An Introduction to the History of Economic Thought

Early Modern Europe 1492-1789

Finance

Finance developed slowly in Medieval Europe. The development of finance was centred on the

major European trading cities.

Credit

Credit is essential for trade. Without credit, trade will stagnate and the growth of credit tracks the development of trade as Western Europe began to recover from the collapse of the Roman Empire and emerge from the Middle Ages.

Credit and money

The growth of credit is usually associated with the increased circulation of money. But credit may actually have preceded the development of money. Some historians argue that credit must have been essential for the growth of cities in Ancient Mesopotamia. Clay tablets appear to record debts incurred in kind even before the use of money.

The attitude of the Medieval Church

The Medieval Church disapproved of lending money for interest. They regarded it as a sin. Usury as it was called was banned by the Church. But it still existed in Medieval Europe.

Jewish and Islamic religious authorities all banned usury among members of the same religion.

Lending money to Christian rulers and merchants offered an economic opportunity for European Jews.

Trading Cities

Trading cities began to emerge in the eleventh and twelfth centuries

Venice was one of the most outstanding of these cities and continued to dominate trade between Western Europe and Asia until the sixteenth century.

Venice

Venice's predominance was based on: A secure position Control of rich agricultural land Developments in shipping and navigation Freedom from many feudal constraints Legal enforcement of property rights and contracts Developed accountancy practices Insurance Availability of credit

Merchant banks

The banks of the Renaissance Italy were merchant banks. The term is still used but then it had a very definite meaning: the first banks in northern Italy were run by grain merchants who bought up the grain produced by the rich, fertile lands of Lombardy.

Many of these grain merchants were Jews fleeing persecution in Spain. They could not own land in Lombardy but they could trade in agricultural produce.

High-risk lending

This was a high-risk business. The grain merchants would lend money to the farmers before the crops were harvested. The crop might be ruined by bad weather and the merchant would lose his money. So the merchant offered less than the harvest would fetch in the market. If the harvest was good then the merchant made a profit out of the difference.

Grain trade

Gradually the grain merchants began to ship the grain to overseas ports. This was risky because ships could be wrecked and the cargo lost at sea. Again their profit came from the difference between the price of grain in the field and the price when it reached a distant market.

Collateral

Loans might be secured with Goods such as clothes, shoes, jewels, or

working tools that could be sold if the borrower did not repay the loan

A guarantor who promised to pay the debt if the lender defaulted

A written agreement Or the borrower's word

Reasons for borrowing

Peasants borrowed money to buy draught animals – horses or oxen

Peasants borrowed to see them through a poor harvest or enemy attack

Families borrowed to pay a daughter's dowry New households borrowed to establish

themselves Artisans borrowed to set themselves up in

business

Public Finance

Reasons for borrowing Military expenditure Poor relief

Grain debt

An early form of “derivative” emerged as merchants began to trade not in grain itself, but in grain debt. A promise to pay a certain weight of grain at a definite future date became a commodity that could be trade.

Insurance

The merchants also developed systems of insurance to underwrite the risks they incurred as a result of the uncertainties of the harvest and the dangers of sea transport.

Lending

Merchants would keep farmers in business through droughts or other natural disasters by lending them money.

Bills of exchange

As the trade developed so some grain merchants would exchange notes promising to pay certain amounts of grain. These notes would be deposited with the grain merchants and could be used as collateral for debts.

Banca

The merchants traded at “banca” - the Italian for benches – in the grain market. This is where the English term “bank” comes from. When a merchant went out of business his bench was broken “banca rotta” - from which the English term “bankrupt” comes.

The Rialto

The Banco della Pizza di Rialto was opened in 1587. It was founded by the city of Venice and was the first central bank. It allowed merchants to deposits funds and transfer money along Venetian trade routes without actually carrying gold or silver.

This was a more secure system that relying on individual bankers because of the scale of the new bank and the size of its deposits.

Central Banks

Other commercial cities followed Venice's example:

Amsterdam in 1609, Hamburg in 1619, Nuremberg in 1621.

Cheque

The emergence of these central banks allowed the development of the cheque. The cheque differs from a bill of exchange. A bill of exchange is a complex agreement drawn up between two individuals. A cheque is transaction between an individual and a bank. Any individual who holds the cheque can draw money from the bank. It facilitated the flow of funds and became increasingly widespread in the course of the 17th century.

Finance

With the emergence of larger state backed banks handling large sums of money it became apparent that it was possible to make money out of banking. The bank's deposits could be lent at interest and charges could be levied on services such as cashing cheques.

Banco Giro

In 1617 the Banco Giro is founded in Venice after the Banco della Piazza di Rialto runs into trouble through accepted unsecured loans. The Venetian state is threatened by the collapse. The creation of the new bank is an attempt to restructure the Venetian debt. The state's creditors are offered loans from the new bank. Venice can now raise loans on the basis of guaranteed credit. It is pattern that many other states will follow.

The golden ducat

The Venetian ducat – a gold coin – was used all over Western Europe. It was regarded as the most reliable currency for international exchange.

Shakespeare's play The Merchant of Venice reflects the prominence of Venice in financial matters and the debates that were going on in

England at the time.

The dispute between Antonio and Shylock in the Merchant of Venice reflects the debate then going

on in England over what “usury” was. Shylock defines lending for interest as “thrift”. Antonio

defines it as “usury”.

Usury in England

Usury was a hotly debated issue in Tudor England. There were several attempts to

enforce a ban on money lending for interest introduced in 1552. As a result England was far behind Venice in the development of a system

of credit.

Martin Bucer argued that not all money lending was wrong. It depended what the money was for and how high the rate of interest was. He wanted English Parliament to set the interest rate at 10%.

His opponent John Young insisted that all interest was wrong. He was supported by many of the

church leaders. But in 1571 a law was brought in allowing interest payments on loans. Interest was

set at 10% and various regulations were introduced to control moneylending.