The Origin of Money 9 – Bonds and the Invention of the ‘National Debt’

The Venetian government is the first we know of which became a debtor to its own citizens, or conversely, where citizens became creditors on the government. As with most innovations in finance, it was the need to raise funds for war that drove the need to raise revenue quickly.

Other city-states had to compete with Venice, and the system spread, first to Genoa, and then to other republics in Northern Italy like Florence, Milan and Sienna. These city-states were all expanding militarily, and they needed money to do it. Since they were republics, they had advantages that the absolute monarchies of Northern Europe did not have, including accountability to their citizens. The merchant classes essentially borrowed from themselves to fund the wars.

These methods of short and long term debt financing spread to Northern Europe but were done on the municipal, not state level, since states were largely still absolute monarchies who could, and did, repudiate their debts on a regular basis.

In Northern Europe tax collection was highly decentralized during the Middle Ages, and national governments relied on municipal and provincial tax receipts for revenue. Many localities in Western Europe turned to securities (annuities, lotteries, tontines, etc.) for short-term and long-term borrowing which were allowable under the Church’s ban on usury. Both France and Spain eventually incorporated these into the nation’s overall financial structure, however, these were still primarily local, not state liabilities. Both governments used debt instruments for borrowing, but these were intermediated by banks and unlike the Italian republics, borrowing costs were high because they were less reliable. The kings of France and Spain, unrestrained by effective parliaments, were serial defaulters.

The Seven United Provinces (today’s Belgium and the Netherlands), which, like the Italian City-states, were trading empires run by a wealthy merchant oligarchy, used these new methods of financing and banking to fund their rebellion against Spain as well as expand their burgeoning overseas trading empire. These securities eventually became negotiable, and markets emerged for buying, selling, and trading these debts. The United Provinces is likely the first place where these became national liabilities. The center of financial innovation shifted from Northern Italy to Holland.

From there “Dutch finance” spread across the Channel to England during the Glorious Revolution of 1688. To manage his mounting war debt, William of Orange took out a loan from the merchant bankers of England in exchange for certain prerogatives from the crown. England was the first major country to consolidate its debt, nationalize it, and monetize it, therefore setting the stage for the public/private hybrid system of money creation and banking that we use today.

Italy Invents the State Bank

It all started with the Crusades. Seaports like Venice and Genoa were launching points for the armies marching south to conquer the Holy Land. The vast amounts of money flowing into these cities during this time allowed them to remove themselves from the feudal order and become self-governing communes. The shipping expertise gained by ferrying soldiers back and forth to the Middle East allowed the Venetians and Genoese to develop the skills to become Europe’s primary merchants and traders, importing exotic goods from the Islamic world into western Europe, and becoming fabulously wealthy in the process.

It was through the Islamic trade centered around the Silk Road and the Indian ocean—the first modern “global economy”–that the Italians learned all sort of innovations that we saw last time, from paper to base-10 place notation, to algebra, to checks, to bills of exchange. These ideas would be used to usher in the “commercial revolution” of the late Middle Ages. They would also make Northern Italy the crucible for European banking and finance.

To fund their expansion, these thassalocracies needed money. Trading empires, as Paul Colinveax would remind us, require superior military technique. At this time, military empires relied mainly not on conscripts (most people in these republics were merchants and artisans), but on professional soldiers, i.e. mercenaries. As Carroll Quigley put it, “the existence of mercenary armies made money equivalent to soldiers and thus to power.” (p. 373)

For much of the fourteenth and fifteenth centuries, the medieval city-states of Tuscany – Florence, Pisa and Siena – were at war with each other or with other Italian towns. This was war wages as much by money as by men. Rather than require their own citizens to do the dirty work of fighting, each city hired military contractors (condottieri) who raised armies to annex land and loot treasure from its rivals. [2]

The main way states raised money during this period, as we saw last time, were taxes and seignorage. Taxes were levied almost exclusively on commercial activity for most of history (since most other activity took place outside of the commercial/money economy). This was unlikely to be as effective in an entrepot dependent upon shipping and trade. Feudal rents and dues were levied by kings, but were less available to city-states outside of the feudal system. Siegnorage was a major way of raising revenue as we saw last time, but for a merchant-based society, devaluing the currency was less likely to be helpful or popular.

The solution arrived at was to borrow money from the city’s wealthy merchant and banking classes.

During the thirteenth and fourteenth centuries major cities such as Florence, Genoa, Milan, and Venice were able to extend their territorial control; those of Venice and Genoa attained the importance of maritime empires.

The formation of a territorial state came at enormous costs. How did urban governments raise the money needed to cover such expenses? Since increasing or raising new taxes required time and, above all, public acceptance, the easiest way was to borrow from the wealthiest citizens.[3]

Despite the ban on usury, no medieval European government – municipal, territorial, or national – was able to function without borrowing, given that its powers to tax and exact rents were limited, while it was often engaged in costly wars. But such loans were usually for short terms, often at punitive rates of interest.

During the twelfth century, the Italian progenitors of the ongoing Commercial Revolution developed what became a system of municipally funded debts, debts that subsequently became permanent. Genoa took the lead, in 1149, when it agreed to give a consortium of the city’s lenders control over a compera, a consolidated fund of tax revenues to be used in paying the city’s creditors.

Venice followed suit in 1164, by securing a loan of 1,150 silver marci against the tax revenues from the Rialto market for twelve years. In 1187, in return for a loan of 16,000 Venetian lire, to finance the doge’s siege of Zara, creditors were given control over the salt tax and certain house rents for thirteen years; thereafter, the Salt Office was made responsible for all such loan payments…by 1207, the Venetians had adopted what had already become the hallmark of public finance in the Italian republics: a system of forced loans, known locally as prestiti, whose interest charges were financed by additional taxes on salt, the Rialto market, and the weigh-house.

Between 1262 and 1264, the Venetian Senate consolidated all of the state’s outstanding debts into one fund later called the Monte Vecchio – mountain of debt – and decreed that debt-holders should receive annual interest at 5 per cent, which the Ufficiale degli Prestiti was required to pay twice yearly from eight specified excise taxes. These prestiti debt claims (with interest payments) were assignable through the offices of the procurator of San Marco and, by 1320 at the latest, a secondary market for them had developed. [4]

A loophole in the medieval prohibition on usury allowed this to take place. Although we regard usury and interest as one in the same, in fact medieval law made a distinction between the two:

Usury is sometimes equated with the charging of interest, but by the thirteenth century it was recognised that the two ideas were different.

Usury derives from the Latin usura, meaning ‘use’, and referred to the charging of a fee for the use of money. Interest comes from the Latin intereo, meaning ‘to be lost’, and originated, in the Roman legal codes as the compensation someone was paid if they suffered a loss as a result of a contract being broken. So a lender could charge interest to compensate for a loss, but they could not make a gain by lending.

It is easier to understand this with a simple example. A farmer lends a cow to their cousin for a year. In the normal course of events, the cow would give birth to a calf and the cousin would gain the benefit of the cow’s milk. At the end of the loan, the farmer could expect the cow and the calf to be returned. The interest rate is 100%, but it is an interest since the farmer, if they had not lent the cow to their cousin, would have expected to end the year with a cow and a calf. Similarly, if the farmer lent out grain, they could expect to get the loan plus a premium on the basis that their cousin planted the grain, he would reap a harvest far greater than the sum lent. [5]

These concepts gave birth to the idea of the medieval census:

A census originated in the feudal societies as an “obligation to pay an annual return from fruitful property”. What this means is that the buyer of the census would pay a landowner, for example, for the future production from the land, such as wheat or wine, over a period of time.

As economic life in western Europe became based on money transactions rather than barter transactions, censii lost the link to specific produce, cartloads of wheat or barrels of wine. The buyer of the census would accept regular cash payment instead of the actual produce, and this was legitimate in the eyes of the canon lawyers as long as the lump-sum paid buy [sic] the buyer ‘equated’ with the value of the ‘fruitful property’ being produced by the seller.

Anyone who could became involved in censii. A labourer might sell a census based on the future revenue from their labour, states sold them based on the future revenue from taxes and monopolies, and the Church invested bequests by buying censii. Censii issued by governments, usually linked to specific tax revenues, became known as rentes. Censii could be ‘temporary’, lasting a few years, or ‘permanent’, until one of the parties died.

In today’s terms, temporary censii resemble modern mortgages, permanent censii resemble the ‘annuities’ pensioners live off today. They could be ‘redeemable’, by one or both parties, meaning that the contract could be cancelled. [6]

The Venetian government required a “forced loan” from their wealthiest citizens in line with their income (i.e. it was progressive) to fund the war effort. Since the loans were forced loans, interest was compensation for the lost money, which was allowable under the Church’s anti-usury doctrine. The government paid an “interest” of 5 percent per year in biannual installments of 2.5 percent to compensate for the lost money. To do this, the government allocated dedicated revenue streams from commercial taxes to pay the interest.

Prestiti were a development from the rentes created by states. Around the twelfth century the Italian city-states of Venice, Genoa and Florence began to forcefully sell temporary rentes to their rich citizens. By the mid-thirteenth century the different issues of rentes were consolidated into a mons (mountain) and everyone who had been made to buy a rente was given a share, proportionate to their contribution, in the mons. [7]

The loans were basically irredeemable—there was no pledge by the government to pay back the principal in a fixed amount of time. These were not bearer bonds; rather, the names of the creditors were recorded in government ledgers at the loan office (Camera degli imprestiti). They were assignable in that the revenue stream could be transferred to a third party with the consent of the owner, but they were not negotiable, however, at least at first. You could not simply sell your bonds on the open market without the knowledge of the original debtor (the government), i.e. they were not easily transferable. Nor were they legal tender which could be used in lieu of cash.

Venice created its mons, the monte vecchio, in 1262 and the shares, known as prestiti, entitled the holder to be paid 5%, a year, of the sum they lent, which was written on the prestiti and known as the ‘face value’. While there was no obligation for the states to pay the coupon, the annual payment, there was an expectation that they would if it could be afforded and the mountain itself was paid back as and when funds allowed. [8]

Eventually, as borrowing costs grew to encompass more and more of state revenue, dedicated agencies were established in order to manage the consolidated debt these states owed to their citizens and others:

During the last quarter of the thirteenth century the demand for loans on Venetian citizens grew: they had to deposit a part of their assessed wealth into state coffers, the sums were registered on public books, and tax revenues were devoted to paying interest. By 1274 Genoa adopted a similar measure, and some loans were consolidated and managed by a single state agency.

The republics of Venice and Genoa were thus the first to transform their floating debt into a consolidated debt; later, some Tuscan communities would follow suit.
The main features of such a system were extraordinary financing through irredeemable forced loans; moderate interest rates; credits that were heritable, negotiable and usable payment; an amount consolidated and managed by a specific authority; and specific tax revenues designated for paying interest. [9]

The Genoese set up a dedicated private bank to manage the public debt around 1400 called the Casa di San Giorgio. Today it is recognized by financial historians as the first modern state bank, and in time, it became more powerful than the state itself! Many European monarchs regularly used it for borrowing, and it even funded some of the first expeditions to the New World (Christopher Columbus’ childhood home was nearby):

On March 2 1408, eight men gathered in the great hall of the Casa di San Giorgio, a trading house on what was then the main street in Genoa, a few metres from where the waters of the Ligurian Sea lap the Italian shore. They were merchants, rich and powerful representatives of the city’s most influential families, and they were meeting to discuss a matter of the utmost gravity. The once-glorious republic of Genoa had fallen on hard times. After years of war with Venice and a crushing defeat at the battle of Chioggia in 1381, the state was effectively bankrupt. The task was to rescue it.

A few months earlier, towards the end of 1407, Genoa’s Council of Ancients had authorised the Casa di San Giorgio to carry out this job. It would be accomplished by creating a bank that would facilitate the repayment of Genoa’s debts in return for interest at 7 per cent and the right to collect taxes and customs owed to the city. The purpose of the meeting that spring day was to declare the Banco di San Giorgio open for business.

..The Banco di San Giorgio would, in time, become as powerful as the republic that created it – more powerful, according to Niccolò Machiavelli. It would survive for nearly 400 years. It would become the world’s first modern, public bank, not just a forerunner of the Bank of England but its prototype…in a short space of time, it became so entwined with the republic of Genoa that the bank and the state were indistinguishable.

Machiavelli described the relationship as “a state within a state”. The Banco di San Giorgio grew so influential that it replaced the Fuggers, the German banking dynasty, as the source of financing for Europe’s cash-starved, perpetually warring monarchs. A century and a half after it was created it had restored Genoese power and influence as a maritime and commercial state to such an extent that the period from 1557 to 1627 was termed the Age of Genoa by Fernand Braudel, the great French historian…Christopher Columbus, Genoa’s most illustrious son, would be a customer…[10]

The management of state finances became increasingly concentrated in the hands of a professional bureaucracy which was separate from direct control by the state. The republics made very sure that the money was paid back reliably. This made loaning to them much more reliable than loaning to monarchs, and they were able to raise more revenue for their operations:

One reason that this system worked so well was that they and a few other wealthy families also controlled the city’s government and hence its finances. This oligarchical power structure gave the bond market a firm political foundation. Unlike an unaccountable hereditary monarch, who might arbitrarily renege on his promises to pay his creditors, the people who issued the bonds in Florence were in large measure the same people who bought them. Not surprisingly, they therefore had a strong interest in seeing that their interest was paid. [11]

Because of their dependability, these government-backed IOUs soon became highly desirable places for rich merchants and nobles to store their wealth, much as they are today, secured by the government’s promises to pay. The guaranteed returns provided a reliable income stream for those able to purchase the bonds. The merchant classes and various institutions bought up the bonds and used them as collateral, endowments for charities, even gifts and dowries, and passed them down to their assignments and heirs.

Over time, as issuing bonds became more common, more and more people became dependent on bonds for their income. Much like today, many of the holders of bonds were not just individuals but institutions and endowments who relied on the bonds as a source of income. This parallels today, where holders of bonds are often institutional holders like retirement accounts and insurance companies:

Throughout the sixteenth and seventeenth centuries it seems that most of the bonds were in the hands of guilds and ecclesiastical and charitable institutions that looked to state debt to assure a sound, even if relatively low, return. The economic importance of the redistribution of money through the government debt can not be neglected…Both in Florence and Genoa, government creditors drew a significant share (about one-fifth) of their income from bonds. Accordingly, a flow of money spread through the city and revived the local economy. [12]

Initially, only citizens of the Republic could buy bonds, but over time, bonds were issued to outside sources. Nonetheless, it appears that the debt in Italian city-states was held mainly by its own citizens, and not by foreign creditors. Buying bonds was seen as a sort of civic duty for the city’s wealthy individuals:

To loan to the commune was regarded as a duty, part of belonging to the urban community. Loans were connected, to a certain extent, with the concept of charity and gifts to the res publica.

Some governments, such as Florence, at first forbade foreigners to held state bonds, while it seems that in Venice since the thirteenth century foreigners were allowed to buy government credits. Some devices, nevertheless, were adopted in order to bypass such prohibitions; the easiest solution was to grant citizenship to those who were willing to buy government bonds…At any rate, the foreign presence among bondholders seems to have been a limited phenomenon: by the early fifteenth century about one tenth of the Florentine debt was held by foreigners; in 1629, 92 percent of the principal of S. Giorgio belonged to Genoese citizens and institutions…Unlike some Italian princely states, such as Milan and the papal state, and German cities, the urban governments of Venice, Florence and Genoa succeeded in raising enormous amounts of money from their citizens and very seldom borrowed from foreigners…[13]

Today, governments sell bonds directly to the public in what is called a primary market. From there, they are traded by investors in secondary markets. At this time, there was no primary market for bonds—only a select few insiders could loan to governments. But soon a thriving secondary market emerged where such debts were bought and sold. The prices of bonds varied, depending on the reliability of the debtor (the state). Because interest was paid on the face value of the bond, if you could buy a bond on the cheap, you would be assured a nice payout. This was effectively an end-run around the Church’s ban on usury:

Quickly a market for Prestiti emerged, where holders who needed ready cash would trade them with people who had a surplus of cash and wanted to save. During times of peace and prosperity they had a high price, but during war and uncertainty, they traded at a low price.

For example, Venetian prestiti traded for their face value around 1340 when the Republic paid off a lot of the mons, but in 1465, during a disastrous war with the Ottoman Turks, they fell to 22% of face. The Florentine prestiti actually had a built in facility where a holder could go to the state and sell them for 28% of their face value, however their market price was never so low as to make this profitable.

The legitimacy of the prestati was debated by the canon lawyers. On the one hand the coupons, the regular cash payments can be seen as compensation for the forced nature of the original loan. The lender had no choice and so does suffer a loss. However, if a prestiti with a face of 100 ducats was sold for 22 ducats, the buyer would be receiving interest at a rate of 5∕22 = 23%; in what way had this buyer of the prestiti been forced to enter into the contract? An interest payment of 23% in these circumstances seemed to be “asking for more than what was given”.

Prestiti are important in that are one of the earliest representations of an actively traded financial instrument. The prestiti does not represent bushels of wheat or barrels of oil, it is a contract where by a state promises to pay a specified amount of money. Whether or not the state does pay out on the contract, is unknown and uncertain, hence the value of the contract is also unknown and uncertain. [14]

In the end, the ability to have people voluntarily lend to the government provided advantages that were simply too great to ignore. Such governments were able to raise large amounts of cash quickly; they were able to raise money from a much wider circle than just the immediate tax base; and they were able to overcome limitations in the amount of specie circulating. This made state borrowing very effective and the places that engaged in it very powerful. In addition, bonds provided reliable places for wealthy citizens to store wealth outside of banks, and the interest payments helped local economies flourish. Money was becoming an important source of military power, too. Luciano Pezzolo summarizes the advantages of bond issuance by Italian city-states:

First, the enormous concentration of capital in some Italian cities allowed governments to transform, through public credit, private wealth into military power, to build a territorial state, and to control a wider economic area…Italian governments collected money from taxpayers at 5 to 7 percent, whereas the major European monarchies of the Renaissance were compelled to borrow at a much higher price.

Second, the debts took on a political function. To be creditors in the government meant sharing the destiny of the regime, and consequently supporting it. In Florence, the Medicean regime tied itself to an oligarchy that profited from the management of government debt. Thus, debt helped create stability.

Third, the social structure was supported by state debt: the considerable bond income drawn by charitable and social institutions and redistributed it the poor maintained a paternalistic policy that was a pillar of the urban political and social system.

Fourth, both government bonds and interest provided an effective surrogate of cash money in the later Middle Ages during a period of bullion shortage. The trade of bonds and interest claims opened up sophisticated forms of speculation and implemented financial techniques that are quite familiar to modern brokers.

Finally, the means devised by governments to finance the deficit offered new forms of social security and investment (dowries, life annuities, lotteries) that are at the roots of [the] later financial system. [15]

In this, we can discern something like David Graeber’s military-coinage-slavery complex emerging around the bond markets:

1.) Governments would raise money for military operations by dedicating future expected revenue streams to loan repayments, effectively becoming debtors to their citizens. That is, they could borrow against future revenues.

2.) The proceeds from the territorial/commercial expansion would be used to pay interest on the loans.

3.) The interest money would then flow back into the domestic economy, causing economic expansion at home, as more people became dependent on the government debt as a store of value and a source of income.

4.) Economic expansion abroad and at home would allow governments to deliver better services to its citizens, ensuring broad popular support.

5.) The dependency on regular payouts by lenders would encourage them to support the political stability of the regime.

6.) City-states which avoided default were able to gain a fundraising advantage over their rivals. Hence, there was a strong incentive to make reliable payments and not to default.

Thus, the concept of the “national debt” was born. This gave rise to a brand new “money interest” whose wealth was held in government debt rather than coin.

Debt Financing Spreads to Northern Europe

Now contrast this with Northern Europe. Most nation-states were still under the feudal system. It would have made no sense for a ruler to borrow from himself, since they theoretically “owned” everything in the kingdom. Instead of borrowing from their citizens, therefore, these kingdoms continued to rely upon other sources of income.

Under the feudal system tax collection was highly decentralized and done mainly at the local level. Wealthy kingdoms, such as France, used tax farming (publican) methods very similar to those of ancient Rome:

Fiscal revenues consisted of a mixture of direct (income or wealth) taxes, indirect (consumption) taxes, and feudal dues arising from the royal demesne. The assessment and collection of these revenues was decentralized. For direct taxes, a global amount was set by the government, and then broken down into assessments for each province, where local authorities would proceed with the next level of assessment, and so on to the local level.

For indirect taxes, collection was carried out by tax farmers on behalf of the government. The procedure was much like the one in place since Medieval times for running the royal mints. The right to collect a given tax was auctioned to the highest bidder. The bidder offered a fixed annual payment to the king for the duration of the lease. Meanwhile, he took upon himself to collect the tax, hiring all the necessary employees. Any shortfall in revenues from the promised sum was made up by the entrepreneur; conversely, any revenue collected above and beyond the price of the lease was retained as profit by the entrepreneur…

Spending is decentralized as well to various treasurers. Each tax had an associated bureaucracy of collectors and treasurers, either government employees or officers (direct taxes) or employees of the tax farmer. The treasurers spent some of the monies they collected, upon presentation of payment orders emanating from the government, and turned over the remainder, if any, to the royal treasury in Paris. [16]

Although it’s anathema under modern economic dogma, government monopolies on various business activities were considered a legitimate way to raise revenue.

Government monopolies, such as salt and recently introduced tobacco, were also farmed out in the same fashion. Indeed, the ability to create monopolies was one of the king’s resources; one of the more outlandish examples being the exclusive right to sell snow and ice in the district of Paris, sold for 10,000L per year in 1701. [17]

Another method was through the sale of political offices. Governments would create offices and sell them at a profit, and the salary paid was essentially interest on the lump sum payment for the original position:

An officer was someone who held a government position not on commission or at the king’s leave, but as of right, and enjoyed various privileges attached to the position (in particular the collection of fees related to his activities). Offices were sold, and the king paid interest on the original sale price, which was called the wages of the office (gages). A wage increase was really a forced loan, requiring the officer to put up the additional capital. Officers could not be removed except for misconduct; however, the office itself could be abolished, as long as the king repaid the original sum. Thus, offices as a form of debt also carried the same repayment option as annuities. [18]

And, as in Italy, the census evolved into annuities which were sold by municipalities as a way of long-term borrowing.

Offices and annuities (which I will generically call bonds, and whose owners I will call bondholders) could be transferred or sold, but with fairly high transaction costs. Both were considered forms of real estate, and could be mortgaged. In the late 17th century the French government, like others in Europe, had begun experimenting with life annuities, tontines, and lottery loans, but on a limited basis, and had not yet issued bearer bonds. Even the short-term debt described above was registered in the sense that the payee’s name was on the instrument, and could be transferred only by endorsement.

A final form of borrowing combined tax creation and lending. The procedure consisted in creating a new tax for some limited time and immediately farming its collection in exchange for a single, lump-sum payment representing the tax’s net present value. [20]

Besides, absolute monarchs could always repudiate their debts, and there was not much recourse for creditors since monarchs had their own armies and made the laws. The kings who did take out loans for military campaigns ended up paying very high interest rates for this reason.

By the early sixteenth century, the Habsburg Emperor, French kings, and princes in the Low Countries had all affirmed their powers to regulate municipal public finances, especially rentes, and the municipal taxes that were used to pay annual rent charges. But this method of financing governments still remained municipal, because only municipalities sold rentes, so that the national institutions required for a funded, permanent public debt had yet to be created…the first national monarchy to establish a permanent, funded national debt based on rentes, by the early sixteenth century, was … the newly unified Habsburg kingdom of Spain.

Both the French and Spanish crowns sought to raise money … but they had to use towns as intermediaries. In the French case, funds were raised on behalf of the monarch by the Paris hôtel de ville-, in the Spanish case, royal juros had to be marketed through Genoa’s Casa di San Giorgio (a private syndicate that purchased the right to collect the city’s taxes) and Antwerp’s heurs, a forerunner of the modern stock market. Yet investors in royal debt had to be wary. Whereas towns, with their oligarchical forms of rule and locally held debts, had incentives not to default, the same was not true of absolute rulers. [21]

Despite this ability to borrow, by the 1500-1600’s France and Spain had become serial defaulters.

…the Spanish crown became a serial defaulter in the late sixteenth and seventeenth centuries, wholly or partially suspending payments to creditors in 1557 , 1560, 1575 , 1596, 1607, 1627 , 1647, 1652 and 1662. [22]

The Netherlands, by contrast, used these financial techniques to fund their war of independence from Spain and in the process became the financial center of northern Europe.

Part of the reason for Spain’s financial difficulties was the extreme costliness of trying and failing to bring to heel the rebellious provinces of the northern Netherlands, whose revolt against Spanish rule was a watershed in financial as well as political history. With their republican institutions, the United Provinces combined the advantages of the city state with the scale of a nation-state. They were able to finance their wars by developing Amsterdam as the market for a whole range of new securities: not only life and perpetual annuities, but also lottery loans (whereby investors bought a small probability of a large return). By 1650 there were more than 6 5,000 Dutch rentiers, men who had invested their capital in one or other of these debt instruments and thereby helped finance the long Dutch struggle to preserve their independence. [23]

The center of European trade moved from the Mediterranean to the North Atlantic starting in the mid-1400’s with the advent of pelagic shipping vessels and the discovery of new routes to Asia by circumnavigating Africa. Portugal and Spain took the lead here. Spain’s “discovery” of the American continent ensured that trade would now be centered on the Atlantic coast, and the Islamic trade in the Mediterranean withered and became less significant, especially after the fall of Constantinople to the Turks in 1453. Eventually, European maritime trade became centered in Antwerp. When the Spanish conquered the southern Netherlands, what we now call Belgium, in 1585, they took Antwerp, which was the main port for Northern Europe. Many of the more highly skilled merchants fled to Amsterdam, which would then become ground zero for the financial revolution.

The reason for the primacy of the Dutch Republic in trading and finance might simply boil down to geography. Holland and the Netherlands are below sea level, which is why they are called the Low Countries. The land had forcibly been reclaimed from the sea by dykes over the centuries. This made the Dutch dependent upon fishing, shipping and trading far more than just about anywhere else, since the water table was too high for farming and there was not much arable land. Yet at the same time the population density of these areas was quite high. So their entire economy had to be dependent almost exclusively on shipping and trade since there were no other options, unlike in France, Spain, Portugal and England.

The Dutch utilized much of the same methods of borrowing as the rest of Europe, but much more effectively:

The Netherlands successfully liberated itself from Spain between 1568 and 1648. The Dutch established the Dutch east India Company in 1602 and the Dutch West India Company in 1621. The Netherlands didn’t have to pay for an expensive court, fought their wars at home rather than abroad, profited from international trade, and saved money. The Amsterdam Exchange dealt not only in shares of the Dutch East India Company and Dutch West India Company, but in government bonds as well.

Most securities were in the form of Annuities issued by the individual provinces, the United Provinces and the towns. This is the essential way in which Dutch lending differed from Italian lending. The Italian credit system relied upon a system of private international banking. The Medicis and other commercial bankers would lend their funds to states, knowing the risks involved. The Italians also had officially chartered banks that intermediated deposits and loans.

Outside of the Italian city-states, loans to heads of state were basically personal loans that clearly ran the risk of default. Spanish, French and English kings borrowed when they had to, defaulted when they couldn’t pay, but had no system of drawing upon the savings of the public. The Dutch, on the other hand, developed state finance based upon the government’s ability to pledge its revenues against the annuities they had issued. Having no royal court, and relying upon local governments, the Dutch paid off loans on time with little risk of default. As risk declined, interest rates fell to 4%, the lowest they had ever been in history, and a rate consistent with the low level of default risk that governments enjoy today. [24]

The Dutch also set up a bourse where national debts could be traded as negotiable securities. They set up a state bank to manage trade. They also developed the modern corporation, where corporate shares were freely tradable, hence establishing the first stock market (the Amsterdam exchange).

The Dutch Republic became the main place where international debts could be bought and sold in secondary markets. While it was neither the first bank or exchange, what made it unique was the fact that this was consolidated in one specific location, with government backing, as well as the scale of operations. Securities from all over became speculative commodities. This was the beginning of trading debts and money that engendered speculative bubbles like Tulip mania. In fact, you could even gamble with assets that you didn’t actually own, setting up the stage for the modern Casino Capitalism.

The novelty at the beginning of the seventeenth century was the introduction of a stock market in Amsterdam. Government stocks and the prestigious shares in the Dutch East India Company had become the objects of speculation in a totally modern fashion. It is not quite accurate to call this the first stock market, as people often do. State loan stocks had been negotiable at a very early date in Venice, in Florence before 1328, and in Genoa, where there was an active markets in the luoghi and paghe of the Casa di San Giorgio, not to mention the Kuxen shares in the German mines which were quoted as early as the fifteenth century at the Leipzig fairs, the Spanish juros, the French rentes sur l’Hotel de Ville (municipal stocks) (I522) or the stock market in the Hanseatic towns from the fifteenth century. The statutes of Verona in 1318 confirm the existence of the settlement or forward market (mercato a termine). In 1428, the jurist, Bartolomeo de Bosco protested against the sale of forward loca in Genoa. All this evidence points to the Mediterranean as the cradle of the stock market.

But what was new in Amsterdam was the volume, the fluidity of the market and the publicity it received, and the speculative freedom of transactions. Frenetic gambling went on here – gaming for gaming’s sake: we should not forget that in about 1634, the tulip mania sweeping through Holland meant that a bulb ‘of no intrinsic value’ might be exchanged for ‘a new carriage, two grey horses and a complete harness’! Betting on shares however, in expert hands, could bring in a comfortable income… Exchanges and growing rich while the merchants said they Were becoming poorer. In every centre, Marseilles or London, paris or Lisbon, Nantes or Amsterdam, brokers, who were little hampered by the regulations, took many liberties with them.

But is is also true that speculation on the Amsterdam Stock Exchange had reached a degree of sophistication and abstraction which made it for many years a very special trading-centre of Europe, a place where people were not content simply to buy and sell shares, speculating on their possible rise or fall, but where one could by means of various ingenious combinations speculate without having any money or shares at all. This was where the brokers came into their own… All the same, such practices had not yet attained the scale they were to reach during the following century, from the time of the Seven Years War, with the increased speculation in shares in the British East India Company, the Bank of England and the South Sea, above all in English government loans…Share prices were not oficially published until 1747 however, whereas the Amsterdam Exchange had been billing commodity prices since 1585.

Several other changes took place as well. To resolve the multiple currencies circulating, state banks became established by governments, and monetary exchange ever more centered around bank credits rather than government-issued monies. You would deposit your coins in the bank and be given a credit for it, which would hold its value, protected from the arbitrary currency fluctuations decreed by sovereigns. Credit creation led to fractional reserve banking. Joint-stock companies were applied to banking, and even made loans to governments.

The seventeenth century saw the foundation of three distinctly novel institutions that, in their different ways, were intended to serve a public as well as a private financial function.

The Amsterdam Exchange Bank (Wisselbank) was set up in 1609 to resolve the practical problems created for merchants by the circulation of multiple currencies in the United Provinces, where there were no fewer than fourteen different mints and copious quantities of foreign coins. By allowing merchants to set up accounts denominated in a standardized currency, the Exchange Bank pioneered the system of cheques and direct debits or transfers that we take for granted today. This allowed more and more commercial transactions to take place without the need for the sums involved to materialize in actual coins. One merchant could make a payment to another simply by arranging for his account at the bank to be debited and the counterparty’s account to be credited.

The limitation on this system was simply that the Exchange Bank maintained something close to a 100 per cent ratio between its deposits and its reserves of precious metal and coin…A run on the bank was therefore a virtual impossibility, since it had enough cash on hand to satisfy nearly all of its depositors if, for some reason, they all wanted to liquidate their deposits at once. This made the bank secure, no doubt, but it prevented it performing what would now be seen as the defining characteristic of a bank, credit creation.

It was in Stockholm nearly half a century later, with the foundation of the Swedish Riksbank in 1656, that this barrier was broken through. Although it performed the same functions as the Dutch Wisselbank, the Riksbank was also designed to be a Lanebank, meaning that it engaged in lending as well as facilitating commercial payments. By lending amounts in excess of its metallic reserve, it may be said to have pioneered the practice of what would later be known as fractional reserve banking, exploiting the fact that money left on deposit could profitably be lent out to borrowers…

The third great innovation of the seventeenth century occurred in London with the creation of the Bank of England in 1694. Designed primarily to assist the government with war finance (by converting a portion of the government’s debt into shares in the bank), the Bank was endowed with distinctive privileges. From 1709 it was the only bank allowed to operate on a joint-stock basis; and from 1742 it established a partial monopoly on the issue of banknotes, a distinctive form of promissory note that did not bear interest, designed to facilitate payments without the need for both parties in a transaction to have current accounts. [25]

This last innovation – the use of private corporations such as banks to consolidate and manage the government’s debt, is at the heart of the modern financial system. The money we use is the government’s liability, backed by its ability to collect taxes. Yet now private banks would continue to be allowed to create credit by extending loans denominated in the same unit of account that the government required to pay the taxes, the ultimate form of financial settlement.

We’ll take a look at how that happened next time.


[1] Not used.
[2] Niall Ferguson; The Ascent of Money, p. 69
[3] William N. Goetzmann and K. Geert Rouwenhorst, eds.: The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 147
[4] John H. Munro: The medieval origins of the ’Financial Revolution’: usury, rentes, and negotiablity. p. 514
[6] ibid.
[7] ibid.
[8] ibid.
[9] ibid.
[11] Niall Ferguson; The Ascent of Money, p. 72
[12] William N. Goetzmann and K. Geert Rouwenhorst, eds.: The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 147
[13] ibid., p. 158
[15] William N. Goetzmann and K. Geert Rouwenhorst, eds.: The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 163
[16] John H. Munro: The medieval origins of the ’Financial Revolution’: usury, rentes, and negotiablity. p. 514
[17] ibid.
[18] ibid.
[19] Niall Ferguson; The Ascent of Money, pp. 73-74
[20] John H. Munro: The medieval origins of the ’Financial Revolution’: usury, rentes, and negotiablity. p. 514
[21] John H. Munro: The medieval origins of the ’Financial Revolution’: usury, rentes, and negotiablity. p. 73-74
[22] Niall Ferguson; The Ascent of Money, p. 74
[23] Niall Ferguson; The Ascent of Money, pp. 74-75
[24a] Fernand Braudel: Civilization and Capitalism Volume 2: The Wheels of Commerce, pp 100-102
[25] Niall Ferguson; The Ascent of Money, p.Pp. 48-49

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