As many of you have noted, a key plot thread of Murder at Somerset House, Book 9 in my Wrexford & Sloane historical mystery series, revolves around the workings of the London Stock Exchange—not only the buying and selling of stocks, but even more importantly, how the government funded its financial needs through a security called the consol.
To avoid what we authors call the dreaded “info dump” I tried to keep the explanation of a consol as simple as possible within the story . . . But for those of you who wish to dive deeper, read on!
The British consol (short for consolidated annuities) was one of the most important financial innovations in the history of public debt. Introduced in the 18th century, these consols were perpetual bonds issued by the British government, meaning they had no maturity date. Instead, they represented a promise by the government to pay a stated amount of annual interest to the bondholder forever, unless under certain limited circumstances the bonds were redeemed.
Given the specific features of consols, they tended to reduce the government’s cost of borrowing in addition to eliminating the risk that the government would have to repay the loan principal at any specific (or potentially inconvenient) time. Another feature of the consol greatly increased the possibility that the buyer would realize a significant capital gain on his/her investment (as shown above, Jane Austen purchased consols!)—i.e. the bonds would become worth more than their initial purchase price.
Jane Austen’s purchase of a consol highlights a critical element of the bond. It was well designed to be sold to a public market. At this time in history, most major government borrowings were to finance wars and various military expenses or other short-term exigencies. But prior to the invention of consols, major government fundraising for such purposes was often through taxation (which in financing the continual warfare of the period often placed a crushing burden on taxpayers) or from banks or small syndicates of wealthy financiers or speculators (which involved certain extra costs and inefficiencies). The structure of consols, however, facilitated their sale to the then-developing broad public markets. By permitting access to this larger source of funds, consols played a central role in funding the cost of wars and empire, stabilizing government finance, and laying the foundation for modern bond markets. (Because of the perceived stability of Britain’s political system and its financial markets, the country enjoyed a singular comparative advantage over other competitor nations in being able to finance through this type of financial instrument.)
In my story, the creation of consols is attributed to the financial genius of Sampson Gideon (1699-1762). He was in fact a brilliant financier and banker of his era who, like David Ricardo some years later, built largely from scratch an immense personal fortune. He became a major figure in the financing and trading of British government debt, as well as a leading financial advisor to the government. His influence is particularly remembered for the role he played during the Jacobite uprising of 1745. Here, again like Ricardo, he purchased large amounts of government debt—which were then selling an enormous discount due to panic in markets and runs on the banks—when the Jacobites began military operations to restore the Stuart monarchy at a time when most of the British army was engaged in war on the European continent. Gideon was a key advisor to the government in arranging for the necessary wartime loan (much of which he provided himself) to fund the successful battle against the Jacobites. Some historians and economic analysts attribute the creation of the consol a few years later as largely Gideon’s invention.
Others, however, suggest the Gideon played a vital but more limited role. In this view, he’s credited with having managed the sale process of the consol into the market and, by dint of his reputation and connections, assured its acceptance in the financial community. But the actual concept of the consol security is attributed to others. Some historians credit Sir George Lyttelton, an influential advisor to the Prime Minister. Another view holds the Prime Minister, Henry Pelham, who served as his own Chancellor of the Exchequer, was himself the intellectual source of the concept. Still others attribute the idea to various unnamed Treasury officials. It is perhaps not surprising that such a successful innovation might have so many claimants to its creation. However, to simplify my story I chose Gideon to stand for the group of talented public servants who brought to market what was truly a revolutionary concept which proved to be a keystone to British power at the time.
The murkiness of the origins story aside, the creator—or creators—of the consol brilliantly reasoned that the British government only needed to borrow especially large sums in times of war or other calamities. The uncertainties created by these conditions, however, led investors to demand higher rates of interest during such fraught times due to the risk that the government would eventually prove unable to continue to make interest payments on the debt or, even worse, fail to repay the principal when the maturity date was eventually reached. And from the government‘s point of view, it was costly to borrow at these elevated rates for the, say, the 10 or 20 years of the duration of the bonds when most wars or other emergencies lasted a shorter period of time.
In 1751, Prime Minister Pelham introduced legislation to consolidate the various types of government debt into one unified form—a single bond with a fixed interest rate and no maturity date. The rate was first fixed at 3.5%, but was lowered to 3% in 1757. However, because market interest rates in wartime and other times of emergency were generally much higher than 3%, the consols were sold by the government “at a discount to their face value”. For example, if interest rates offered by competing securities were, say, 6% rather than 3%, the purchase price for a consol with a face value of £100 would be around £50—effectively giving the holder a 6% market rate of return. If interest rates offered by competing securities were 4% or 5%—or in some cases even 10%— the market price at which the government would offer the bonds would be adjusted accordingly.
As noted above, the wars or other emergencies leading to the issue of consols were generally only temporary. When they ended, interest rates would drop to the peacetime levels, which stayed fairly steady at around 3%. Then the £100 consol be once again be worth the £100 pounds face value. So the holders who purchased a discounted consol would have earned the higher rate of effective interest while holding the bonds for which they paid a much smaller amount—and then could receive the £100 face value if they chose to sell it on the active public market for such securities, thereby earning a sizeable capital gain. Thus, the consol not only allowed the government to avoid ever having to repay the principal on its borrowings, it also served as a device for creating wealth for its buyers (especially as capital gains were not subject to tax during most of this period) as they were free to sell their consol at any time.
Indeed, after the Seven Years War ended in 1762, consols went up in value approximately 20% in the next six years. And in the decade after the American War of Independence, even though that conflict didn’t go well for Britain, the value of consols rose by about 33%. This increase in individual wealth, along with the economic boost from increased government spending, was the source of a huge part of the financing for the inventions and innovations that sparked the Industrial Revolution.
