Chapter 2 - European Financial
Markets in History
1
This Lecture

The early beginnings

Financial centres and peripheries

Financial innovations

From pawn brokers to ABS

From cowrie shells to electronic money

Scale economies and lock-in
2
The early beginnings
The first financial activities: following trade
•
First limited
10th century
to the local town or village
to walking distances
to major trading routes
to business with personally known people
•
With increasing long-distance journeys
12th century
increasing welfare
growing court life and urbanity
pilgrimages and crusades
rising awareness of other regions
emerging crafts, rising purchasing power
emerging preferences for luxury goods
•
With the rise of merchant empires
division of labour in long-distance trade
emergence of dominant cities
15th century
3
The early beginnings
The first financial centres: Italian cities
Venice
Genoa
Florence
4
The early beginnings
The first financial centres: Italian cities
Venice
benefitted from
–
the special relationship with Byzantium
–
its role as early colonial power (Crete, Corfu,
Cyprus, Alexandria)
–
access to products of the Levant and Asia
–
military and technological superiority
–
relationship to the Islamic world and its
already flourishing money economy.
5
The early beginnings
The first financial centres: Italian cities
Genoa
–
established the first regular maritime trade
with Flanders in 1277.
–
The first references to banking in Europe in
the Middle Ages are found in Genoese
records of the 12th and 13th centuries.
–
The king of Spain, "lord of precious metals"
(Braudel) was among Genoese bankers'
clients who changed the irregular sources of
Spanish revenues from taxes and silver
imports from the New World into regular
streams of income.
6
The early beginnings
The first financial centres: Italian cities
Florence
–
From the 12th century onwards Florence was the origin
of the great banking families, such as the Peruzzi,
Bardi, Acciaiuoli, and later the Medici,
–
which were all characterised by having large capital
stocks
–
and wide networks of subsidiaries and relations in
western Europe, north Africa and the Levant.
7
The early beginnings
The first financial centres: Italian cities
The Peruzzi
In 1335, the Peruzzi company had at least 15 branches
in western Europe, north Africa and the Levant.
It had an estimated staff of about 90 factors or
employees.
Its capital was about 90 000 florins, ...
which was a considerable wealth taking into account
that, for example, before 1500 the value of a palace like
that of the Medici in Florence was estimated to be 5 000
florins (De Roover).
8
The early beginnings
The first financial intermediaries:
•
Pawnbrokers
Small lenders who lent money at high interest rates holding
some of the borrower's personal belongings as collateral.
Regarded as no better than prostitutes - sinners but necessary to
society (Kindleberger)
•
Money changers
At first only exchanged currencies with no element of credit
involved;
played an important role in trading centres given the great
variety of coins in the Middle Ages.
•
Bankers
From the twelfth and thirteenth centuries onwards local transfer
banks began to take deposits and make payments on behalf of
depositors.
In addition, since there were competing currencies, and gold and
silver coins circulating simultaneously, they accepted deposits
repayable in different kinds of money.
9
Money changers
Money changers are still found today in big
cities all over the world but also in remote and
poorly developed rural areas or war-torn regions
where banks do not exist or do not function
well.
Jodhpur, Sardar Market, India
10
The early beginnings
The first financial innovations:
•
Bank money based on fractional reserve
•
Bill of exchange
•
Limited-liability partnership
•
Coins
•
Cheques
•
Government bonds
•
Marine insurance
11
The early beginnings
The first financial innovations:
Bank money based on fractional reserve
When money changers began taking deposits and
making payments on behalf of depositors transfering
deposits from one trader to another it was no longer
necessary to transport coins.
However bankers always held a certain amount of cash in
case depositors ask their money back. Over time, they
found out that it was not necessary to hold cash covering
the total value of deposits and they kept only a fraction of
that amount at hand investing the rest in trading activities
or lending it at interest to third parties.
In other words, they began operating on a fractional
reserve basis.
12
The early beginnings
The first financial innovations:
Bill of exchange
The bill of exchange was a contract defining an
agreement between two people, the deliverer and the
trader.
The deliverer agreed to advance a sum of money to
the trader,
and, in return, received from him a “letter missive”,
the bill of exchange, payable
• at a distant place and
• in another currency.
Usually, the implementation of the contract required
two other parties to be involved acting as agents: the
payor and the payee.
Under the prohibition of usury bills of exchange
were long used as credit in disguise.
13
The early beginnings
The first financial innovations:
Limited-liability partnership
Long-distance trade increased the demand for
financial products which allowed to raise funds,
defer payments and share or transfer risks.
Since the 10th century Italian cities knew the oneventure contratto di commenda (in Venice known
as collegantia, in Genoa as societas maris):
A merchant received a sum of money from
someone at the beginning of a voyage and, on his
return, the gains and losses he made were divided
between the two parties according to the share of
capital each of them had provided.
The commenda was in use until the 15th century
when long-distant trade had become routine and
old-style merchants were replaced by
businessmen operating through agents.
14
The early beginnings
The first financial innovations:
Government bonds
In Genoa and Venice the first government bonds
were issued before 1200. Citizens lend money to
the communes in exchange for “shares of stock”
paying regular interest. Most of them were “forced
loans” with the amounts lent calculated by the
communes on the basis of the citizens’ wealth.
Citizens finding themselves short of cash could
waive their credit to the commune to a third party usually for a smaller amount than the sum
originally lent.
In Florence, which fought expensive wars
employing companies of mercenaries and artillery,
public debt rose from around 50 000 gold florins in
1300 to about 450 000 in 1338 and 600 000 in 1343.
In Genoa, public debt titles were known as luoghi
and traded by citizens and foreigners just like
present-day securities (Cipolla).
15
The early beginnings
The first financial innovations:
Marine insurance
Increasing uncertainties as the result of rising
international warfare and violence throughout
the Mediterranean world and western Europe
and the spread of brigandage on land routes
and piracy on the seas raised the demand for
insurance.
In Italy, prototypes of marine insurance date
back to the 13th century.
Genoa became the centre of marine insurance
- a position the city maintained up to the 17th
century when it was replaced by London.
16
Interlude: the Champagne fairs
Lagny
Paris
Provins
Troyes
Bar-surAube
17
Interlude: the Champagne fairs
In the 13th century the Champagne fairs in the European
heartland became important centres of financial activities
where merchants from Italian cities and the industrially
developing textile region of Flanders met.
The individual fairs established a continuous cycle throughout
the year.
It started with the fair of St Ayoul at harvest time in September
at Provins and continued with Troyes in November, followed
by Lagny and Bar-sur-Aube.
18
Interlude: the Champagne fairs
The reasons for the dominant role of the fairs were:
•
the counts of Champagne who were politically independent
offered competitive terms to traders. They, in turn, benefitted
from tolls on goods in transit and rents on halls, stables and
houses, from charging license fees for economic entreprises
and for seals and registering.
•
The counts offered protection to the merchants from the day
they set out to the fairs even negotiating with the dukes of
Burgundy and the counts of Flanders to ensure the safety of
their travel.
•
They established a local system of justice at the fairs
appointing guards to officially enforce contracts, collect fines
and punish cheating.
19
Interlude: the Champagne fairs
The role of the fairs declined mainly for three reasons:
•
In 1285, the region came under the jurisdiction of the King of
France and the towns lost their special status.
•
When the Atlantic sea route opened Italian merchants could
reach Flanders without passing through France.
•
With increasing division of labour Italian companies began to
establish permanent agencies in major European cities.
However, while the volume of trade at the fairs was
shrinking the financial business continued until
1310/1320 - for the first time in Europe on a regular
basis independent of the trade of goods.
20
The rise of merchant empires
... and the threefold division of labour:
Sedentary merchants
specialising in the financing
and organisation of trade
Full-time agents
resident in foreign places,
selling and purchasing goods
following the instructions sent
by their principals
Specialist carriers
transporting the goods from
principals to agents by land or
by sea
21
The second succession of financial centres:
the Low Countries
Bruges
Antwerp
Amsterdam
22
The Low Countries
Bruges
•
The beginnings of the town’s international role date back to 957 when the counts of
Flanders allowed the city to establish an annual trade fair.
•
Bruges’ true rise started in 1134 when a storm changed the cost line opening a deep
channel, the Zwin, which allowed the navigation of big commercial ships.
•
Using Damme, and from 1290 onwards Sluis, as outports Bruges became the main
trading port at the North Sea coast.
•
In 1252, the town established relations with the Hanseatic League.
•
Between the 13th and 15th centuries Bruges became one of the richest cities in the
world.
•
At its height, 16 nations were represented there, half of them from Italy.
•
Economic recession and political unrest brought an end to Bruges’ predominance.
23
The Low Countries
Antwerp
•
In 1488, Emperor Maximilian ordered foreign merchants to shift their offices
from Bruges to Antwerp.
•
Antwerp was the first European town to grant almost total liberties to both
domestic and foreign merchants.
•
In 1518, the Antwerp exchange was founded which was open to merchants from
all nations.
•
In the 1570s and 1580s, the Spanish-Dutch conflict, the closure of the river
Scheldt and the isolation of the town by Spanish troops put an end to Antwerp’s
supremacy.
24
The Low Countries
Antwerp
One reason for the existence of fairs in the Middle Ages
had been the temporary lifting of trade restrictions.
In Antwerp, under far-reaching liberalisation almost
uninterrupted market trade became possible.
25
The Low Countries
Amsterdam
•
The last city in the succession of financial centres in Europe whose ambitions
were not supported by a modern united state whose efforts were directed at
becoming a trade and financial empire (Braudel).
•
Among Amsterdam’s advantages were the port and its superiority in
shipbuilding, its geographic position and its liberal government in contrast to
that of Antwerp in the conservative Spanish Netherlands.
•
The Amsterdam Bourse became Europe’s leading securities market.
•
European merchants concentrated their transactions in one or more specified
towns known as staples and Amsterdam became the biggest staple in the
western world.
26
The Low Countries
Amsterdam
In 1728, Daniel Defoe described the Dutch as “the
Carryers of the World, the middle Persons in Trade,
the Factors and Brokers of Europe: ... they buy to sell
again, take in to send out: and the Greatest Part of
their vast Commerce consists in being supply’d from
all Parts of the World, that they may supply all the
World again.”
27
The Low Countries
The second wave of financial innovations:
•
Bruges became known as the first place to establish brokers, called
“makelaer” or “couretier”, as intermediaries.
•
In Antwerp, the bond or debenture was invented: assets and liabilities were
settled by an issuer who committed himself to pay an agreed sum at
maturity to the owner of a paper that could be sold by the borrower in the
meantime.
•
Another Flemish invention was the rentes, an alternative to loans to
governments which were strongly controversial in usury debates.
•
Amsterdam largely contributed to stock trading becoming widely accepted.
•
Forward transactions as a specific form became a common tool of
exchange trading.
28
Coin-weight box
Since coins’ intrinsic value, i.e. that of their
weight in precious metal, played an
important role in medieval trade money
changers travelled with balance and
weights, which they kept in a specially
designed box.
The example on the left side is from
Antwerp from 1730 and is stamped inside
the lid with a printed vignette consisting of
instructive texts and illustrations.
Source: http://www.nbb.be/Sg/En/Contact/33_19e.htm.
29
London
With the emergence of London as the centre of
international merchant banking after Amsterdam’s decline
in the 17th and 18th centuries a new era began.
The City of London maintained its predominance until the
First World War,
temporarily lost it to New York,
and regained it in the 1960s with the rise of the
Euromarkets.
30
London
There are several key developments favouring the rise of the City:
•
the Navigation Act of 1651 which favoured English shipping and trade;
•
the establishment of English colonies;
•
the effects of the French Wars of 1793-1815 on Amsterdam;
•
the migration of many Dutch commercial and banking families that stayed in
London when peace returned to the low countries;
•
the presence of Jewish financiers after 1066, who became the main providers
of loans until the middle of the 13th century;
•
the settlement of Italian and Hanseatic merchants.
31
London
In the late 15th century, Italian merchants handled about a
quarter of England’s overseas trade;
they dominated its banking system in using financial
techniques and capital not available to native merchants
and
introduced almost all institutions and instruments an
organised financial market at that time required
(Ingersoll).
32
London
Up to the 18th century, England had neither an efficient
banking system nor a well-functioning capital market.
Before the 1880s, there were two almost separate financial
sectors:
the City with its highly sophisticated system of mainly
foreign banks and insurance, shipping and commodity
markets;
and the rather backward country banking sector.
33
London
In the late 17th and 18th centuries, there were some radical
changes:
•
The first true English banking houses were founded around 1700
and increasingly replaced foreign institutions in international
financial activities;
•
the Bank of England was established in 1694 becoming the only
central bank in the world producing a paper currency with a fixed
and guaranteed gold value;
•
since the late 17th century it became possible to buy insurance
against all kinds of calamities from individual brokers and
underwriters.
34
London
In the 19th century, London’s international role strengthened:
•
It became common for European merchant banks to open offices in
London; American banks followed;
•
the Barings and the Rothshilds became the most powerful financiers in
the City;
•
London became the centre of international lending - mostly government
and railway issues, but also mining, industry and public works, in
America, Australia, Canada, India and New Zealand - with a large
proportion of the money originating overseas and much of the businesses
handled by London offices of American and German finance houses.
•
Internationalisation was fostered by technology: The first submarine
cable linking London to Paris was established in 1851, to New York in
1866 and to Melbourne in 1872.
35
Other European centres
London’s main rival in the 19th century was Paris.
Between 1850 and 1870 Paris was the first place in Europe for foreign
exchange and historians emphasise its dealings with Russia and Italy.
In Germany, up to the second half of the 19th century
Frankfurt was the most important financial centre
owing a great deal of its success to names as Bethmann and Rothschild. It
became strong in bond trading, but lost its position to Berlin with the boom in
railway stocks and the crisis of 1848, only to take the lead again after 1945.
36
Other European centres
Meyer Amschel Rothschild (1744-1812) established
the famous Rothschild dynasty in Frankfurt in 1766.
He was followed by his eldest son Amschel Meyer
Rothschild (1773- 1855); his other sons established
banks in London, Paris, Vienna and Naples.
The parent house in Frankfurt ceased to exist in
1901; Banque Rothschild in Paris was nationalised
in 1982. Rothschild banks still exist in London
(N.M.Rothschild & Sons Ltd. with branches and
subsidiaries in 40 countries) and Zurich (Rothschild
Bank AG).
37
The 20th century
With declining influence of the United Kingdom in the global economy
and the economic and political rise of the USA London’s role as an
international financial centre was weakened.
New York took the lead and maintained this position up to the stock
market crash of 1929 and the following worldwide economic crisis when
London temporarily regained its supremacy.
World War II brought another setback for London and New York again
took the lead.
With the emergence of the Euromarkets in the 1960s the City of London
became the lasting unrivalled Number One among a growing number of
competitors in Europe and worldwide.
38
General observations
In economic literature financial development is often regarded as a
linear, stepwise process from simpler to more sophisticated forms.
Two examples:
39
Financial relations
loans
from friends
and family
pawn brokers,
money lenders
commercial
banks
bond
markets
stock
exchanges
derivatives,
ABS,
synthetic
products
In history, financial relations
often started with informal
borrowing and lending
arrangements with friends
and family, followed by
professional pawn brokers
and money lenders and
then developed into a
system dominated by
banks with bond and stock
markets playing an ever
growing role with more
sophisticated financial
products such as
derivatives and assetbacked securities (ABS)
emerging still later on.
40
Development of money
barter
cattle and
crops
cowrie
shells
metal
coins
In the history of money
developments started with
individual barter and then
proceeded from crops and
cattle to cowrie shells. The
next steps were metal
coins, followed by paper
currency and, most
recently, electronic money.
paper
currency
electronic
money
41
A linear, stepwise process?
Development of finance:
•
History shows that in western Europe financial products of varying complexity
often emerged in parallel in reaction to the needs of trade and finance.
•
On the other hand, even highly advanced economies long made without a
fully developed financial system as the German example demonstrates.
•
History also shows that the process from lower to higher sophistication is not
irreversible. Examples are some of the new EU member countries.
Poland and Hungary had already well-developed stock
markets at the end of the 19th century.
42
A linear, stepwise process?
Development of money:
Again, the process is not irreversible.
One example from outside Europe is Japan, where mintage of coins started in the 8th
century only to be abandoned again in 958 when the government forbade all circulation of
coins after 250 years of mixed success and the country returned to rice and fabrics as
mediums of exchange.
This situation lasted until in the 12th and 13th centuries merchants and smugglers
introduced foreign coins which soon became widely used and remained the main pillars of
the Japanese currency system for the next 500 years.
43
Lessons from the history of financial centres in
Europe?
•
Long-distance trade first created the backbone along which
money and credit travelled across Europe.
•
The high risks involved established the need for inventing
cashless means of payment, capital pooling and insurance.
Further sources of inspiration for financial innovations were
•
frequent failures as the result of excessive loans to
finance wars and other rulers’ ambitions;
•
speculative bubbles in financial and commodity
markets;
•
the prohibition of usury and other restrictions.
44
Lessons from the history of financial centres in
Europe?
The rise and decline of European financial centres was influenced by
many factors:
Political and economic influences
Examples are the Spanish-Dutch conflict that put an end to Antwerp’s
supremacy, or the decline of Amsterdam during the French wars.
Institutional influences
These may help explain the rise and fall of German centres in the 18th and
19th centuries which were rooted in two different developments: in the
general market activities of trade fairs in towns like Nuremberg and
Augsburg, and in the guilds and merchant cooperatives found in Frankfurt,
Cologne, Hamburg, Berlin and elsewhere.
Natural disasters and other “historic accidents”
One example is the storm that in Bruges in the early 12th century opened a
deep channel allowing the navigation of big commercial ships which
contributed to making the town the biggest trading port on the North Sea
coast for many years.
45
Lessons from the history of financial centres in Europe?
Scale economies, path dependence and lock-in
Scale economies
Broadly defined, scale economies are benefits arising from a
production of more, rather than less, allowing maintenance of a low
share of fixed costs per unit.
For example, if inventing or adapting a new product or production technique requires
significant setup costs, larger firms would, on this ground, perform better than smaller ones.
Scale economies may also arise from agglomeration effects and a concentration of activities
in one place.
A concentration of financial institutions in one location leads to improved information flows,
greater liquidity and higher efficiency in organised markets, and a centralisation of support
services, that all contribute to reduce costs.
46
Lessons from the history of financial centres in Europe?
Scale economies, path dependence and lock-in
Scale economies are special sources of rigidities in an economy giving
rise to path-dependence and lock-in.
Path-dependence broadly means that history matters.
The current international status of a financial place is depending on the advantages – and
disadvantages – it has acquired in the past and the way in which those have influenced financial
firms' location decisions.
Lock-in stands for an inflexibility resulting from this process.
Even if offering high incentives for financial institutions to change location, due to long-established
bonds and customs newly emerging competitors will find it hard to succeed in challenging the
status of the Number One.
47
Scale economies and lock-in explain some advantages
underpinning London’s status both in Europe and
worldwide.
Others are
• the existence of high quality professional and supporting services
These include accounting, actuarial and legal services, IT and the whole range of
services which in the economic literature is known as producer services.
• an efficient infrastructure
This includes office accomodation and telecommunications.
• the use of the English language.
48
The influence of electronic trading and the internet?
The need for financial institutions and activities to “cluster” in centres
declined, but history also showed that relations between information
technology and financial location are complex:
•
Unlike many other sectors, in international finance IT is not a new
phenomenon.
Since the invention of the telegraph in the early 19th century,
financial services have always been bridging distances using every
available new medium and technology for speeding up communication
and trade.
•
Many financial activities continue to require proximity.
One aspect here is risk considerations and the experience that electronic
surveillance is no substitute for human management. Others are the role
of trust building that is crucial to many financial transactions and the
need to become familiar with a special context before making financial
decisions. Further arguments for an ongoing centralisation are innovation
and networking and the desire to benefit from the constant presence,
exchange and communication with others.
49
Note that

Before 1200 Genoa and Venice both introduced the instrument of
public debt to finance infrastructure and military projects.

In the 12th century it took 30 to 40 days for wool from Southampton to
reach Porto Pisano on a Florentine galley; the distance between
Venice and Alexandria was covered in three weeks in favourable
weather - and in three months under less favourable conditions.

In the early 14th century it took 21 days to transport coins collected in
Rouen to the Papal court at Avignon but only eight days for a courier
to deliver a bill.

Bills of exchange were traded on the fairs of Italy and the Champagne
as early as in the 12th century.
50
Note that

In Italy, prototypes of marine insurance date back to the 13th century.

The first European cities minting their own coins were Florence (the
Fiorino) and Genoa (the Genovino) in 1252.

Bank money based on fractional reserve dates back to the 14th century
with cash reserves (with central banks non-existent and surpluses
invested in rather illiquid assets) making up to 30 percent of deposits.

By 1350, in most banking centres “manual” or “merchants’ exchange” the exchange of coins against each other - was replaced by deposit
banking.

In the 14th century, there was a daily courier service between Bruges
and Venice overland.
51
Note that

Among Bruges’ wealthiest residents was the van der Beurs family, innkeepers who allegedly gave their name to the later bourse.

The first known share worldwide dates from 1602. It was issued by the
Dutch East India Company (Vereenigte Oost-Indische Compagnie, or
VOC).

In the late 17th century Edward Lloyd’s Coffee House began to engage
in the shipping business. Contrary to a widespread belief, Lloyd’s
Coffee House itself, although a central institution in London, had never
been an insurance company. Its function was comparable to that of an
exchange: to be a forum for maritime insurance business where special
“rules of conduct” prevailed.

It was only in 1863 that M.M. Warburg, formed in 1798 in Hamburg,
changed its name from money changer to banker.
52
Key Words

Bank - rooted in the benches or “bancos” Italian merchants established at European
trade fairs in the middle ages.

Bourse - An organised market or exchange located in a building or regular meeting
place for trading financial products such as securities and foreign exchange.

Contratto di commenda - developed in Italian cities from the tenth century onwards,
forerunner of the joint-stock companies, a form of limited-liability partnership to share
economic risk enabling people to use their savings to invest in long-distant trade.

Usury - an ecclesiastical doctrine, developed in Europe from the ninth century
onwards, which condemned loans at interest.

Rentes - a financial product first appearing in Flemish towns in the 1270s developed
from an older medieval contract, the census, of probably feudal origins. Initially, the
census was a means by which the a landowner or peasant could acquire some capital
while the investor received a guaranteed annual income, either perpetual, or at least for
a lifetime without expecting repayment. Rentes represented the purchase of a future
stream of income. The modern English term coming closest is annuity.
53