by Felix Martin
The task of a judicious exchange-banker such as the mysterious Italian at Lyons was so to transact in the first days of the fair that by the time the Day of Payments came round, he could offset all his credit and debit balances perfectly, and turn a profit into the bargain. But the real source of the exchange-bankers’ phenomenal enrichment and power was not simply their ability to speculate on the fluctuations of the fledgling foreign exchange market. The system of exchange by bills was not just a means of facilitating international trade or foreign exchange—remarkable as these achievements were. It was something much grander, and more politically significant. Bit by bit, the exchange-bankers had assembled all the moving parts of a great machine that enabled private credit to circulate as money throughout Europe. All three of money’s fundamental components were there. Like the Argentine Crédito, the system had its own unit of abstract value, the écu du marc. It had its own system of accounting—the rules of book-keeping set out in Pacioli’s De Arithmetica, and the standard protocols agreed between the great merchant houses for applying it. And it had its system for the transfer and clearing of credit balances using the bill of exchange and the great clearing house of the central fair. The system of exchange by bills had become nothing other than “a supranational private money interacting with domestic public monies.”21 By crowning a pan-European hierarchy of credit with the self-regulating network of their cosmopolitan but close-knit cabal, the exchange-bankers had succeeded, it seemed, in building Utopia. With their perfection of the system of exchange by bills, they had constructed a viable private money on a continent-wide scale.
The economic significance of this astonishing achievement was plain to see in both the commercial revolution that it facilitated and the fabulous wealth of the men who had built it. But there was more—much more—to the new system of bankers’ money than that. It was the harbinger of an epochal political change as well—one that would change the face of finance for ever.
7 The Great Monetary Settlement
PRIVATE MONEY AND MARKET DISCIPLINE
Claude de Rubys, the historian of the Lyons fair, was one observer who spotted the political significance of the international system of exchange by bills: it enabled the mercantile class to escape from their reliance on sovereign money. As an experienced statesman, de Rubys was aware that control of a nation’s money was one of the most basic and lucrative sources of sovereign power. He also understood that the creation and management of private money by bankers was an act not only of economic innovation, but potentially of political revolution. The money interest was now equipped both with Oresme’s powerful arguments—the ideas of the public interest and the needs of trade as guiding principles of monetary policy—and with a potential alternative, should the sovereign refuse to heed them. The great merchant houses had discovered a means of producing an international money beyond any one sovereign’s jurisdiction. Moreover, so tightly knit was this cosmopolitan elite, and so expertly constructed its hierarchy of credit networks, that it had no need of precious metal to serve as collateral for its promises to pay. Its money was invisible, intangible, consisting only of the confidence of the small group of exchange-bankers at the tip of the pyramid in one another’s abilities to assess risks, to be able to meet payments as they came due, and to limit the issuance of credit. This was an enemy impossible to grasp, let alone defeat—a Monetary Maquis with a real “Army of Shadows.” Now it was the money interest that could back its arguments with threats—threats to abandon the sovereign’s money if it was not managed in accordance with their interests. The boot was firmly on the other foot.
Unsurprisingly, sovereigns sought to wage a rearguard action against this new enemy. The most useful recruits were men who knew the secrets of the bankers from first-hand experience. Sir Thomas Gresham, England’s royal agent at Antwerp from 1551, was one such poacher-turned-gamekeeper. Gresham came from a prominent mercantile family. His father had been one of the chief beneficiaries of Henry VIII’s distribution of monastic assets, and had traded on these riches to become Lord Mayor of London. Gresham himself was in his own turn “a successful business man, a financial expert, and a confidential agent of the government.”1 His experience in the first two roles was to come to his aid in his capacity as the English crown’s financier-in-chief in the Low Countries following the financial disasters of the last decade of Henry VIII’s reign. From a high of 26 Flemish shillings in 1544, the English pound sterling had commenced a seemingly inexorable decline in value on the exchange at Antwerp, at one point in 1551 sinking to only 13 Flemish shillings—a 50 per cent depreciation in seven years.2 Since the English crown was a major debtor in Antwerp, this precipitous decline was unwelcome: it increased the real burden of the king’s debt in the same proportion. Moreover, whilst it was difficult to deny that the English crown’s foreign borrowing might have been excessive, court opinion held—in the time-honoured tradition of government officials facing market pressures—that the real culprit was the exchange-bankers, whose low opinion of English creditworthiness was nothing but a scam to earn them unjustified profits. Most culpable of all, wrote the minister William Cecil, were none other than the mysterious Italians, who “go to and fro and serve all princes at once … work what they list and lick the fat from our beards.”3
By 1551, the court was in despair. But Gresham had a plan. Following his appointment as agent, he pitched the idea of an exchange stabilisation fund to be deployed to combat unwarranted depreciation of the pound sterling. He requested a secret infusion of £1,200 or £1,300 a week for the purpose. With such ammunition, he said, he could neutralise the bankers’ power to sell sterling whenever they disapproved of the English crown’s policies. The young Edward VI’s Regency Council was persuaded, and the plan was put into effect. Gresham’s ploy was certainly prescient—government intervention in the foreign exchange markets using stabilisation funds was to become a standard tool of policy in the twentieth century. Unfortunately, it was also ahead of its time in discovering the limited abilities of such schemes to succeed in the face of market scepticism. After just two months, the English government balked at the cost of Gresham’s apparently ineffectual interventions, and cancelled the programme. Undeterred, Gresham returned with a new plan; but this one was much more conventional. The foreign currency reserves of the English merchants at Antwerp were to be commandeered as a forced loan to the crown. The crown’s foreign currency debts due to the slippery exchange-bankers would be refinanced into a sterling loan from its own subjects. It was ingenious and effective—but it was an admission of defeat. The exchange-bankers could not be beaten at their own game. The only remedy was for the sovereign to exert its power of coercion over its subjects. But that could only increase their incentive to join the resistance.
As so often in the history of monetary thought, theory lagged behind practice. Businessmen, policy-makers, and bankers themselves understood the developing system from the bottom up; Gresham even published a treatise on the topic. But a full appreciation of banking’s general political significance had to wait nearly two more centuries for the furnace of the French Enlightenment to fuse together previously separate strands of economic and political thought. France in the mid-eighteenth century was ripe for such a catalytic role. Politically, it remained the bastion of the Ancien Régime—an unreconstructed feudal monarchy in a continent long since disturbed by the winds of constitutional change. Financially, France was one of the most backward states in Western Europe, but intellectually it was the centre of the world. The extraordinary contrast between its dazzling republic of letters and its moribund bodies politic and financial meant that it was the thinkers of the French Enlightenment who first fully articulated the link between money, banking, and politics.
The most brilliant analysis of all appeared in the masterwork of the greatest constitutional thinker of the age: Charles-Louis de Secondat, Baron de la Brède et de Montesquieu. Montesquieu’s The Spirit of the Laws was a crowning achievement of the French Enlightenment—a ma
sterful blend of history, anthropology, and political analysis that argued for the establishment of constitutional government on the English model. Montesquieu gave special attention—and special praise—to the role of commerce as a beneficial force in political development, and reserved his greatest admiration for international finance. “It is astonishing that the bill of exchange has been discovered only so late,” he wrote, “for there is nothing so useful in all the world.”4 Even in France, though it remained a century behind England in political reform and monetary development, the discipline that the foreign exchanges imposed upon the king’s policies meant that however absolute the sovereign’s powers might appear, they were in practice severely circumscribed. Violent abuses of the sovereign money of the sort practised in the ancient world and the Middle Ages, he wrote, “could not take place in our time; a prince would confound himself, but would not fool anyone else. The foreign exchanges have enabled bankers to compare all the monies of the world and to evaluate what they are really worth … They have eliminated the great and sudden arbitrary actions of the sovereign—or at least the effectiveness of such actions.”5
The irony that Gresham had confronted in practice was now fully understood and elegantly elaborated in theory. Feckless sovereigns’ abuse of their monetary prerogatives had stimulated the rediscovery of banking and the invention of the great system of exchange by bills. As a result, it was sovereigns that now had to dance to the tune of the money interest rather than the other way round. All of a sudden, the eerie insubstantiality of the bankers’ operations was not a source of suspicion, but a stealth weapon in the crusade for constitutional government. “In this manner we owe … to the avarice of rulers the establishment of a contrivance which somehow lifts commerce right out of their grip,” wrote Montesquieu.6 Or rather, they had inadvertently tied their own hands, finding themselves compelled to manage money ever more in the interests of the community for which Oresme had spoken. By forcing the money interest into a successful rebellion, “sovereigns have been compelled to govern with greater wisdom than they themselves might have intended … [Now] only good government brings prosperity [to the prince].”7
In 1993, James Carville, the chief strategist on U.S. president Bill Clinton’s election campaign the year before, evoked the extraordinary power of money to constrain political action in the modern world, in an interview for the Wall Street Journal. “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter,” he joked, “but now I want to come back as the bond market. You can intimidate everybody.”8 Carville’s succinct formulation became justly famous; but the idea was far from original. He was evoking an Enlightenment vision of money as a force that can discipline even the mightiest sovereign. In fact, the most memorable sound bite on the topic in that earlier era was coined by another James—the Scotsman James Steuart, whose 1767 Inquiry into the Principles of Political Economy was one of the first works of economics in the English language.9 Steuart’s judgement neatly summarised the complete transformation in monetary thought that had taken place in the four centuries since Nicolas Oresme’s Treatise, let alone since the days of the Jixia academy. These earlier authorities had held that money was ultimately an instrument of the sovereign—and that the best one could do was to plead with him to use it wisely. Steuart’s vision was quite the opposite. Monetary society, he wrote, was nothing other than “the most effective bridle ever was invented against the folly of despotism.”10
Two Jameses—Steuart (left) and Carville (right)—with one important idea: that money can be a powerful tool to control the sovereign.
(illustration credit 7.1)
BANKING ON THE STATE: THE PHILOSOPHER’S STONE OF FINANCE
But things were not quite so simple. There are good reasons, we recall, why sovereign money is generally the default. No private issuer enjoys the same extent for its markets, the same capacity to coerce demand for its liabilities, or the same psychological association with confidence in society. The bankers might have built themselves a new Jerusalem—but it was a monetary Utopia just as prone to invasion by stark realities as any in history. Private issuers could default—and their creditors be left with worthless bills drawn on insolvent counterparties. Liquidity could evaporate as confidence flagged, throwing the most carefully laid plans for the synchronisation of payments into disarray. Even the pyramid of credit erected by the bankers stopped somewhere—at the exclusive circle of international financiers—and even their money market could suffer from crises of confidence, or simply from the impact of unexpected events.
Indeed, the fate of the new private money was no less ironic than that of the old sovereign money. On the one hand, it was essential that banking remain the exclusive preserve of a narrow elite. Only a self-regulating clique could incubate the interpersonal trust necessary to operate a private monetary network, and the barriers to new entrants were negligible once its principles were understood. Unlike the sovereign, the bankers had no power of coercion to enforce their franchise. As a result, bankers guarded their secrets jealously and started a proud tradition of “shroud[ing] their practices in a finicky formalism which lent itself perfectly to preserving their monopoly.”11 But these very same conditions also imposed obvious limits to its expansion. The credit notes of the international bankers could circulate amongst themselves, but outside that magic circle, they were bound to be a conundrum. The very features that made the bankers’ private money work were the ones which meant it could not actually displace sovereign money.
The result was a chronically unstable monetary disequilibrium—a long-running guerrilla war between sovereigns and the private money interest which neither side could win. All this was to change with a final historic invention at the end of the seventeenth century. As had been the case with money itself, this was an innovation that was the result of transplanting advanced ideas from the most sophisticated commercial culture of the age into a financial backwater—but one which enjoyed a unique political inheritance. In this reprise of the old drama the part of the sophisticate was to be played by the Low Countries, and that of the bumpkin by England.12 Holland’s cutting-edge technology was “Dutch finance”: the most advanced system for managing the national debt that then existed. England’s contribution was its recent, painful adoption of constitutional monarchy. The resulting invention was the Bank of England—and with it, the basis of all modern banking systems, and all modern money.
At the close of the seventeenth century, England remained racked by the constitutional crisis that had erupted into civil war in the 1640s. The experiment with Republican government under the Cromwells had failed and the deposed King Charles I’s son had been restored to power in 1660. But though the old divisions between Royalists and Parliamentarians were fading, a new opposition driven by the divergent interests of land-owning Tories and commercially minded Whigs was emerging. The reason was nothing new. If anything, the fiscal incontinence of the sovereign that had been the immediate cause of the civil war had deteriorated further. So decrepit were the restored King Charles II’s finances by 1672 that he was forced to default on his debts, announcing a “Stop of the Exchequer.” The predictable result was a collapse in the crown’s credit. By the end of the decade the terms on which the English sovereign could borrow were significantly worse than those available to private merchants.13
Nor was the fiscal situation improved by the ingenious solution to the constitutional crisis that eventually followed Charles II’s death and his brother James’ accession—the “Glorious Revolution” of 1688, which saw William of Orange invited to assume the throne of England. It rapidly transpired that William’s leading motive in accepting the English Parliament’s offer was not a selfless desire to save England from popery, but his appetite for more generous resources with which to defend Holland against the predatory ambitions of Louis XIV’s France. No sooner had William taken the throne than he had joined England to a continental coalition that proceeded to launch
a war against the French. Taxes were raised to yield £4 million a year—a sum unheard of in Charles II’s day—but expenditure rose by even more, to £6 million a year. The difference had to be raised from creditors, using ever more desperate means. By the spring of 1694, England had endured five years of heavy war taxation—more than a third of it levied on land and therefore felt disproportionately by the Tory gentry. What was worse, there was no end in sight. The war dragged on, the king’s credit was shot, and another year’s vast deficit was yawning. A second default of the fraying Exchequer loomed.
Fortunately, the late seventeenth century in England was not only the era of constitutional chaos. It was also an age of vigorous innovation in the fields of money and public finance. The king’s ministers and advisers were deluged by proposals from so-called “Projectors” for new ways to fund the deficit.14 Some were ingenious, many crackpot. Almost all boiled down to the same basic idea of finding a mechanism for borrowing against future tax revenue. The trick was to discover a formula which satisfied creditors’ desire for better security and more control, and yet preserved the dignity of the sovereign. But with the war deficit always threatening, the king’s ministers were not in a position to be overly choosy. One novel plan was for a state lottery involving the sale of 100,000 lottery tickets at £10 each and marketed uncomplicatedly as “The Million Adventure.”15 The money raised was lent on to the Treasury in the usual way, but investors bored by the monotony of coupon payments enjoyed the chance to win an elaborately graded menu of cash prizes.16 Fads of this sort proved successful at enticing jaded creditors to part with their money, but when all the prizes were paid out, they proved to be just as expensive as ever. No amount of actuarial ingenuity could disguise the fact that the standing of the king’s credit with potential lenders remained abysmal.
