International Banking and Financial Systems

Evolution and Stability

Luigi De Rosa

• Publisher: Taylor & Francis
• Year: 2017
• Print ISBN: 9781138724907
• eBook ISBN: 9781351754163
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This title was first published in 2003. In this volume of essays - based on papers delivered to 2001 conference, International Banking and Financial Systems - leading European bankers and banking historians give their assessment of the evolution of central banking in 20th-century Europe. As well as providing a historical perspective, the volume also explores how the lessons of the 20th century may be brought to bear on current and future trends in central banking. In so doing, this volume provides an insight into the ways in which economic stability and growth has been, and can be, promoted.

Part I
Europe in the Twentieth Century and Financial Systems: Factors of Crisis, Stability and Growth

Section A
Europe and Central Banks in the Twentieth Century

Chapter 1
A Historical Analysis in the Context of Finance and Banking

Peter Mathias

Introduction

This book on the evolution of banking – particularly central banking – in Europe in the twentieth century is not to be regarded as simply a retrospect, looking at the past in a 'rear-view mirror' (the historian's professional viewpoint, with hindsight as his only professional advantage). Retrospection, perceptively analysed, can also utilize the past as a perspective through which to assess the present and likely future. This is particularly so when considering the evolution of institutions. Short of the cataclysms of total war and revolution, institutions evolve gradually, being deeply structured into society, economy and government, unlike the history of events –l'histoire événement – which is largely imposed upon this institutional matrix. The evolution of institutions is greatly 'path-dependent' in this way. Historians can therefore, with professional legitimacy, use their long-term perspective of the past to reduce (but never eliminate) the indeterminacy masking the options for future change. Knowing the path by which existing arrangements have evolved widens the awareness through which we view the present and what is to come. Perhaps this is what an educated guess means. But there is Lenin's salutary comment that 'history is more cunning than any of us' while the same truth is encapsulated by the old story of the fortune-teller's shop, abandoned and boarded up, with a notice pinned on the door which read: 'closed owing to unforeseen circumstances'.

The economic and political context is experiencing dramatic structural changes for Europe and the international economy: the great eastward expansion of the European Union (which is not just an aspect of the EU but a systemic change in the entire concept and actuality of Europe). With this comes the full operation of the European Central Bank and the common European currency as a main agency and symbol of the new Europe. This is not to mention the wider horizons: the faltering (or worse) of the United States economy after a decade of unfaltering growth at an unprecedented pace; with all the global consequences this will bring; the continuing question mark over the revival of the Japanese economy and its structural reform (with all that implies for S.E. Asia); China coming in from the cold through the World Trade Organisation; and what lies ahead immediately for Russia?

Clearly, immense changes are on the horizon as we traverse the millennium year. How much more then, in the long perspective of the twentieth century behind us, should we appreciate the seismic developments which have come to Europe within the international economy and to all its constituent parts, which are explored in this set of contributions.

The main essays of this book will focus upon banking and look outwards from banking institutions and their operations to the economic and political context within which the banks acted. By contrast this initial chapter is designed to provide a general view of the main historical trends which shaped the evolution of banking systems and the central banks at their head. Given the enormous scope of historical change over such an eventful century (an accurate adjective!) the trends can only be sketched with a very broad brush.

The complexities are compounded by the fact that banking (both in the institutional sense and in the operation of banking activities) has to be construed in the operation of the economy as a whole, and in relation to the formulation of economic, financial and monetary policy (which gives the state an important, inescapable role). In anything except the shortest of short runs banking is integral with the 'real' economy: any presumed dichotomy between the workings of an economy and its financial arm is false because, in the longer term and in the wider context, the financial dimension is not autonomous. Moreover, the interplay of forces between financial activities and economic activity more generally is complex, changing over time and dependent upon the specificity of context, both institutional and éventuelle.

The context shapes the relationships between the banking system (particularly the central bank) and the economy, powerfully influenced by the nature of the state concerned. Politics is never irrelevant to the dynamic produced in the interplay of finance and economics. To what extent is this momentum for change a product of the internal dynamics of the economy concerned? To what extent is it a reaction to forces being imposed from the international economy (perhaps political as well as economic and financial)? An autocratic state, wanting to control the levers of power, will have a propensity to exert its authority over the central bank, if not commercial banks, to seek financial ends through the exercise of political power. A small economy, with a large primary sector, its export earnings from primary produce being its main source of foreign exchange, will have little leverage to mitigate the impact of deteriorating terms of trade. This will be all the more so if the economy depends on a regular inflow of foreign capital (short or long-term), if extensive financial assets are held by foreigners, if overseas-based banks have a significant presence in its financial structure and if a high proportion of foreign-exchange earnings are mortgaged to service debt. Whatever the formal rules of the game (whether 'gold standard' conventions are in play by the central bank or not) by one route or another severe deflation and a fall in the level of economic activity, trade, investment and employment will ensue. Financial levers will be the means of imposing the necessary economic constraints in such a deflationary spiral, imposed by the external shock of deflating demand for primary product imports, contracting volumes in trade, falling prices and deteriorating terms of trade, the momentum for this sequence of contractions being primarily derived from the major players in the international economy, the advanced industrial economies.

For them the effects of a down-turn in activity (primarily internally generated) need not be so devastating. Their main trading flows will be internal, or with other advanced economies. A smaller fraction of their trading values (and purchasing power) will derive from trade with smaller, primary-produce exporters, which for them will be of much higher values in relation to their economies. In consequence, if America or Europe gets a cold, they will get double pneumonia.

Moreover the possibilities open to the larger advanced economies for taking remedial financial actions to counter deflationary forces (or to counter inflationary pressures in opposite circumstances) are much greater. Central banks can manipulate interest rates and monetary policy with much greater leverage upon events. A whole armoury of fiscal and other measures of financial policy can be brought to bear if the apparatus of government is effective. In such a context the decisions of the central bank, particularly if taken in coordination with the central banks of other powerful players in the international economy, can play a decisive role in stabilising the economy and placing it back on a path of sustainable growth after an imposed shock.

Of course, the dynamics of the nexus between the 'real economy' and the financial system can operate in the opposite direction. A stock market 'bubble' or a banking crisis – where inherent financial instability results from fraudulent, speculative or over-optimistic decision making by banks – can radiate outwards to the wider economic community as losses are exposed, loans get called in, credit becomes restricted and interest rates rise. This was not just a phenomenon of small, unstable countries with weak institutional structures. An unstable internal banking system characterized the United States in 1914 and was instrumental in the creation of the Federal Reserve system.

It is counterproductive to elaborate further on the possible permutations in the relationships between banking and the economy. The main part of this text therefore aims to provide a chronological sequence of the main historical trends and the characteristics of the various phases of evolution of these relationships-in short to provide a framework within which the more specialized contributions which follow may be construed.

Before the Deluge: The European and International Position before 1914

The context within which banking has to be considered in 1914 was that of the sustained expansion and transformation of the world economy, with relatively mild fluctuations, driven primarily by market forces, both internally and internationally, responding to the opportunities of advancing technology, rising population and incomes, effective governments and developing efficiencies in institutions embodying business and financial dealings. The evolution of banks, and their role in internal and international financing of economic activity is an important dimension of global developments. Financial assets were growing in all European countries (and other 'modern' economies) two to three times faster than the rate of growth of GDP. Financial institutions grew in numbers, range and scale as capital markets deepened and diversified.

The basic 'real' data of this unprecedented phase of modern economic growth –integral with the industrialization of the main 'Western' economies – need always to be borne in mind. In 1890-1913 western European countries experienced population growth of 0-8 per cent p.a., real income growth of 2-6 per cent p.a. (and per capita growth of 1-7 per cent). Western European economies, with North America increasingly since 1850, were the main 'engines of growth', with industrialization and urbanization proceeding apace. In 1913, Western Europe had an average level of real GDP per capita of almost $700 (in 1960 prices) with North America almost twice as high and the Eastern European average just over $400. International trade values were expanding by over 4 per cent p.a. The gap with other world regions was widening. Expansion was enhanced by large flows of migrants moving to roles of 'higher value-added' than in the countries they had left: 34 million emigrants sailed from Europe between 1851 and 1910.

Britain remained by far the greatest trading nation and financial presence in this process of expansion and progressive integration of the world economy, although (by 1910) no longer the dominant industrial economy. Half of total European registered shipping of 35 000m, tons was British (the United States having only 5m. registered tons), and most had been built in British yards. Equally with long-term foreign investment, dominated by the savings of Western European countries: of $45 000m. in such flows by 1914 (principally portfolio investment), $20 000m. had come from Britain. The direction of British foreign investment was mainly extra-European (in contrast to France and Germany) which helps to explain the crucial global role of Britain in trade and finance in this period. The short-term credit market, financing international trade by the medium principally of bills of exchange, had centred on London. Credit balances from all over Europe and beyond, when given endorsement by London banks and discount houses, could be put to use in financing trade (not just trade based on the UK). This gave London a global role in the liquidity of world trade even more than in the long-term international capital market. But endorsement in sterling was critical; in these operational terms the world was trading on a 'sterling standard' as much as a 'gold standard', as one supported the other.

Foreign investment spurred the creation of infrastructures, underpinning the development of both 'old' and industrial countries and 'new' settled and colonized countries (for which exports of primary products and minerals were to be their main contribution to the world economy): the railways (taking up the major part of foreign investment), port facilities, urban utilities, telegraph and telephone systems. This came at the initiative, and largely under the control, of business interests based overseas; and overseas banks and financial institutions, such as insurance, followed those business interests, handling the finance of their relations with the overseas markets which had created the momentum for development in the first place. This was not just a core-versus-periphery nexus, a primary-product-export versus an import-of-industrial-goods dichotomy of trade. Britain was the largest exporter of a key raw material – coal – in the world and the United States, as well as becoming an industrial Titan by 1914, was also the largest Western world exporter of foodstuffs and raw materials other than coal.

The financial networks and financial flows supporting this vast expansion and restructuring of the world economy, led by European countries, have an importance of their own: financial arrangements in this period were such as to minimize constraints. The United Kingdom, as by far the greatest presence globally, had the prime responsibility for encouraging international liquidity; her institutions, notably the Bank of England, and her financial and trading policies, were the most important constituents of the system, and strongly influenced other participating states. Free trade (in particular the absence of import tariffs on almost all agricultural products) encouraged the growth of 'complementarity' in Britain's trading relationships. Britain was much the largest importer in the world economy, particularly of food and raw materials. The import bill increased eightfold between 1850 and 1913, pumping sterling credits out into the world economy. The British economy ran a cumulative deficit on the balance of trade, this being converted into a massive surplus in the balance of payments by international earnings from services (shipping above all, other financial services, the repatriation of profits and earnings and so on). This was not derived directly from industrial dominance but ...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• List of Figures and Tables
• List of Contributors
• Foreword
• List of Abbreviations
• Introduction
• I EUROPE IN THE TWENTIETH CENTURY AND FINANCIAL SYSTEMS: FACTORS OF CRISIS, STABILITY AND GROWTH
• II PROSPECTS OF THE INTERNATIONAL BANKING AND FINANCIAL SYSTEM
• Index