The Euthanasia of the Rentier (part I)

The fate of those who lost their shirts on Confederate bonds was not especially unusual in the nineteenth century. The Confederacy was far from the only state in the Americas to end up disappointing its bondholders; it was merely the northernmost delinquent. South of the Rio Grande, debt defaults and currency depreciations verged on the commonplace. The experience of Latin America in the nineteenth century in many ways foreshadowed problems that would become almost universal in the middle of the twentieth century. Partly this was because the social class that was most likely to invest in bonds - and therefore to have an interest in prompt interest payment in a sound currency - was weaker there than elsewhere. Partly it was because Latin American republics were among the first to discover that it was relatively painless to default when a substantial proportion of bondholders were foreign. It was no mere accident that the first great Latin American debt crisis happened as early as 1826-9, when Peru, Colombia, Chile, Mexico, Guatemala and Argentina all defaulted on loans issued in London just a few years before.

Driving Dixie Down (II)

In i860 the port of Liverpool was the main artery for the supply of imported cotton to the British textile industry, then the mainstay of the Victorian industrial economy. More than 80 per cent of these imports came from the southern United States. The Confederate leaders believed this gave them the leverage to bring Britain into the war on their side. To ratchet up the pressure, they decided to impose an embargo on all cotton exports to Liverpool. The effects were devastating. Cotton prices soared from 6%d per pound to 27%d. Imports from the South slumped from 2.6 million bales in 1860 to less than 72,000 in 1862. A typical English cotton mill like the one that has been preserved at Styal, south of Manchester, employed around 400 workers, but that was just a fraction of the 300,000 people employed by King Cotton across Lancashire as a whole. Without cotton there was literally nothing for those workers to do. By late 1862 half the workforce had been laid off; around a quarter of the entire population of Lancashire was on poor relief. They called it the cotton famine. This, however, was a man-made famine. And the men who made it seemed to be achieving their goal. Not only did the embargo cause unemployment, hunger and riots in the north of England; the shortage of cotton also drove up the price and hence the value of the South's cotton-backed bonds, making them an irresistibly attractive investment for key members of the British political elite. The future Prime Minister, William Ewart Gladstone, bought some, as did the editor of The Times, John Delane.

Driving Dixie Down (I)

In May 1863, two years into the American Civil War, Major-General Ulysses S. Grant captured Jackson, the Mississippi state capital, and forced the Confederate army under Lieutenant-General John C. Pemberton to retreat westward to Vicksburg on the banks of the Mississippi River. Surrounded, with Union gunboats bombarding their positions from behind, Pemberton's army repulsed two Union assaults but they were finally starved into submission by a grinding siege. On 4 July, Independence Day, Pemberton surrendered. From now on, the Mississippi was firmly in the hands of the North. The South was literally split in two.

The fall of Vicksburg is always seen as one of the great turning points in the war. And yet, from a financial point of view, it was really not the decisive one. The key event had happened more than a year before, two hundred miles downstream from Vicksburg, where the Mississippi joins the Gulf of Mexico. On 29 April 1862 Flag Officer David Farragut had run the guns of Fort Jackson and Fort St Philip to seize control of New Orleans. This was a far less bloody and protracted clash than the siege of Vicksburg, but equally disastrous for the Southern cause.

Rothschild - The Bonaparte of Finance (part IV)

Meanwhile, Radicals on the Left bemoaned the rise of a new power in the realm of politics, which wielded a veto power over government finance and hence over most policy. Following the success of Rothschild bond issues for Austria, Prussia and Russia, Nathan was caricatured as the insurance broker to the 'Hollow Alliance', helping to protect Europe against liberal political fires.

In 1821 he even received a death threat because of 'his connexion with foreign powers, and particularly the assistance rendered to Austria, on account of the designs of that government against the liberties of Europe'. The liberal historian Jules Michelet noted in his journal in 1842: 'M. Rothschild knows Europe prince by prince, and the bourse courtier by courtier. He has all their accounts in his head, that of the courtiers and that of the kings; he talks to them without even consulting his books. To one such he says: "Your account will go into the red if you appoint such a minister." ' Predictably, the fact that the Rothschilds were Jewish gave a new impetus to deep-rooted anti-Semitic prejudices. No sooner had the Rothschilds appeared on the American scene in the 1830s than the governor of Mississippi was denouncing 'Baron Rothschild' for having 'the blood of Judas and Shylock flow[ing] in his veins, and . . . unit[ing] the qualities of both his countrymen.' Later in the century, the Populist writer 'Coin' Harvey would depict the Rothschild bank as a vast, black octopus stretching its tentacles around the world.

Rothschild - The Bonaparte of Finance (part III)

To an extent that even today remains astonishing, the Rothschilds went on to dominate international finance in the half century after Waterloo. So extraordinary did this achievement seem to contemporaries that they often sought to explain it in mystical terms. According to one account dating from the 1830s, the Rothschilds owed their fortune to the possession of a mysterious 'Hebrew talisman' that enabled Nathan Rothschild, the founder of the London house, to become 'the leviathan of the money markets of Europe'. Similar stories were being told in the Pale of Settlement, to which Russian Jews were confined, as late as the 1890s. As we have seen, the Nazis preferred to attribute the rise of the Rothschilds to the manipulation of stock market news and other sharp practice. Such myths are current even today. According to Song Hongbing's best-selling book Currency Wars, published in China in 2007, the Rothschilds continue to control the global monetary system through their alleged influence over the Federal Reserve System.

The more prosaic reality was that the Rothschilds were able to build on their successes during the final phase of the Napoleonic Wars to establish themselves as the dominant players in an increasingly international London bond market. They did this by establishing a capital base and an information network that were soon far superior to those of their nearest rivals, the Barings.

Rothschild - The Bonaparte of Finance (part II)

Mobilizing such vast amounts of gold even at the tail end of a war was risky, no doubt. Yet from the Rothschilds' point of view, the hefty commissions they were able to charge more than justified the risks. What made them so well suited to the task was that the brothers had a ready-made banking network within the family - Nathan in London, Amschel in Frankfurt, James (the youngest) in Paris, Carl in Amsterdam and Salomon roving wherever Nathan saw fit. Spread out around Europe, the five Rothschilds were uniquely positioned to exploit price and exchange rate differences between markets, the process known as arbitrage.
If the price of gold was higher in, say, Paris than in London, James in Paris would sell gold for bills of exchange, then send these to London, where Nathan would use them to buy a larger quantity of gold. The fact that their own transactions on Herries's behalf were big enough to affect such price differentials only added to the profitability of the business. In addition, the Rothschilds also handled some of the large subsidies paid to Britain's continental allies. By June 1814, Herries calculated that they had effected payments of this sort to a value of 12.6 million francs. 'Mr Rothschild', remarked the Prime Minister, Lord Liverpool, had become 'a very useful friend'. As he told the Foreign Secretary Lord Castlereagh, 'I do not know what we should have done without him . . .'. By now his brothers had taken to calling Nathan the master of the Stock Exchange.

Rothschild - The Bonaparte of Finance (part I)

Nathan Mayer Rothschild

Master of unbounded wealth, he boasts that he is the arbiter of peace and war, and that the credit of nations depends upon his nod; his correspondents are innumerable; his couriers outrun those of sovereign princes, and absolute sovereigns; ministers of state are in his pay. Paramount in the cabinets of continental Europe, he aspires to the domination of our own.

Those words were spoken in 1828 by the Radical MP Thomas Dunscombe. The man he was referring to was Nathan Mayer Rothschild, founder of the London branch of what was, for most of the nineteenth century, the biggest bank in the world. It was the bond market that made the Rothschild family rich - rich enough to build forty-one stately homes all over Europe, among them Waddesdon Manor in Buckinghamshire, which has been restored in all its gilded glory by the 4th Lord Rothschild, Nathan's great-great-great-grandson. His illustrious forebear, according to Lord Rothschild, was 'short, fat, obsessive, extremely clever, wholly focused . . . I can't imagine he would have been a very pleasant person to have dealings with. 'His cousin Evelyn de Rothschild takes a similar view. 'I think he was very ambitious,' he says, contemplating Nathan Rothschild's portrait in the boardroom at the offices of N. M. Rothschild in London's St Swithin's Lane, 'and I think he was very determined. I don't think he suffered fools lightly.'

Though the Rothschilds were compulsive correspondents, relatively few of Nathan's letters to his brothers have survived. There is one page, however, that clearly conveys the kind of man he was. Written, like all their letters, in almost indecipherable Judendeutsch (German transliterated into Hebrew characters), it epitomizes what might be called his Jewish work ethic and his impatience with his less mercurial brothers:

I am writing to you giving my opinion, as it is my damned duty to write to you . . . I am reading through your letters not just once but maybe a hundred times. You can well imagine that yourself. After dinner I usually have nothing to do. I do not read books, I do not play cards, I do not go to the theatre, my only pleasure is my business and in this way I read Amschel's, Salomon's, James's and Carl's letters . . . As far as Carl's letter [about buying a bigger house in Frankfurt] is concerned . . . all this is a lot of nonsense because as long as we have good business and are rich everybody will flatter us and those who have no interest in obtaining revenues through us begrudge us for it all. Our Salomon is too good and agreeable to anything and anybody and if a parasite whispers something into his ear he thinks that all human beings are noble minded[;] the truth is that all they are after is their own interest.

Small wonder his brothers called Nathan 'the general in chief. 'All you ever write', complained Salomon wearily in 1815 , 'is pay this, pay that, send this, send that.' It was this phenomenal drive, allied to innate financial genius, that propelled Nathan from the obscurity of the Frankfurt Judengasse to mastery of the London bond market. Once again, however, the opportunity for financial innovation was provided by war.

Mountains of Debt (part II)

It was not only the Italian city-states that contributed to the rise of the bond market. In Northern Europe, too, urban polities grappled with the problem of financing their deficits without falling foul of the Church. Here a somewhat different solution was arrived at. Though they prohibited the charging of interest on a loan (mutuum), the usury laws did not apply to the medieval contract known as the census, which allowed one party to buy a stream of annual payments from another. In the thirteenth century, such annuities started to be issued by northern French towns like Douai and Calais and Flemish towns like Ghent. They took one of two forms: rentes heritables or erfelijkrenten, perpetual revenue streams which the purchaser could bequeath to his heirs, or rentes viagères or lijfrenten, which ended with the purchaser's death. The seller, but not the buyer, had the right to redeem the rente by repaying the principal. By the mid sixteenth century, the sale of annuities was raising roughly 7 per cent of the revenues of the province of Holland.

Both the French and Spanish crowns sought to raise money in the same way, but they had to use towns as intermediaries. In the French case, funds were raised on behalf of the monarch by the Paris hôtel de ville-, in the Spanish case, royal juros had to be marketed through Genoa's Casa di San Giorgio (a private syndicate that purchased the right to collect the city's taxes) and Antwerp's heurs, a forerunner of the modern stock market. Yet investors in royal debt had to be wary. Whereas towns, with their oligarchical forms of rule and locally held debts, had incentives not to default, the same was not true of absolute rulers. As we saw, the Spanish crown became a serial defaulter in the late sixteenth and seventeenth centuries, wholly or partially suspending payments to creditors in 1557, 1560, 1575 , 1596, 1607, 1627, 1647, 1652 and 1662.

Mountains of Debt (part I)

'War', declared the ancient Greek philosopher Heraclitus, 'is the father of all things.' It was certainly the father of the bond market. In Pieter van der Heyden's extraordinary engraving, The Battle about Money, piggy banks, money bags, barrels of coins, and treasure chests - most of them heavily armed with swords, knives and lances - attack each other in a chaotic free-for-all. The Dutch verses below the engraving say: 'It's all for money and goods, this fighting and quarrelling.' But what the inscription could equally well have said is: 'This fighting is possible only if you can raise the money to pay for it.' The ability to finance war through a market for government debt was, like so much else in financial history, an invention of the Italian Renaissance.

Of Human Financial Bondage

Early in Bill Clinton's first hundred days as president, his campaign manager James Carville made a remark that has since become famous. "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 told the Wall Street Journal. "But now I want to come back as the bond market. You can intimidate everybody." Rather to his surprise, bond prices had risen in the wake of the previous November's election, a movement that had actually preceded a speech by the president in which he pledged to reduce the federal deficit. 'That investment market, they're a tough crowd,' observed Treasury Secretary Lloyd Bentsen. 'Is this a credible effort [by the president] ? Is the administration going to hang in there pushing it? They have so judged it.' If bond prices continued to rally, said Federal Reserve Chairman Alan Greenspan, it would be 'by far the most potent [economic] stimulus that I can imagine.'1 What could make public officials talk with such reverence, even awe, about a mere market for the buying and selling of government IOUs?

Bankrupt Nation (II)

Before we can answer these questions properly, we need to introduce the other key components of the financial system: the bond market, the stock market, the insurance market, the real estate market and the extraordinary globalization of all these markets that has taken place over the past twenty years. The root cause, however, must lie in the evolution of money and the banks whose liabilities are its key component. The inescapable reality seems to be that breaking the link between money creation and a metallic anchor has led to an unprecedented monetary expansion - and with it a credit boom the like of which the world has never seen. Measuring liquidity as the ratio of broad money to output* over the past hundred years, it is very clear that the trend since the 1970s has been for that ratio to rise - in the case of broad money in the major developed economies from around 70 per cent before the closing of the gold window to more than 100 per cent by 2005.

 (NB* A ratio known to economists as Marshallian k after the economist Alfred Marshall. Strictly speaking, k is the ratio of the monetary base to nominal GDP.)

In the eurozone, the increase has been especially steep, from just over 60 per cent as recently as 1990 to just under 90 per cent today. At the same time, the capital adequacy of banks in the developed world has been slowly but steadily declining. In Europe bank capital is now equivalent to less than 10 per cent of assets, compared with around 25 per cent at the beginning of the twentieth century. In other words, banks are not only taking in more deposits; they are lending out a greater proportion of them, and minimizing their capital base.

Bankrupt Nation (I)

Memphis, Tennessee, is famous for blue suede shoes, barbecues and bankruptcies. If you want to understand how today's bankers - the successors to the Medici - deal with the problem of credit risk created by unreliable borrowers, Memphis surely is the place to be.

On average, there are between one and two million bankruptcy cases every year in the United States, nearly all of them involving individuals who elect to go bust rather than meet unmanageable obligations. A strikingly large proportion of them happen in Tennessee. The remarkable thing is how relatively painless this process seems to be - compared, that is, with what went on in sixteenth-century Venice or, for that matter, some parts of present-day Glasgow. Most borrowers who run into difficulties in Memphis can escape or at least reduce their debts, stigma-free and physically unharmed. One of the great puzzles is that the world's most successful capitalist economy seems to be built on a foundation of easy economic failure.

The Evolution of Banking (II)

In this process an especially important role was played by the new savings banks that proliferated at the turn of the century. By 1913 British savings bank deposits amounted to £256 million, roughly a quarter of all UK deposits. The assets of German savings banks were more than two and a half times greater than those of the better known 'great banks' like Darmstàdter, Deutsche, Dresdner and the Disconto-Gesellschaft. All told, by the eve of the First World War, residents' deposits in British banks totalled nearly £ 1.2 billion, compared with a total banknote circulation of just £45.5 million. Money was now primarily inside banks, out of sight, even if never out of mind.

Although there was variation, most advanced economies essentially followed the British lead when it came to regulation through a monopolistic central bank operating the gold standard, and concentration of deposit-taking in a relatively few large institutions. The Banque de France was established in 1800, the German Reichsbank in 1875, the Bank of Japan in 1882 and the Swiss National Bank in 1907. In Britain, as on the Continent, there were marked tendencies towards concentration, exemplified by the decline in the number of country banks from a peak of 755 in 1809 to just seventeen in 1913.

The Evolution of Banking (I)

Financial historians disagree as to how far the growth of banking after the seventeenth century can be credited with the acceleration of economic growth that began in Britain in the late eighteenth century and then spread to Western Europe and Europe's offshoots of large-scale settlement in North America and Australasia. There is no question, certainly, that the financial revolution preceded the industrial revolution. True, the decisive breakthroughs in textile manufacturing and iron production, which were the spearheads of the industrial revolution, did not rely very heavily on banks for their financing. But banks played a more important role in continental European industrialization than they did in England's. It may in fact be futile to seek a simplistic causal relationship (more sophisticated financial institutions caused growth or growth spurred on financial development). It seems perfectly plausible that the two processes were interdependent and self-reinforcing. Both processes also exhibited a distinctly evolutionary character, with recurrent mutation (technical innovation), speciation (the creation of new kinds of firm) and punctuated equilibrium (crises that would determine which firms would survive and which would die out).

The Birth of Banking (IV) - Practice of Fractional Reserve

To understand the power of these three innovations, first-year MBA students at Harvard Business School play a simplified money game. It begins with a notional central bank paying the professor $100 on behalf of the government, for which he has done some not very lucrative consulting. The professor takes the banknotes to a bank notionally operated by one of his students and deposits them there, receiving a deposit slip. Assuming, for the sake of simplicity, that this bank operates a 10 per cent reserve ratio (that is, it wishes to maintain the ratio of its reserves to its total liabilities at 10 per cent), it deposits $ 10 with the central bank and lends the other $90 to one of its clients. While the client decides what to do with his loan, he deposits the money in another bank. This bank also has a 10 per cent reserve rule, so it deposit $9 at the central bank and lends out the remaining $81 to another of its clients. After several more rounds, the professor asks the class to compute the increase in the supply of money. This allows him to introduce two of the core definitions of modern monetary theory: M0 (also known as the monetary base or high-powered money), which is equal to the total liabilities of the central bank, that is, cash plus the reserves of private sector banks on deposit at the central bank; and M1 (also known as narrow money), which is equal to cash in circulation plus demand or 'sight' deposits. By the time money has been deposited at three different student banks, M0 is equal to $100 but M1 is equal to $ 271 ($100 + $90 + $81), neatly illustrating, albeit in a highly simplified way, how modern fractional reserve banking allows the creation of credit and hence of money.