactly what happened to the Bank. The entanglement

dynamics did not generate a substantial increase in the regulatory apparatus. Bank bargains instead

degraded both the Bank market and commercial characteristics until it was no longer considered a

market organization. The Bank’s entanglement generated both the unintended process of

concentration of reserves and its new non-market ordering roles as a banker’s bank, resulting in

converting the Bank into a half polity half commercial quasi-central bank. Finally, the last

Continuance Act in 1844 charter changed the Bank’s fundamental structure (Bagehot, 1873; Fetter,

1965). However, the Bank did not fully recognize its central banking characteristics until after the

crises of 1857 and 1866. The process not surprisingly culminated with the full transition of the
23
Bank from a for-profit competitive institution toward a non-competitive central bank. The full

entanglement happened with difficulties during the last half of the nineteenth century (Dowd, 1993,

chapter, 11).17 By the time of the Baring Crisis in 1890, the Bank had come to fully admit its role as

proto-central bank at the core of the entangled network, putting its shareholders’ profitability aside

(Fetter, 1965). Departing from its remaining commercial aspects, this final step of full self-

recognition settled the Bank’s full entanglement to the point that its unintended systemic role as the

lender of last resort had to be fully recognized over its for-profit commercial ordering.

5. Conclusions

This paper contributes to expanding our understanding of how central banks evolve, viewed through

a broad public choice perspective. We specifically focus on how bank bargains enhance the political

entanglement process and its dynamics, without relying on accounts of direct supervision or

financial crisis (Salter, 2014; Smith et al., 2011). According to our framework, the entanglement

process can upsurge through specific political-economic contract renegotiations, which allow polity

organizations to export some of its common property ordering features to economy organizations.

We have applied this theory to the Bank of England’s unintended evolution. The Bank’s evolution

was, unlike what Goodhart (1988) claims, an evolutionary example of the unintended consequences

of political economy entanglement, initiated by a process of dynamic bargains. The charter process

and the open-ended renewal structure allowed for a negotiation process which permitted the

invested parties to renegotiate new unfolding contingencies. Under uncertainty the renewal process

allowed the Bank to survive, but it also allowed it to mutate towards extra-market settings, which

furthered entanglement. We explored how the dynamic entanglement process led the Bank to obtain

17
Although the Bank Act of 1844 did not give the Bank full responsibility to act as a lender of last resort, it did give the
Bank monopoly over issuing English notes. It was only after the crises of 1857 and 1866 that the Bank started to
fully acknowledge their public duty as a lender of last resort (Fetter, 1965). The self-awareness of the
entanglement’s extent led them to recognize their unintended public status by the end of the century.
24
a unique non-market position in the banking network by allowing it to be a polity-economic hybrid;

this position gradually incentivized the rest of the banking system to accumulate reserves in the

Bank leading to a proto-central banking structure.

An interesting conclusion from the entanglement is that the Bank’s evolution is poorly understood

as stemming exclusively from both a “joint-production” framework (Broz, 1998, pp. 235–236) and

government intervention (Bagehot, 1873; Selgin, 1993). Instead, political entanglement from bank

bargains stresses two points. First, what can be seen as a direct institutionalization to solve

collective action problems through bargains (Broz, 1998) can also lead to unintended institutional

phenomena with wider unknown repercussions (Wagner, 2010; 2012). In other words a joint-

production approach illuminates the provision of a public good (public creditworthiness through

Bank charters) but obscures entanglement details and its effects on reserves that arise through the

dynamics in the adjoined excludable good (the charters’ rent-seeking aspect). Second, what may

seem like simple government intervention (Bagehot, 1873; Ikeda, 1997) is in reality repetitive

participations of entities within a legal and constitutional framework (Buchanan, 2008; Patrick and

Wagner, 2015). The Bank of England is one of those emergent cases: it was gradually entangled to

become a central bank through bank bargains that were made among interested parties. Thus

entanglement based on charters is not solely enhanced by government or political entrepreneurs but

also by a constant participation of private actors and entities in the network. This does not suggest

that constitutional limits on the capacities of polity entities to bargain political characteristics in

order to mitigate potential entanglements should be discouraged (Brennan and Buchanan, 2000).

Constitutional political economy (Buchanan, 1990; 2008) might show how we can positively alter

the ‘rules of the game’ at the pre-constitutional level in banking to avoid leveraging property rights

in exchange from financing. Resilient pre-constitutional orders can prevent emergent post-

constitutional dynamics of bank bargains that transform banking into undesirable triadic

relationships through time, forestalling the possible erosion of the general banking rules.
25
In this paper we have also addressed two underdeveloped explorations in the entangled political

economy literature (Salter, 2014). First, we have shown that the theory of entanglement can still be

successfully applied to cases in which there are no economic crises facilitating entanglement. In the

absence of crisis, the theory is still applicable to understand the nature of relationships through

contractual and bargaining processes. Our outline suggests that the key element to focus future

research on in non-crisis dynamics is the incomplete characteristics of contracts, bargains

mechanisms, and how they are designed to address open-ended relationships among entities.

Second, we have suggested one of the reasons why the entanglement process is unidirectional,

stemming from the polity exporting common ordering characteristics to the commercial entity. The

reason involves the nature of the bargain and the resources available for the parties to negotiate

exchanges. The polity entity will bargain common ordering features and beneficial property rights

structures in exchange for accessing credit and financing. Therefore the entanglement can be

perceived as a residual aspect of a bilateral polity-economic exchange in which economic resources

are exchanged for non-market characteristics. This might help to explain why the entanglement

process seems unidirectional (Salter, 2014).

These contributions might help to direct focus on the different ways in which polity and economic

organizations can interact through bargaining processes in environments with incomplete contracts.

This would open possible research paths to understand how central banks emerge and how they will

keep evolving, viewed through a wider public choice perspective. Further exploring these concepts

might fruitfully lead to advancing our understanding of political economic entanglement dynamics

as well as market mechanisms erosion, which are both present in existent competitive banking

systems. Understanding the dynamics of entanglement allow us to look for robust ways to construct

constitutional frameworks and political mechanisms to inhibit or reverse their emergence and

growth (Brennan and Buchanan, 2000; Buchanan, 2008). As long as political entities allow for
26
incomplete contracts, leverage legislation, and bank charters to enhance bank bargains,

entanglement in banking will likely continue to emerge and advance. It is critical to further work on

the constitutional and legislative mechanisms of bank chartering as well as on governments’ role

and limits in determining and enforcing bank contracts’ property rights. Entanglement political

economy in a broader Public Choice perspective might contribute to enhance those constitutional

concerns.

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Figure 1: Additive Political Economy

Figure 2: Political Economy Entanglement

30
Figure 3: The Dynamic Entanglement

a)   Government and Bank Bargain

b)   Concentrations of Reserves

31