Handbook of Key Global Financial Markets, Institutions, and Infrastructure

594 Pages·10.404 MB·English

by  Caprio G.

C H A P T E R
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History of Financial Globalization, Overview
C.W. Calomiris*, L. Neal†
*Columbia University,New York,NY, USA
†University ofIllinoisatUrbana-Champaign, Columbus,OH,USA
O U T L I N E
References 14
Financial globalization appears to be a recent phe- thenatureandcausesofmorerecentfinancialcrises,in-
nomenon, dating from the end of the Bretton Woods cludingtheimportanceofasymmetricinformationprob-
System in the tumultuous years 1971 through 1973 and lems for explaining illiquidity crises (Calomiris and
the increasing removal of capital controls by national Gorton,1991;NealandWeidenmier,2003),buthistorical
governmentsworldwidesincethe1970s.Thesteadyre- comparisons highlight differences as much as similari-
movalofgovernmentrestrictionsonthemobilityofcap- ties.Bankingcrisestodayaremorefrequentandmorese-
ital has created repeated opportunities for managers of vere and associated with different shocks and different
financialresourcestomakeever-largerprofitsforthem- financial system flaws than in the past. Although it is
selvesandtheircustomersasaglobalsecuritiesmarket true that fiscal shocks and real estate booms and busts
has emerged. The importance of the financial sector in have been consistent contributors to financial crises for
all national economies that participate in the global centuries,thebehaviorofbanksduringandbeforecrises
financial markets has increased remarkably as well, has changed over time. For example, Schularick and
illustratingthattoday–asinthepast–domesticfinan- Taylor(2011)showthathistorically,incontrasttorecent
cial development and international financial linkages decades,banksexhibitedmuchlowerleverage,anddid
typically are typically complementary phenomena, notexpandtheirleverageprocyclically.Studiesofbank
ratherthansubstitutes.Unfortunately,thescaleandfre- failuresalsoemphasizethathistorically,wavesofsevere
quency of financial crises – especially banking crises – bank failure were far less common than today. Both
have increased as well. thesephenomenaarelinkedbymanyauthorstothere-
For financial historians, however, the current era of cent increase in the extent to which banks’ debts are
financialglobalizationisreallytheresumptionofapro- protectedbygovernments,whichgivesrisetoa‘moral-
cess that was well underway from the middle of the hazard’problemofrisktaking;inthepast,otheraspects
nineteenth century and ended only with the outbreak offinancialsystemdesign(e.g.,unitbankingstructurein
of World War I in July 1914. From 1914 to 1971, the the United States, as described in the article by Charles
responses of national governments to the economic de- Calomiris) were more relevant contributors to cross-
mandsoftwoworldwars,thetraumaoftheworldwide countrydifferencesintheextentofbankfragility.
Great Depression (1929–33), and the division of the The patterns of development of financial globaliza-
world into market-oriented, capitalist economies and tion in previous ages, however, remain extremely rele-
centrally planned economies thereafter reversed the vant for understanding the opportunities as wellas the
course of financial globalization at least until 1973 controversiesthathavebeencreatedbyfinancialglobal-
(Obstfeld andTaylor, 2004). izationinthetwenty-firstcentury.Inspiredbytheissues
The analysis of financial crises in the heyday of the raisedbythecurrentphaseoffinancialglobalization,fi-
classicalgoldstandarddoesprovide someinsightsinto nancial historians have been reassessing the historical
HandbookofKeyGlobalFinancialMarkets,Institutions,andInfrastructure 3 #2013ElsevierInc.Allrightsreserved.
http://dx.doi.org/10.1016/B978-0-12-397873-8.00001-3
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1. HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
developmentsthatlaidthebasisforpreviousepisodesof starting in 1127, southern China continued to prosper
financial developments, and which were accompanied undertheYuandynasty(1271–1368).TheMingdynasty
by both tangible signs of economic progress and (1368–1644), however, began with an anticommercial
occasionalfinancialcrises.Tappingintothegrowinglit- policythatendedthisphaseofeconomicexpansion,un-
erature that this generation of financial historians has til it reversed course in the sixteenth century. The Qing
andiscreating,theeditorsresponsibleforthehistorical dynasty (1644–1911) carried out further refinements in
section of the Encyclopedia decided to invite various financialinstitutions,especiallyaftertheTaipingRebel-
scholars to contribute essays that would summarize lionof1850–64.But,asDebinMashows, theweakcen-
theresults oftheirresearch with respectto specificepi- tral state thereafter let a multitude of currencies and
sodes that we thought would be especially interesting units of account proliferate throughout the interior of
for general users of the encyclopedia. Not everyone China. Externally, China’s silver standard enabled it to
responded, sothere arelacunae inour coverage, which enjoy export-led growth until the Boxer Rebellion that
in any event could never have been exhaustive. How- endedtheQingdynasty.China’sroleintheinternational
ever,mostscholarsbelieve,withus,thatthefoundations economy suffered from civil war and Japanese occupa-
formodernfinance,especiallyinitscurrentglobalman- tionuntilcompleteisolationwiththeCommunistregime
ifestation, werelaid as far back as Romantimes. in1948,whichmaintaineditsautarkicpolicyuntil1978.
Roman law distinguished sharply between private The financial experiments in the century between the
andpublicspheresofaction,reservingtherightofcon- Taiping Rebellion and the Communist victory in 1948
tract enforcement to the custom agreed among private had little long-term effect on theeconomy.
individuals or groups while maintaining the priority Modern financial capitalism is usually said to begin
ofreasonsofstatewhenpublicgoodshadtobefinanced. in the West, despite the precedents of the Ottoman
PeterTemin’sessaydescribeshowprivatebusinesswas and Chinese Empires, especially with the initiatives
financedbybankingandhowamarketforprivatemort- oftheItaliancity-states,particularlyGenoaandVenice.
gagesonestatesaroseduringtheRepublic,onlytovan- Claudio Marsilio notes the importance of the Genoese
ish during the Empire. The emperors did not bother to mercantile and political elite combining their interests
createalong-termgovernmentdebtinstrument,relying in financing both the long-distance trade of the city
insteadonthepreemptivepowerofthestatetodealwith andthemilitaryandnavalexpensesofthecitythrough
wars,insurrections,ornaturaldisasters,andevenpublic the facility of the Casa di San Giorgio, created in 1407.
facilities and celebrations. Nevertheless, by extending This institution, along with the Banco di Rialto (1587)
theprivilegesofRomancitizenshiptomenofsubstance in Venice, served as a model for finance of the various
throughout the empire and not just to residents of the city-statesthataroseinnorthernEuropeinthecenturies
cityofRome,extensivetradewithintheempireandbe- following. Luciano Pezzolo argues for the primacy of
yondcouldbefinancedonthebasisofcontractsenforce- Venice, however, with its successive issues of govern-
able ultimately by the state. The extension of Roman ment debt and its eventual assurance of payments of
citizenshipinthiswayextendedthemercantilepractices interest to outside investors, even those from Genoa.
of the Greeks and Phoenicians to the entire Mediterra- GiuseppedeLucasimilarlyarguesthatpublicdebtinno-
nean world andinto northwestern Europe. vations played a central role in the development of the
Movingeastward,S¸evketPamukdescribesthenhow Duchy of Milan. Piero Fausto Caselli reinforces this
the Ottoman Empire took on the system left by the theme, describing the financial practices of the papacy,
Byzantine Empire in Eastern Europe to establish a cen- beginning with the Avignon popes in 1348. Papal debt
tral bureaucracy that managed through its pragmatism was of long term, regularly serviced until the crises
andhabitofnegotiatingwithlocalelitesandmerchants duringtheNapoleonicWarswhenwidespreadsecular-
to create a flexible and durable financial system, side- ization of church properties destroyed the basis for
stepping adroitly the strictures of Islamic law against papalrevenues,andwidelyheld,evenbybankersfrom
theuseofinterest.TheOttomansfinallyenteredthein- Florence,Venice,andGenoa.Theaccountingpracticesof
ternationalfinancialmarketswhentheycalleduponthe the Curia provided models for the effective handling
resourcesof Britain and France tounderwrite their role ofpublicdebtsthroughoutEurope,whiletheinsistence
in theCrimean Warof 1854. ofthepopesonstablecoinagerancountertothegeneral
Moving even further eastward, Richard Von Glahn pattern of debasements starting with the influx of
explores in detail the various monetary devices of the American silverin thesixteenth century.
Chinese imperial dynasties starting with the Sung DennisFlynn’sarticletakesatrulyglobalapproachto
dynasty (960–1276), which established the world’s first theunderstandingofthetradeinpreciousmetalshistor-
viable paper currency, progressive taxation, and the is- ically and draws attention to the global impact of the
suanceofstatemonetaryandcreditinstruments.Despite tradeinAmericansilver,whichwasreallyacommodity
the setbacks from nomadic invasions in the north, trade globally more than a means of finance of a
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
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HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
newtrade.AmericansilverprovidedtheEuropeanmid- Wars, when it helped pay for the provisions of
dlemenanewcommodityforthemtotradewithChinese Napoleon’s armies.
merchants,ratherthanameansofsettlinginternational OscarGelderblomandJoostJonkerfocusonthepub-
current accounts with capital flows. In this respect, lic finances of the Low Countries, distinguishing be-
American silver simply added to the supply of copper, tween the Spanish Netherlands in the south, which
cowries, and other tradables that could induce imports failedtogenerateaviablepublicfinancebasedontrad-
of Chinese silks and porcelains and Indian cottons to ablegovernmentdebtafteritsrevoltfailed,andthenew
theAmericas via Africa and Europe. Dutch Republic in the north, which managed to create
The financial aspects of American silver were felt both a central government debt and consolidated debt
most directly in Spain under Charles V and Philip II. by the major provinces, especially that of Holland and
Mauricio Drelichman discusses how the Spanish kings the city ofAmsterdam.
used their supplies of American silver to finance their AnneMurphydispelstheideathatEnglishpublicfi-
constantwarsaroundtheperipheryoftheHolyRoman nanceswereimprovedbyadoptingDutchpractices,de-
Empire.Ultimately,evenPhilipIIhadtorelyontheser- spitetheinfluenceofWilliamIII’sDutchadvisorswhen
vicesofGenoesebankerstomakepaymentstohistroops heassumedthethroneofEnglandin1688.Butthepres-
andnavalforces,usingtheirnetworksofcorrespondents sures of financing the successive wars begun under
throughout the Mediterranean and into northern William III against the French did bring to fruition the
Europe.Whenhisrevenuesfailedtocoverhisdebtobli- developments underway since the initiatives of war fi-
gations, he became a serial defaulter, but the Genoese nance undertaken by Cromwell and Parliament during
bankers acting in concert forced him to refinance his the earlier Civil War in England. In other words,
short-termdebtscalledasientosintolongerterm,andre- William’sinternationalambitionsweremoreimportant
salable, juros backed by specific taxes collected by the than his lineage.
bankers or their agents. Even the asientos were sold The obvious successes of the Dutch and English in
downstream by Genoese, who retained only fractions public finance, combining both a public bank responsi-
of the original debts. Ultimately, the accumulated ex- ble for the payments of taxes and expenditures by the
penses of the Thirty Years War left Spanish central fi- central government and a body of long-term govern-
nances beyond even the ingenuity and cohesiveness of ment debt that was managed by private individuals
theGenoese bankers. of sound reputation and available for investment by
TheessaybyJohnMunrodescribesinfascinatingde- outsiders, led to the initiatives of John Law in France.
tail how the idea of perpetual rents on state properties Franc¸ois Velde analyzes Law’s attempts to reorganize
could be applied by princes and city fathers to create a Frenchpublicfinancesalongthelinessosuccessfullyini-
financial revolution throughout urban Europe, essen- tiatedbytheDutchandEnglish,whilealsodrawingon
tially by claiming to offer debt holders an equity stake his observations of Genoese practices. Velde concludes
intheaffairsoftheissuingauthorityandtherebyavoid- thatmuchofLaw’ssystemthatheconstructedwaswell
ing conflict with the religious strictures against usury. conceivedandsound,butthattryingtosustainthemar-
Michael North, however, notes that it took Italian mer- ketvalueofhishugeCompagniedesIndesonthebasisof
chant bankers, who were responsible for handling the anunrealisticallylowrateofinterestat2%,usingitsmo-
papal revenues derived from the Baltic states, to bring nopolyoverbanknotestosupportshareprices,wasafa-
some of these financial innovations to fruition in the tal error.
Hanseatic League, while the Dutch provided most of Nearly a century later, however, Alexander
theoutsidefinance for theBaltic trades. Hamilton–whorecognizedthemeritsofEnglishpublic
StephenQuinnanalyzestheinitialmistakesandeven- debtmarkets,thestimulativeeffectsofbankchartering,
tual successes of the Bank of Amsterdam, deliberately and John Law’s creative ideas about the potential de-
created on the model of the Banco di Rialto of Venice velopmental contribution of government to finance –
in1609.Plaguedbytheconfusionofmultiplecoinspro- managed to imitate aspects of each of these examples
duced by competing mints throughout the Rhineland successfully and actually improve on them in the
duringtheThirtyYears’War,thecityauthoritiesfinally newlyfoundedrepublicoftheUnitedStatesofAmerica,
set the Bank’s inside unit of account at a fixed value in accordingtoRichardSylla.CriticaltoHamilton’ssuccess
terms ofsilverwhileallowingdeposits of outside coins inorganizing the finances ofthefledglingrepublic was
at a variable exchange rate, the agio. This, he argues, to assure outside investors, especially the supportive
wasthefirststepincreatingatruecentralbankwithin- DutchbutalsothepreviousenemyBritishinvestors,that
side money. While the papal, Genoese, and Venetian their interest paymentswouldbefaithfully serviced.
precedentsareimportant,noneofthemprovidedtheex- When the public finances required to finance the in-
tensive payment services that the Bank of Amsterdam creasingly expensive wars among the fractious Europe
providedfromitsfoundingrightthroughtheNapoleonic states were achieved by a combination of control over
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
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1. HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
mintingfacilitiesandassignmentofindirecttaxesfaith- companies. Employees of the overseas English compa-
fullytoserviceoflong-termdebts,privatefinancecould nies were allowed to trade on their own account,
bemobilizedtounderwriteincreasingvolumesoftrade although they were subject to removal and cashing of
both within Europe and between Europe and overseas. bonds deposited with the home office, in case of egre-
Clemens Jobst and Pilar Nogues-Marco lay out how gious misconduct. Shares in the companies were
the leading mercantile powers of the Netherlands, allowed to be traded widely as only large stockholders
France, and Britain accomplished this by combining hadavoteinelectingthedirectorsannually,andeligibil-
the creation of private foreign bills of exchange with itytobeadirectorrequiredtrulysubstantialholdingsof
thepaymentservicesofpublicbanksintheleadingmer- stock.Maintainingalargeanddiversifiedcustomerbase
chant cities of Europe. Inferring the short-term private forthesharesofthecompaniesrequiredregularandat-
ratesofinterestchargedforfinancingtradefromthedif- tractive interest payments.
ferences between sight and time bills of exchange, they Twofactorshaveledtotheriseoffinancehistorically:
findthatprivateratesofinterestweresignificantlylower long-distance trade and long-lived productive assets.
than the usual rates paid by public authorities on long- Bothmarketsforgoodsandservicesandmarketsforas-
term debt. In this way, the long-run complementarity setsrequiredsomeformoffinancetobridgethetimebe-
ofpublicandprivatefinanceemergedduringtherarein- tween when agreement on a trade was reached and
tervals of peace in Western Europe. Although commer- when actual delivery was made. Expanded trade and
cial credit rates rose during wars of the eighteenth improvedstandardsoflivingthatresultedfromtheben-
century,theyquicklyfelltolowerlevelswhenhostilities eficial uses of finance, however, more often than not
ceased. have led to increased conflict with outsiders, or even
Meanwhile,theDutch,British,andFrenchcompeted with traditional power elites inside an economy. Pre-
to determine the best way to engage in long-distance servingthebenefitsoffinanceinthelongrun,therefore,
overseastradeincompetitionwiththeearliersuccesses isandalwayshasbeenveryhard.Ultimately,theoper-
of the Portuguese and Spanish. Abe De Jong and Joost ationsoffinancethroughinstitutions(banks)orthrough
JonkerbegintheDutchsagawiththesmallvoorcompag- markets(stockexchanges)havetobesupportedbyand
nien that initiated the Dutch intrusion into Portuguese meettheapprovalofgovernmentauthorities,whocreate
tradewiththeEastIndies.Thecombinationofanumber thelegalrightsandboundariesofpowersthatdefinefi-
ofseparatesmalljoint-stockpartnershipsintotheVeree- nancialinstitutions.Coordinationoftheinnovationsthat
nigde Oostindische Compagnie (VOC) in 1602 estab- arisespontaneouslyinbanking,capitalmarkets,orgov-
lished a unique combination of public and private ernment powers can be difficult, and societies typically
interests.Shareswereprivatelyheldandeventuallyhigh must learn over time how to manage the complexities
dividends were paid to keep shareholders content, but that financial innovations create for private opportuni-
governance was kept in the hands of the authorities of ties andgovernmentpolicychoices.
the seven cities whose voorcompagnien had been com- Financial innovations in the ‘modern’ era have
bined into the VOC. Unfortunately, for the long-run responded to new economic, military, and political
success of the company when it confronted increasing needs – indeed, most of the financial innovations of
competitionfromEastIndiacompaniescreatedbyother ‘modern’ finance were conceived as part of the ambi-
European powers, the separation of governance from tious public–private strategies that intertwined sover-
stockholderinterestsforcedittorelyonissuingnewdebt eigns, merchants and financiers, and which promoted
ratherthannewequitywhenitwishedtoexpandoper- the defining accomplishments of empire-building and
ations.Thisweaknessalsomeantthatitcouldnotserve trade-expansionduringthesixteenth toeighteenthcen-
asaneffectivemodelforotherDutchjoint-stockcompa- turies.Thecreationofbillsofexchangewascrucialasa
niesorextendedpartnershipscreatedtoexploittrading low-cost means of financing trade, and these instru-
opportunities in theWest Indies or theBaltic. mentsalsolinkedglobalfinancialcentersandfacilitated
French attempts to imitate Dutch success are de- flowsoffundsamongthem.Charteredcorporations,in-
scribed by Larry Neal, who emphasizes the persistent cludingbanks,fundedandorganizedprivateandpublic
problem of state support leading to state interference fundinginsupportofdevelopingnewtraderoutes,con-
andwithdrawalofprivatecapitalfromthesuccessiveef- quering newlands,and promoting military victory.
forts of the French to create joint-stock companies for Thatisnottosay,however,thatfinancial‘revolutions’
theiroverseastrade,companiesbrieflycombinedunder simply occurred passively and predictably in response
one megacorporation by John Law, as described by totheneedsforfinance.Financingarrangementsrequire
Franc¸ois Velde. By contrast, Ann Carlos describes how active participation by governments to define and pro-
the joint-stock companies created in England managed tect the property rights associated with bank charters,
to solve the manifold problems of agency and informa- debt collection laws, and shareholders’ rights, and do-
tionasymmetrythatplaguedboththeFrenchandDutch mestic politics may not be favorably disposed toward
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
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HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
creating an efficient financial system. Anders Ogren’s differencebetweenpersonalexchange,basedonconfiden-
entry on the Swedish financial revolution describes the tial information between the banker and the client,
protracted political struggles over the chartering of whethertheclientisadepositororaborrower,andim-
banks that delayed the Swedish financial revolution personal exchange, based on publicly available informa-
for many decades. Calomiris and Haber (2012) show tion accessible to all participants. Larry Neal’s article
that, more generally, politics is the great constraining onthedevelopmentofseveralofthemostimportantse-
force on countries’ abilities to create financial systems curities markets traces the progress in institutional de-
that permit financial development to assist the process sign that encouraged the public trading of debt and
of economicdevelopment. equity.
Although the modern world produced the great fi- Two implications follow from these distinctive
nancial innovations that defined (and that continue to methods of organizing financial intermediation: one is
define) financial development – public debt and equity that innovations in either financial institutions or mar-
markets, international bills of exchange, negotiable in- kets create disruptions in the intermediation carried on
strumentlaw,thecharteringofbanksandcentralbanks, by the other branch of the system – further financial
thecreationof joint-stock corporations and the creation innovations, and sometimes crises, can be the results.
oflimitedliabilityincorporation–theoriginsofmodern Anotherimplication,however,isthatwhenbothcompo-
financial instruments can be found even in the ancient nentsareoperatingeffectivelytoperformthefivefinan-
world. On his Web site at the Yale School of Manage- cial functions listed above, the performance of each is
ment, Goetzmann (2010) has begun to piece together enhanced by the other, and the economy prospers as a
findingsofarchaeologistsoftheancientworldtofindev- result. The monitoring capabilities of the banks over
idenceoffinanceinthebeginningstagesofcivilizations. the credit and liquidity needs of their clients are in-
Hestartswiththeevidenceofa‘WallStreetinBabylon,’ creased by information obtained from fluctuations in
a close-knitneighborhoodfoundin the ruins of ancient the prices of the securities issued into public markets,
Ur,wherehoardsoffinancialrecordsintheformofclay whether the securities are bonds or equities. The price
tablets and bullae were discovered. The records of one discoveryfunctionofcapitalmarkets,ontheotherhand,
family indicate that they flourished by financing long- is improved by the operations of financial intermedi-
distance trade and local agriculture until the king, aries, including banks privy to the confidences of their
Ram-Sin, issued an edict declaring all debts null and clients,whocanusesuperiorinformationtobuyorsell
void in 1788 BCE, our first record of a financial crisis. any given security.
The family was ruined and the remaining records deal The importance of maintaining personal bonds of
only with continuing law suits, a recurring theme trust in finance of operations involving long-distance
throughout financial history! tradeandlong-livedassetsexplainswhybankstypically
Perhapstheearliestexampleoffinanceprovidingthe dominatethemeansoffinanceinearliesttimes.DariusII
necessarysinewsofwarformilitarysuccessoccurredin wasfinancedbyasingle,powerfulfamily;Athensraised
Persiain423BCE.DariusIImanagedtoseizethethrone money to defend against Xerxes from her citizens at
by borrowing large sums from the wealthy Murashu large,butonlyfromhercitizensandtheninopenoutcry
family to hire an armed force to escort him into the intheagora(Cohen,1992).EvenVeniceandGenoa,the
capital city of Persepolis and depose his half-brother Italian city-states given credit for initiating the instru-
Sogdanus, who had claimed the throne on the death of ments of modern finance – stable currencies, bills of
their father. Paul Millett (1991) documents the impor- exchange,andlong-termpublicdebt–restrictedtheiris-
tance of banking in ancient Athens for financing the suesofdebttotheirowncitizensandkeptpublicrecords
long-distancetradenecessarytosustaintheirprosperity oftheirclaimsandonlyopeneduptheirmarketsingov-
whileEdwardCohen(1992)relatesaswellhowmarkets ernment debt to outsiders when the rising expenses of
were used to raise money in case of war, our first waroutstrippedtheresourcesoflocalcitizens(q.v.entry
recorded example of the complementarity between on Venice). Even the first steps towards use of capital
banks and marketsforproviding finance. markets by government authorities maintained the
AtackandNeal(2009)pointsoutthatinmodernsys- essential marks of personal, bank-oriented, exchange
tems of finance banks and market systems perform the through the Banco di Rialto in Venice (q. v. entry on
same five basic functions of (1) providing liquidity, (2) Venice) or the Casa di San Giorgio in Genoa (q.v. entry
resolvingdenominationmismatches,(3)reducingcredit onGenoa).Peter Temin(q.v.entry onRome)notesthat
risk,(4)mediatingmaturitydifferences,and(5)bearing whileRomeclearlyhadprivatebanks,andprivatelong-
interestrateandexchangeraterisk,butthatfinancialin- termsecuritiesintheformofmortgagebonds,therewas
stitutions and markets perform these functions differ- no public debt to be traded as such, and the same held
ently, often solving similar problems in different ways. for imperial China. Oddly, the complementary roles of
The bank-market distinction may also be seen as the public markets for government debt and private banks
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
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1. HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
for private enterprise that maintained the maritime witnessed the explosion of an international market in
empires of the early Phoenicians and Greeks were governmentbondsandthenrailroadbondsandshares,
eschewed by the land-based empires of Rome and eventually culminating in mortgage bonds created in
China.These‘balanced-budget’empiresreliedonforced continental Europe.
conscriptionofsoldiersorlaborerstomeetemergencies Market-led innovations were mostly in public debt,
arisingfromlocalrebellions,foreigninvaders,ornatural although the equity shares of the Dutch East Indian
disasters. Company were arguably a private security if we over-
Banks dominated historically as the chief form of fi- lookthewayitwasadministeredastheoverseasadmi-
nance for powerful empires as in the cases of Rome ralty of the United Provinces of the Netherlands.
andChina,andevenaslateastheHabsburgempireun- Typically,theinnovationsinpublicdebtdevelopedvar-
der CharlesVand Philip II. Banks alsoprovided thefi- iousmeanstoassurenoncitizensthattheywouldalsore-
nancingoflong-distancetrade,typicallyinstagesalong ceive continued interest payments on the same basis as
thefabledSilkRoadofcentralAsia,orinseasonalvoy- citizens.Someinnovationswereindirectlyinpublicdebt
agesinmonsoonAsiaorintheMediterraneanorNorth through the chartered joint-stock companies in Britain
Sealittorals.Openmarketsforpublicdebtandthenpri- thatreceivedtheirchartersandrighttoissuesharesonly
vatedebtofcorporationsthatprovedcomplementaryto on the basis of acquiring large amounts of existing,
existingbankingpracticesfinallyaroseaspermanentin- heavilydiscounted,governmentdebt.Theseinnovations
stitutionsintheNetherlandsandGreatBritainoverthe were followed by foreigners setting up banks (Hopes in
courseoftheseventeenthcentury.Firstthetownsofthe Amsterdam, Barings in Exeter, Rothschilds in London,
HabsburgNetherlandsopenedtheirbooksforlifeannu- Paris, Naples, and Vienna) where a public market for
ities to noncitizens in desperate efforts to collect funds government-sponsored securities existed, helping to
fromabroaderinvestorbasethantheirowninhabitants. finance the expansion of foreign trade. Goldsmiths
ThentheUnitedDutchEastIndiaCompanyallowedfor- provedespeciallycapableofintermediatingforeigntrade
eignerstoinvestinitsshares,butwithoutallowingthem throughouttheeraofmetalliccurrenciesintheeighteenth
voiceinthegovernancestructureofthecompany,which and nineteenth centuries. Merchant banks, such as the
was firmlyheld by the city authoritiesof the six partic- Rothschilds and Barings, then dominated international
ipating ports. When the Dutch stadholder, William of financeoverthecourseofthenineteenth century. Banks
Orange, became William III of Great Britain in 1688, from the leading industrial powers – Britain, France,
there followed a variety of joint-stock companies char- then Germany, and the United States – set up branches
tered by Parliament to help finance the continuation of around the world. Innovative financial intermediaries
wars against Louis XIV of France, but each new char- such as credit cooperatives emerged in Germany and
tered company, starting with the Bank of England in Scandinavia,mortgagebanksintheUnitedStates,andes-
1694, explicitly allowed foreigners to own stock. While peciallyinsurancecompanies,whichmovedfrommarine
foreigners could not become directors, they could vote insurancetofireinsurance,andfinallylifeinsurance.The
in the annual meetings of major shareholders (Neal, internationalactivityofalltheseintermediaries,however,
1990, Chapter1). wassharply curtailedduring theretrenchmentofglobal
Thereafter, financial innovations flourished. Bank- capital markets from 1914 to 1971 and they were forced
oriented innovations moved from Genoa and Venice toconcentrateontheirrespectivenationalmarkets.
throughAmsterdamleadingtopublicbanksthroughout The possibilities of long-run success, however, were
Europe,culminating,arguably,withtheEuropeanCen- often overshadowed by the severity of short-run crises.
tral Bank in 1999. Meanwhile, market-oriented innova- Bank-led innovations frequently led to stock market
tions were led by the Bisenzone ‘virtual market’ that crises. Even the VOC suffered a setback in the market
Italianbankerscreatedinthesixteenthcentury,moving for its shares shortly after establishment of the Bank of
toAntwerp,thenLondon’sRoyalExchangeandeventu- Amsterdam in 1609. The bear attack of 1610 was led
ally to London’s Exchange Alley, culminating with the by Isaac Le Maire, a dissatisfied shareholder who had
globalsecuritiesmarketsafterthecollapseoftheBretton been cut off from influence over the company’s trade
Woodssystemin1973.Bothtypesofinnovationsproved policies in 1610. When John Law tried to establish the
complementaryinthelongrun,andtogether,theypro- bestfeaturesofbothBritishandDutchfinancialinstitu-
videdthebasisformoderneconomicgrowthsince1700. tionsinFrancebycreatingaBanqueRoyalein1717,the
Bank-led innovations were followed by market re- MississippibubbleinthepriceofsharesinhisCompag-
sponses such as markets for shares in the various com- niedesIndesfollowedsoonafterwardswithadramatic
menda created by Venetian merchants, markets for the collapse in mid-1720. Law was forced to flee into exile
equitysharesintheVOCintheNetherlands,andeven- for the rest of his life. A similar scheme initiated in
tuallybearerbondsintheformofperpetualannuitiesin London in 1720 led to the South Sea bubble and the
Holland and later in France. The nineteenth century quick collapse by October of the same year in the price
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
9
HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
of its new shares. The Grundungzeit of imperial Ger- the floor of the exchange. Flash trading by computer-
many’sjoint-stockcorporationsfundedbythenewuni- driven algorithms raises concerns by regulators in the
versal banks founded on the principle of the French twenty-first century. Innovations that impact either the
Cre`dit Mobilie`re was quickly ended by a general col- existing trustcultureorinformationtechnologyrequire
lapse in stock prices. adjustmentbybanks,financialmarkets,andgovernment
Market-ledinnovationssuchasthebisenzone,avirtual agents.Crisescanbepartofthelearningprocessofthat
market for short-term commercial credit in northern adjustment.
Italy of the sixteenth century (Pezzolo and Tattara, Inthebackgroundoftheriseoffinancialcapitalismin
2008), were sometimes followed by bank failures, such westernEuropefromatleastthesixteenthcentury,there
asthecollapseofGenoese bankers afterthesuspension lurked even then the influence of what economists call
of payments by Philip II on the asientos he had sold to the‘trilemma’facedbyeconomicpolicymakerswhoat-
them. The collapse of the Mississippi bubble destroyed tempt to maintain open capital markets, autonomous
the remaining banks in France, leaving bank finance monetary policy, and a fixed exchange rate relative to
ultimately to the Huguenot diaspora operating from other currencies. Fixed and stable exchange rates pro-
Geneva (Luethy, 1959, 1970). There were widespread motetheexpansionoftradewhileaccesstothesavings
bankruptcies and prolonged suspensions among Lon- offoreigninvestorsallowsmoreinvestmentstobemade,
don’s goldsmith bankers after the collapse of the South but protecting the interests of domestic producers may
Sea bubble and widespread country bank failures after require the exercise of monetary policy independently
thestock market crash of1825in London. of the desirability of maintaining fixed exchange rates
Financial innovations – in financial intermediation, and/orcapital mobility.
capital markets, and government initiatives in public Thethreeleadingmercantilepowersofearlymodern
finance – sometimes have led to crises in the short run, Europe – the Netherlands, Great Britain, and France –
despite their attractiveness as long-run improvements engagedinextendedpolicyexperimentsovertheperiod
in financial mechanism design. The essential problem, from 1648 to 1815 (Neal, 2000). The Netherlands main-
in some cases, has been to reestablish the essential ele- tainedfixedexchangeratesthroughout,sufferingalack
mentsoftrustwhenimpersonalexchangeissubstituted of monetary independence increasingly from the latter
for traditional personal exchange. An early answer to half of the eighteenth century on and then was subject
that problem appears to have been the creation of a torestrictionsoncapitalmobilityundertheNapoleonic
‘brand’ by certain intermediaries, exemplified by the regime after 1808.
Rothschilds in the early nineteenth century and sus- France persistently maintained a claim on monetary
tained by other leading merchant banks such as J. P. independencethroughout,variouslyforsakingfixedex-
Morgan in the United States right through most of the changeratesorcapitalmobilitywiththerestofEurope,
twentiethcentury. regardlesswhetherithadtheregimeofLouisXIV,John
The importance of branding by reputable intermedi- Law’s System in 1717–20, Cardinal Fleury’s metallic
aries is discussed in detail by Marc Flandreau, Juan standard after 1726, a fiat currency in the initial stages
Flores, Norbert Gaillard, and Sebastia´n Nieto-Parra in oftheFrenchRevolution,orareturntoabimetallicstan-
their entry on nineteenth and twentieth-century invest- dard overseen by apublic bank under Napoleon.
mentbanking.‘Branding,’whetherbyamerchantbank, Great Britain, initially the most backward of the
or a stock exchange in New York or London, or a gov- three mercantile powers, encouraged capital mobility
ernment agency such as the Securities and Exchange throughout,evenintheextremesoftheprolongedwars
Commission,canbeessentialforsustaininga‘trustcul- with France from 1793 to 1815, limiting only the remit-
ture.’ Financial innovations require rebranding or at tance of actual interest payments to foreign creditors
leastrevalidationofanexistingbrandtosustainthetrust whoweretemporarilyunderthecontrolofFrenchforces
culture.Informationflowsmustcontinueaswellamong on the Continent. It was evident by the conclusion of
the banks, markets, and regulators to sustain the trust the French Revolutionary and Napoleonic Wars that
culturethroughrepeatedinteractionsthatgeneratesatis- Britain’s commitment to capital mobility, forsaking at
factoryresultsforallparties.Anyinteraction,ofcourse, times monetary independence after the recoinage of
may be disrupted by innovations in the information 1698 or fixed exchange rates during the ‘paper pound’
technology. Price lists for major securities available to periodof1797to1819,wasthedominantstrategyfacil-
the public for purchase in London, for example, itatingthestartofmodernindustrializationaswellasen-
appearedasearlyas 1698when anewEastIndia Com- ablingvictory inmostof the wars.
panywascharteredbythegovernment.Telegraphfacil- AsdiscussedinthethreeentriesbyRuiEsteves,Sarah
ities were strictly controlled in the London Stock CleelandKnight,andHughRockoff,undertheclassical
Exchange through the nineteenth century in order to goldstandardofthenineteenthandearlytwentiethcen-
limit access of outsiders to the prices being formed on turies,mostoftheworldparticipatedinaninternational
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
10
1. HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
regimeoffixedexchangeratesandopencapitalmarkets, Netherlands (Velde, Murphy, and Gelderblom-Jonker),
in which domestic monetary policy was limited by the each country experienced a stock market bubble and a
needtoaccommodatethedisciplineofexternalbalance. subsequent collapse.
Overtime,however,anddespitethepost-WorldWarII Butthelong-runconsequencesofthesecrisesdiffered
attempt to revive the fixed exchange rate regime in the dramaticallyacrosscountries.TheFrenchresponsewas
Bretton Woods System, political pressures shifted gov- mostdramatic,andmostdamaginginthelongruntothe
ernments’ priorities more toward domestic objectives, future of French finance. When the nobility who had
leading to the collapse of the international system of profitedfromtheinflationcreatedbyJohnLaw’sBanque
fixed exchange rates. Royalerevoltedagainsthisdecreestoreducethenomi-
This global moment of upheaval was not unique in nalvalueoftheiraccounts,theRegenteventuallyhadto
world history. Periodically, major international crises declarethebankbankrupt.Thebankruptcycommission
havealteredthehistoricaldevelopmentofinternational thenevaluatedeachaccounttoseehowithadbeenini-
finance thereafter. The decree of R¯ım-Sˆın, apparently a tiated and then wrote down each account by differing
rebel ruler, moved the ‘Wall Street of Babylon’ from amounts, depending on the form of the deposits. For-
Ur to Larsa upstream and eventually to Babylon (van eigners using bills of exchange drawn by their local
Mieroop, p. 70). The banking crisis in Rome of 33CE, bankers on their correspondents in Paris were credited
temporarily solved by the Emperor Tiberius’s interest- with only 5% of their accounts. French nobles who had
freelendingtobanksinsupportofRomanlandholders, deposited royal debts issued by Louis XIV at least
augured a changed policy by Rome toward settling its 5years previously, were credited with 90%. No fewer
veteran legionnaires. Thereafter, demobilized troops than six different tranches were distinguished by the
weresettledalongthefrontiersofanoverextendedem- commission over the next several years. The so-called
pire rather than placing them on existing latifundia. Visa amounted to a segmented default by the bank, in
Some historians argue that this was the process that effect a graduated capital levy by the government. For-
eventually led to the end of an overextended empire. eignandcommercialinvestmentinFrancewasstymied
Fortunately for the rise of capitalism and the modern fortheremainderofthecentury,althoughforeigntrade
world, later examples of international crises had more didresumeonceafixedexchangeratewasreestablished
pleasant outcomes. Indeed, the ‘big bang’ of financial in 1726. The Compagnie des Indes narrowly escaped
capitalism arose with the stock market explosions in bankruptcyaswell,asitscapitalstockhad,briefly,been
France,England,andtheNetherlands–theMississippi made equivalent to accounts with the Banque Royale.
bubble,theSouthSeabubble,andthesubsequentripples It was eventually allowed to continue just trade with
in theNetherlands. Asiaonthebasisofamuchreducedcapitalstock,which
Each stock market bubble was initiated by govern- did not allow it to compete successfully with either the
ments that soughtto reducethe fiscal burdenof servic- Dutch or English East India companies.
ing the huge debts they had accumulated in the course The Netherlands let the individuals who had bor-
of fighting major wars in the period from 1689 to 1713 rowed funds to speculate on the rise in price of West
(the War of the League of Augsburg and the War of IndiaCompanysharesgobankrupt,whilethecompany
the Spanish Succession). To do this, each government continued with its market capitalization substantially
tookadvantageoftheanticipatedgainsfromnewtrade reduced. Only one new company, a marine insurance
opportunities in the Atlantic, the result of a weaker company based in Rotterdam, was allowed to continue
Spanish empire, to expand existing joint-stock corpora- inexistence(eventuallytobeabsorbedbyFortisshortly
tions with new capital stock in exchange for cashing before that company was forced into bankruptcy at the
in existing, and heavily discounted, government debt. outsetofthesubprimecrisisof2007).Theotherprojected
Rentiersinallthreecountrieshadsufferedeithercapital companies were allowed to lapse, with losses taken by
losses as in France and Spain or lower rates of return the remaining subscribers. Meanwhile, Dutch invest-
onexisting securitiesasinBritain andtheNetherlands. mentsintheBritishsecurities,especiallythenewshares
Regardless,financierseverywherewereeagertorecoup thathadbeenissuedbytheSouthSeaCompany,contin-
theirfortunesandtheopportunitiesinforeignventures uedandevenincreasedintheBankofEnglandinorder
offered at least the possibility of higherreturns. togainvotingpowerintheupcomingelectionsofdirec-
To meet these demands, John Law’s Compagnie des tors. Eventually, the Dutch financiers turned increas-
Indes in France was the most ambitious plan, but the ingly to financing other European powers, ending up
South Sea Company in England was a close second with the newly formed United States of America, but
andevenlargerrelativetothesizeofthenationalecon- never managing to establish a domestic manufacturing
omy,whiletheDutchonlybrieflytoyedwithexpanding basecompetitive with that ofBritain.
the stock of their West India Company. As described TheBritishresponsewastomaintainthecapitalstock
in the respective entries for France, Britain, and the oftheexpandedSouthSeaCompanyasmuchaspossible
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW
11
HISTORYOFFINANCIALGLOBALIZATION,OVERVIEW
butfirstputtingthevarioussubscribersallonthesame obviouslyrisky,securitiesofferedbytheLatinAmerican
basis. There had been no fewer than four separate sub- republics. From 1822, after the restoration of the gold
scriptions to the new capital stock and the terms had standardbyGreatBritainin1821,thepricesoftheLatin
been made progressively worse for each round of sub- Americansecuritieswerebidupforseveralyears,creat-
scribers.TheBankofEngland,whichhadagreedtoase- ing another stock market bubble. When it became clear
cured loan to the South Sea Company as the crisis by mid-1825 that the mines were unproductive and the
unfolded, was allowed to expand its capital stock by fiscal resources of the rebelling colonies were unequal
50% to absorb the equivalent amount of government to the costs of their military adventures, a general col-
debtfromtheSouthSeaCompany.TheSouthSeaCom- lapseinthestockmarketoccurredwithaclassicscram-
pany’s remaining capital stock was then split in half, ble for liquidity atthe end of the year.
with half converted to perpetual annuities yielding 5% Thistime,theresponseoftheBritishgovernmentwas
annual interest for the next few years. The conversion toforcetheBankofEnglandtobroadenaccesstofinance
was carried out in June 1723 and stock market activity byopeningupbranchestoprovidelocalaccesstoitsfa-
resumed with the annuities eventually rising above the cilities by country banks, allow joint-stock banks to be
shares of the trading company. In subsequent wars, formed outside London, repeal the Bubble Act of 1720
theBritishgovernmentturnedtoissuingitsownversion so that existing companies could explore new forms of
oftheSouthSea’sperpetualannuities,culminatinginthe business not specified in their original charters, and re-
ConsolidatedThreePerCentAnnuitiesin1752,lumping vise bankruptcy laws to allow bankrupt firms more
together all the Three Per Cent annuities that had opportunities to recover from insolvency if it proved
been issued during the preceding War of the Austrian due only to a temporary liquidity shock. In the mean-
Succession. time, foreign lending was curtailed, save that interme-
The lesson that could have been learned from the diated by a few leading merchant bankers, especially
threedivergentresponsestothecollapseoftheinterna- Rothschild’sandBarings.Butthedomesticfinancialsec-
tional stock markets in 1720 was that effective govern- torflourished,firstwiththeriseofbill-brokingfirmsin
ment intervention to stabilize the market by offering a based in London but operating throughout the United
newsecuritytorefinancethepreviouslyissued‘toxicas- Kingdomandtheempire,andlater(especiallyafterfur-
sets’ enabled both the capital markets and the banking therreformsinthe1830sand1840s)withtheriseofjoint-
institutionstoresumenormalactivityandcontinueasef- stock banks with extensive branching networks, some
fectivecomplementsinprovidingfinancefortheexpan- extending overseasas well.
sion of the national economy. Moreover, the ‘funds’ of After the gold rush bonanza in California and then
theBritishgovernmentwereattractiveassetsforforeign Australiaenabledmuchoftheindustrialworldtocom-
investors, including those in the city of Berne, many mittoaninternationalgoldstandard,aseriesofinterna-
Dutchmerchants,andevenAmericancolonists,includ- tionalfinancialcrisesensuedovertheperiodfrom1847
ingGeorgeWashington,whomaintainedhisholdingsof to 1914. In an exhaustive econometric analysis of the
BankofEnglandstockthroughouttheAmericanWarof transmission of liquidity shocks during the various
Independence.ThesuccessoftheBritish‘financialrevo- international financial crises of the classical gold stan-
lution’overtheperiodfrom1688to1752inprovidingan dard period, 1871–1914, Neal and Weidenmier (2003)
international market for its securities enabled the gov- found that only the panic of 1907, originating in
ernmenttosustainmilitaryvictoriesinitsongoingcon- theUnitedStates,appearedtohavebeenseriouslycon-
flicts with the Netherlands and France and its private tagious, with its effects spreading as far as the United
entrepreneurseventuallytofinancetheinvestmentsthat Kingdom, Germany, France, and Italy in 1908. Con-
ledto the classic Industrial Revolution. trary to the claims of Kindleberger (2000), Neal and
The next truly international financial crisis came in Weidenmierfindthattheearliercrises,bycontrast,seem
1825, when another stock market bubble occurred in tohavebeenremarkablyconfinedtothecountryofori-
Europeancapitalmarkets,thistimefocusedonthesecu- gin,onceallowancewasmadeforthecloseconnections
rities offered to European investors by the former colo- with trading partners that existed before the crisis.
nies of the Spanish empire in Central and South Even with the panic of 1907, however, the ultimate
America.Theseweregovernmentbondsissuedinimita- source of the panic in New York could be traced back
tion of the now favored British Three Per Cent Consol toachangeinthewaythe‘rulesofthegame’inthegold
andstocksinthevariousmines,fabledfortheircenturies standardregimewerefollowedbyamajorplayer.Inthis
of producing silver. The reduction in yields on govern- case,itwasnoneotherthantheBankofEngland,which
mentsecuritiesthataccompaniedtheendoftheNapole- inlate1906haddeclareditwouldnolongerrediscount
onic Wars and the general return to prewar bimetallic billsofexchangedrawnintheUnitedStates,anunusual
standards for national currencies provided incentives defensivemeasureagainstthepreviousdrainofgoldas
for investors to buy the new, higher yielding, if British insurance companies finally made good on the
I. GLOBALIZATIONOFFINANCE:ANHISTORICALVIEW