The Cash Nexus: Money and Politics in Modern History, 1700-2000

by Niall Ferguson

  ‘THE TRUE LORDS OF EUROPE’

  After 1815 there was a gradual spread of what contemporaries came to think of as the British financial system. As we have seen, the defining characteristics of this system were: a professional tax-collecting bureaucracy, parliamentary and public scrutiny of budgets, a funded national debt guaranteed by parliament and a central bank with a partial monopoly over note issue. The gold standard and free trade were later and optional adjuncts to this system. But free capital movement was from the outset an integral part of it, for it was only through the London bond market that the continental European fiscal systems – to say nothing of the North and South American republics that had secured their independence in the war years – could be stabilized in the post-war period.

  Between 1818 and 1832 twenty-six loans were floated in London on behalf of foreign governments with a nominal value of £55.8 million.37 One of the first of these, the Prussian loan of 1818, illustrates the way attempts were made to export the British institutional model along with British capital.38 From the outset of the negotiations, Nathan Rothschild argued that any loan would have to be secured by a mortgage on Prussian royal domains guaranteed by the representative estates of the domains concerned. When the Prussians demurred, Rothschild spelt out his reasons for wanting such a guarantee:

  [T]o induce British Capitalists to invest their money in a loan to a foreign government upon reasonable terms, it will be of the first importance that the plan of such a loan should as much as possible be assimilated to the established system of borrowing for the public service in England, and above all things that some security, beyond the mere good faith of the government … should be held out to the lenders … Without some security of this description any attempt to raise a considerable sum in England for a foreign Power would be hopeless[;] the late investments by British subjects in the French Funds have proceeded upon the general belief that in consequence of the representative system now established in that Country, the sanction of the Chamber to the national debt incurred by the Government affords a guarantee to the Public Creditor which could not be found in a Contract with any Sovereign uncontrolled in the exercise of the executive powers.39

  In short, a constitutional monarchy was seen in London as a better credit risk than a neo-absolutist regime.40

  Admittedly, Rothschild was prepared to settle for much less than parliamentary control in the Prussian case: the final contract merely stated that ‘for the security of the creditors’ there would be a special mortgage on the royal domains, which were ‘wholly disposable according to the House[hold] Law of November 6, 1809, passed by H.M. the King of Prussia and the princes of the royal house with the assent of the provincial estates’.41 This was a long way from British-style parliamentary control. On the other hand, there is an obvious link from Rothschild’s negotiations to the subsequent Clause 2 of the ‘Decree for the Future Management of the State Debt’ of January 1819, which imposed a ceiling on the state debt, earmarked revenues from the royal domains for debt service, and declared: ‘If the state should in future for its maintenance or for the advancement of the common good require to issue a new loan, this can only be done in consultation with and with the guarantee of the future imperial estates assembly.’42 This meant that any future loan by the Prussian state would automatically lead to the summoning of the estates; in other words, it conceded the link between public borrowing and constitutional reform. This explains why of all the German states Prussia borrowed the least in the 1820s and 1830s and why, when the policy of retrenchment broke down in the 1840s, the consequences were revolutionary.

  As the key player in the world’s biggest market, Rothschild was the prototype financial master of the universe. In May 1818 he fired off a letter to the Director of the Prussian Treasury which perfectly captures his sense of his own power – the power of money: ‘The cabal there [opponents of the Rothschild loan at the Prussian court] can do nothing against N. M. Rothschild, he has the money, the strength and the power, the cabal has only impotence and the King of Prussia … should be well pleased and thank Rothschild, who is sending you so much money [and] raising Prussia’s credit.’43 Small wonder, then, that Carville-esque remarks about the power of the Rothschilds and their rivals turn up time and again in the correspondence of nineteenth-century politicians, as well as in the writings of journalists, novelists and poets. ‘Who hold the balance of the world?’ asked Byron in Canto XII of Don Juan (1823):

  Who reign

  O’er Congress, whether royalist or liberal?

  Who rouse the shirtless patriots of Spain?

  (That make old Europe’s journals squeak and gibber all.)

  Who keep the world, both old and new, in pain

  Or pleasure? Who make politics run glibber all?

  The shade of Bonaparte’s noble daring? –

  Jew Rothschild, and his fellow Christian Baring.

  Those, and the truly liberal Laffitte,

  Are the true lords of Europe. Every loan

  Is not a merely speculative hit,

  But seats a nation or upsets a throne.

  In Disraeli’s Coningsby the elder Sidonia is described as having foreseen in 1815 that ‘after the exhaustion of a war of twenty-five years, Europe must require capital to carry on peace. He reaped the due reward of his sagacity. Europe did require money, and Sidonia was ready to lend it to Europe. France wanted some; Austria more; Prussia a little; Russia a few millions. Sidonia could furnish them all.’ As a result he became ‘lord and master of the money-market of the world and of course virtually lord and master of everything else. He literally held the revenues of Southern Italy in pawn; and monarchs and ministers of all countries courted his advice and were guided by his suggestions.’44

  The key to the power of the Rothschilds is that they were a truly multinational partnership, with ‘houses’ in London, their birthplace Frankfurt, Vienna, Naples and Paris. It was not only Nathan who inspired contemporary fascination; it was the fact that he was the primus inter pares of five ‘Finance Bonapartes’ (the phrase was coined by Metternich’s Secretary Friedrich von Gentz). Balzac’s Nucingen, for example, is very obviously modelled on Nathan’s brother James: a ‘Louis XIV of the counting house’, an ‘elephant of finance’, who ‘sells deputies to the ministers and the Greeks to the Turks’ – in short, the personification of ‘the age of gold in which we live’.45 To the young Heine, writing in the 1820s, James and his elder brothers appeared to be a bulwark of the reactionary post-Vienna order:

  Without the Rothschilds’ help, the financial embarrassment of most states would have been exploited by subversives wanting to mislead the populace into upsetting whatever order or disorder constituted the status quo. Revolutions are generally triggered off by deficiency of money; by preventing such deficiencies the Rothschild system may have served to preserve peace in Europe.46

  MEASURING POLITICAL RISK, C. 1830–1870

  Yet despite such contemporary assessments of the Rothschilds’ power, the bond market was prone to violent and unpredictable crises which were beyond the control of even the biggest player.

  In the early 1820s the London market was inundated with bond issues by South American states (including a number that did not actually exist); but the tightening of fiscal and monetary policy in Britain, combined with political instability in the debtor states, led to a disastrous crash in 1825. Brazilian bonds which the Rothschilds had issued at a price of 85 fell to 56; Mexican, Colombian and Peruvian bonds all fell below 20.47 Latin monarchies proved no more reliable than Latin republics. Portugal and Spain attracted investors in the 1830s, but they proved almost as unreliable as the Latin American states in the 1820s. By the late 1830s the Rothschild brothers privately referred to Iberian bonds in their correspondence as ‘shit’. Nor was it only Hispanic states that defaulted. Between 1837 and 1843 eight North American states did so too.48 The years 1847–9 witnessed the worst European financial crisis of the century, the effects of bad harvests and revolution. Recovery
in the 1850s was also precarious. A succession of wars beginning with the Crimean War and continuing with the wars over Italian and German unification generated new bond issues in Europe, but at the same time increased the risks to investors. Because few countries joined Britain on the gold standard before the 1870s, these risks included not only default but depreciation.

  In making their assessments about sovereign bonds, modern investors tend to look first at the most recent indicators of fiscal and monetary policy, for example budget deficits as a percentage of GDP or monthly monetary growth rates; their assessment will be in some measure informed by knowledge of the figures of preceding years. In the words of one celebrated bond salesman: ‘The American bond market … lurches whenever important economic data is [sic] released by the US Department of Commerce…. The markets decide what is important data and what is not. One month it is the US trade deficit, the next month the consumer price index.’49 In the past, however, there were fewer economic data on which to base judgements about default-risk or future inflation and depreciation. Early nineteenth-century investors had fairly good and regular information about certain commodity prices, gold reserves, interest rates and exchange rates, but fiscal details apart from annual budgets were few and far between, and there were no regular or reliable estimates of national income. In non-parliamentary monarchies, even annual budgets were not always available or, if they were published, could not be relied upon. There was no headline cost-of-living index before the First World War.

  Instead, evidence from contemporary sources strongly suggests that mid-nineteenth century investors were more likely to infer changes in fiscal and monetary policy from political events. Among the most influential bases for such inferences were four assumptions:

  1. that a political move to the left, ranging from outright revolution to a change of ministry due to elections, would tend to loosen fiscal and monetary policy;

  2. that a new and radical government would be more likely to pursue an aggressive foreign policy which might, in turn, lead to war;

  3. that any war would disrupt trade and hence lower tax revenues for all governments (in the words of the French premier Villèle in the mid-1820s, ‘Cannon fire is bad for money’);50 and

  4. that direct involvement in war would increase a state’s expenditure as well as reducing its tax revenues, leading to substantial new borrowings.

  Though to some extent truisms, it is clear that all these assumptions owed much to the experience of the period between 1793 and 1815: war involving a revolutionary France was the markets’ biggest nightmare. Indeed, the experience of the 1790s – when revolution, war, default and inflation had sent the yields on French securities soaring from 6 to 60 per cent51–reverberated, like the Marseillaise, for nearly a century: in 1830, in 1848 and in 1871. Each time Paris sneezed, to paraphrase Metternich, the European markets caught cold (though London tended to rally as capital left Paris for the safer market across the Channel). Nevertheless, it was only with the end of the Boulanger crisis (1887–8) that the fear finally disappeared of a French domestic political upheaval leading to a European war.

  Figure 26 allows us to trace quite precisely – on a weekly basis – the fluctuations of the bond yields for four of the five great powers in the London market between 1843 and 1871 (prices of Prussian bonds were not quoted in the source for the data).52 The stories are markedly different. British yields were lower than other yields throughout. Austrian yields tended to rise, while French and Russian yields followed quite different paths in between. Part of the explanation for these differences was obviously the divergence of exchange rates, since only Britain was on gold, while France was bimetallic and both Russia and Austria were on (and sometimes off) silver. However, exchange rate regimes can only explain a part of the volatility of yields in this formative period. Of equal, though not entirely separable, importance were political events, particularly wars and revolutions. Indeed, anyone with an elementary knowledge of European history will be able to formulate a persuasive prima facie explanation for nearly all the major yield increases in the figure.

  Table 15 summarizes the magnitude of bond market crises precipitated by the principal wars and revolutions of the period. A number of striking points emerge. For example, the biggest crisis on the European bond market in the nineteenth century occurred during the two months after the outbreak of the 1848 revolution in Paris. In London, Austrian and French bonds were both severely hit, with yields rising by as much as 662 basis points in the former case and 505 in the latter. But even Russian bonds were affected, though there was no revolution there. Only British bond yields fell in this period, reflecting as much the recovery of the British money market from the financial crisis of 1847 as the switching of investors from continental bonds into safer consols. Clearly, the market as a whole had no expectation of a revolution in London, which was used as a safe haven by many continental investors.53 The outbreak of the Crimean War had an effect on all major bonds, including even consols, for obvious reasons: but it is interesting that Austrian yields rose even faster than Russian (by 243 basis points as against 175). This differential between a manifestly over-stretched Habsburg regime and its rivals widened disastrously in the wars of 1859 and 1866: Austria’s defeat by France and Italy pushed yields up by more than 400 basis points, and her defeat at the hands of Prussia by just under 300. (Consol yields also rose in 1866 but, since this was due to the financial crisis caused by the collapse of the Overend Gurney discount house, I have omitted the figures.) Austrian yields remained high because after May 1870 they were formally excluded from the London stock exchange following the 1868 conversion operation, which had been combined with a tax on foreign as well as domestic bondholders.54

  Figure 26. Unadjusted yields on European bonds, London prices, end of week, 1843–1871

  Source: The Economist.

  Note: Breaks in the series are due to markets being closed (in 1847–8) or prices not being quoted in London (especially true in the case of Austria before 1870).

  Table 15. Wars, revolutions and the bond market, 1830–1914 Event Britain France Russia Austria

  Key:

  1 1830 Revolution: revolt against Charles X’s 5 ordinances

  2 1848 Revolution: revolt in Paris after ban on banquets

  3 Crimean War: British fleet ordered to Dardanelles

  4 Austro-Italian War: Austrian ultimatum to Sardinia to disarm

  5 Austro-Prussian War: Prussian troops occupy Holstein

  6 Franco-German War: Leopold of Hohenzollern’s acceptance of Spanish throne

  7 Russo-Turkish War: Russia declares war on Turkey

  8 Russo-Japanese War and 1905 Revolution: outbreaks of war

  9 Approach of First World War: assassination at Sarajevo

  Source: The Economist (except for the figures for 1830, which are based on data from Rothschild Archive and the Spectator).

  Note: All increases in basis points (1 per cent = 100 basis points). Figures for 1914 not strictly comparable because of market closure after 31 July.

  That nineteenth-century investors priced bonds in response as much to political news as to less accessible fiscal or monetary indicators is not difficult to demonstrate. Thus we find James de Rothschild assessing the implications of the Revolution in France in October 1830: ‘You can’t begin to imagine what might happen should we get war, God forbid, for if that were the case, then all the securities would suffer such a fall that it would be impossible to sell anything.’55 A month later he sought to quantify the risk: ‘We have a holding of 900,000 rentes; if peace is preserved they will be worth 75 per cent, while in case of war they will drop to 45 per cent … I am convinced that if peace is maintained rentes will improve on three months by at least 10 per cent …’56 From an early stage it was the possibility of war that concerned him far more than the change of dynasty. After all, as the poet and journalist Ludwig Börne remarked wryly, the new king’s relations with the haute banque were so close that he had ‘taken the titl
e Emperor of the five per cents, King of the three per cents, Protector of bankers and exchange agents’. James’s brother Salomon was relieved to watch Louis Philippe take the coronation oath to uphold a slightly revised constitution: ‘Thank God that we have come so far that the matter has ended so well, for otherwise the rentes would not have stood at 79 but would have fallen to 39, God forbid.’57 But there was always the danger that Louis Philippe would not be able to restrain his ministers, some of whom found memories of the 1790s distinctly intoxicating. As James’s nephew Nat put it, during a later French crisis, ‘In general when troops begin to move bondholders are frightened …’58

  Towards the end of his career, James de Rothschild’s tendency to assess political events in these terms had become the stuff of bourse legend. ‘So, M. le baron,’ the Piedmontese premier Cavour was heard to ask James de Rothschild a month before his country’s French-backed war against Austria in 1859, ‘is it true that the bourse would rise by two francs the day I resign as Prime Minister?’ ‘Oh, monsieur le comte,’ replied Rothschild, ‘you underestimate yourself!’59 Rothschild responded similarly to Napoleon III’s inflammatory speech at Auxerre on 6 May 1866, in which the Emperor denounced the treaties of 1815. Once, Napoleon had assured France’s neighbours, ‘L’Empire, c’est la paix’ (‘The Empire means peace’). But now, declared Rothschild, ‘L’Empire, c’est la baisse’: literally, ‘the Empire means a falling market’.60

  It was not only bankers who thought this way. In 1840, as Palmerston intransigently rejected the French premier Thiers’s bids for a face-saving compromise over the Eastern Question, King Leopold of the Belgians told his niece Queen Victoria:

  Politics are uppermost in people’s minds, and everybody has been more or less loosing [sic] by the funds and other securities tumbling head over heels. I see with some satisfaction that the English funds that were before the [abortive Anglo-French] Convention at 91 are now at 87 and were even less, I hope this will rouse our friend Melbourne [the British Prime Minister].61