A History of Credit and Power in the Western World

Scott B. MacDonald

• Publisher: Routledge
• Year: 2017
• Topic: Economics
• eBook ISBN:
  9781351535328
• Subtopic: Economic History
• Index: Economics

The end of the Cold War put the planet on a new track, abruptly replacing the familiar world of bipolarity, red phones, and intercontinental ballistic missiles with the strange new world of the Internet, e-commerce, and Palm Pilots. The "New World Order" was defined by a U.S.-led war against Iraq, bloody ethnic strife in Bosnia and Rwanda, and religious turmoil in Central Asia. This evolving global system, however, overlooked the powerful role of credit, which functions as a critical building block for developing greater national and individual wealth. This volume examines the evolution of credit in the Western world and its relationship to power. Spanning several centuries of human endeavor. it focuses on Western Europe and the United States and also considers how the Western system became the global credit system. Six major themes run throughout: (1) the direct relationship between credit and power; (2) different kinds of political power promote different kinds of economic behavior; (3) various societal and cultural groups were often more successful in mingling credit and political power; (4) the Western credit system evolved in tandem with the development of the nation-state; (5) historically, there has been a pattern of financial crises; (6) credit spread from being the privilege of the wealthy and powerful to being available to vast numbers. MacDonald and Gastmann have broken history into five periods, ranging from early pre-modern, defining the earliest references to banking and credit as exemplified by the Code of Hammurabi, circa 1726 BC, through the Roman Empire with its creation of money and growing use of credit in trade, the barbarian invasions of the 11th century which led to a breakdown in credit networks in the West, through the establishment of the Italian city-states, to the modern period which incorporates the rise of credit in the Low Countries in the 1500s and extends through the rise of London and New York as the major international credit hubs.

Part 1
Introduction

1
Introduction

Beautiful Credit. The foundation of modern society. Who shall say that this is not the golden age of natural trust, of unlimited reliance upon human promises?

—Mark Twain and Charles Dudley Warner, The Gilded Age, p. 243

A well-maintained irrigation system brings an adequate supply of water to thirsty crops in the field. It can make a dusty and sun-baked field green and verdant, capable of producing food for the hungry. In a sense, every drop of water is precious. A poorly maintained irrigation system wastes water and often results in crop failure. Much of the same can be said of credit in the global economic system: efficient allocation and use produces positive results in economic development benefiting the majority of citizens; poor allocation and misuse leads to corruption, graft, and economic and financial collapses. Under these circumstances only a handful at the top benefit.

At the beginning of the twenty-first century the global economic system is supported by an international credit system. That credit system is hardly perfect, but it does provide badly needed capital for a host of users, ranging from national and subnational (states, provinces, and municipalities) governments in the Americas, Asia, the Middle East and Europe, and in parts of Africa to Fortune 500 corporations and the myriad of small enterprises and households the world over. Although the objectives of governments, multinational corporations, and individuals are different, the need for credit is the same. In a sense, credit is like water. It is a key wellspring of life—in this case, economic life. Without credit, most businesses would find it difficult to function, and certainly many governments would be forced to scale down their operations and reduce expenditures (certainly not a bad idea in some cases). Consequently, a well-run credit system is essential for the flow of goods and services around the planet as well as for helping families and individuals realize their dreams. Calls for a new “international financial architecture,” which reverberated in the late 1990s, reflect that the international organization of credit is hardly a fine-tuned and well-structured system. Rather it is highly volatile, often spooked by rumors, and given to periodic panics. The market is the main primeval force that determines who gets what and why. While the international credit market is hardly perfect, it is better than any alternatives that have been tried, such as the failed efforts of the Soviet Union’s command economy to strategically allocate credit.

This book is a history of credit, spanning several centuries of human endeavor and focusing mainly on Western Europe and the United States. Other great cultures, such as the Chinese and Indians, developed sophisticated economic systems, but none created financial infrastructures capable of giving birth to highly efficient credit systems that are still with us. The approach used is close to financial history, modified by a healthy dose of political science, complemented by social history. A central strand among the major themes of the book is the relationship between the evolution of credit and power—simply stated, who has what and why, or who is a creditor and who a debtor? This book does not seek to provide a comprehensive narrative account of Western civilization. That task has been undertaken much more competently by others.

Six major themes run through the book. First and foremost is the thesis that there is a direct relationship between credit and power. The wealth represented by credit augments political power. Yet for a credit market to work in an efficient manner, it is essential that power provides political stability and the rule of law. The rule of law remains a core necessity, as reflected by the deeply rooted development problems suffered by Russia, Ukraine, and Indonesia in the 1990s.

The second theme is that different kinds of political power promote different kinds of economic behavior.¹ A functioning modem credit system found more fertile soil in the northern Italian city-states, in the cities of the Holland and Flanders, and in England than on the Russian steppes, the Anatolian highlands, or the Balkans. Politics decidedly was a factor as the leadership elites in the former areas regarded economic activity, in particular, trade, important. In the latter regions, local leadership elites were more rooted in agriculture and property-ownership than entrepreneurship and augmentation of one’s wealth through commerce. This difference was evident in policies adopted by the various governments as well as who had influence in each political system. It was also evident in the willingness of some leadership elites to surrender or relegate the function of credit to minorities.

The third theme is cultural. Throughout much of the history of credit certain societal groups were able to embrace more readily the workings of credit and its relationship to trade and commerce. This point should be neither overstated nor understated. However, the involvement of such groups as the northern Italians, Jews, Dutch, French Protestants, Scots, English, and Americans cannot be easily dismissed. Why did these societal or cultural groups—sometimes as minorities—rise to the top in providing credit in a particular economy and hence hold some degree of political power or, at least, influence?

A considerable amount of literature, based on the works of Max Weber, Talcott Parsons, Florence Kluckholn, and George Foster, argues that “progress-prone” societies are rational, ascetic, ethical, universalist, achievement-oriented, activist, future-oriented, and egalitarian. These societies also seek a balance between group and individual interests and observe life as a positive-sum game. In contrast, “progress-resistant” societies are fatalistic, particularistic, ascriptive, passive, individualistic and familistic, past- or present-oriented, and hierarchical. They perceive life as a zero-sum game. According to one study, examples of progress-prone societies include Western Europe, North America, China, Taiwan, Korea, Japan, Hong Kong, Singapore, and East Asian immigrants in the United States, Southeast Asia, Brazil, and elsewhere.² It also extends to successful religious or ethnic groups such as Jews, Quakers, Mormons, Armenians, Sikhs, and Jains.

We observe this cultural theme in the treatment of Protestants by Max Weber. In his 1904 book, The Protestant Ethic and the Spirit of Capitalism, Weber argued that the break with the Roman Catholic Church during the Reformation encouraged the rise of capitalism by relieving it of its anxieties, its scruples, or, in others, its bad conscience. For Weber, there is a direct link between the early Protestant reformers and the Puritans and the Americans. Evidence of this linkage came in the form of one of the founders of the United States, Benjamin Franklin, who coined such capitalist sayings as, “Remember that time is money.. .Remember that eredit is money.. .Remember that money is of a prolific generating nature” (Advice to a Young Tradesman).

What we can take away from the cultural dimension is that culture does have an impact in shaping both political and economic behavior. In the case of credit, culture is important from the standpoint of how a particular group regarded the idea of usury, the extension of credit, and its use in daily life. For example, was credit to be used to purchase consumer goods or was it for developing a productive enterprise? Taking this one step further, culture helped establish the perceptual lens through which groups like the Jews, Catholics, and Protestants regarded credit as a force to promote development through rationalization, efficiency, and stability.

The fourth theme of the book is that the Western credit system evolved in tandem with the development of the nation-state, in particular with the Netherlands, the United Kingdom, Germany, France and the United States. If in the seventeenth and eighteenth centuries first Holland and then England developed successful credit systems this was due to the legal system they had. Other critical factors that helped stimulate a working credit market were a system of strong public finances (that included a government debt market), a strong complementary position in trade, and a commanding position in capital markets via a stock market, supported by strong banks. To this could be added an open political system, which allowed a degree of creativity to flow freely. Creativity remains a key force in the development of new financial instruments that help give the global credit market depth and sophistication.

The fifth theme is that the historical development of the global credit market is hardly a smooth line. It is rather a history of considerable volatility, with the crash of more than one famous banking house and the dishonor of default shaking many governments, as well as the short memories of investors. Humankind has demonstrated an amazing ability to repeatedly stampede itself into financial crises, starting with Dutch Tulipmania and continuing through the financial crises of the early twenty-first century. The pattern that appears evident is one of credit expansion in a period of economic growth and prosperity, followed by over-extension of both prime borrowers and lenders, then a crisis of confidence and a crash. After the dust settles, there is a gradual rebirth of the credit activity. Indeed, the words of economists Barry Eichengreen and Albert Fishlow in examining Mexico’s financial problems in December 1994 and early 1995 strike a chord: “This characterization of the historical record implies, of course, that smooth capital transfers are the norm and disruptions to international financial flows the punctuation marks. The opposite might also be argued: debt-servicing difficulties, the suspension of voluntary lending, and calls for third-party intervention—the constituents of which are called debt crises—are the normal state of affairs.”³

The sixth and final theme is the spread of credit from being the privilege of the wealthy and the powerful to being available to vast numbers of North Americans, Japanese, and Europeans. The traditional banking families, like the Fuggers, Welsers, and Rothschilds, did not make their fortunes lending to the unwashed masses, and certainly this was true of the initial American creditors, as well. Rather their business was to supply credit to governments, and later to major companies, such as railways, steelmakers, and other heavy industries. It was only in the second and third decades of the twentieth century that this process of spreading credit down through the ranks developed. Following the Second World War it expanded rapidly. It happened through the creation of credit unions, the actions of commercial banks (sometimes pushed by governments), and most significantly through the credit card.

What is Credit?

What then is credit? According to The Harper Collins Dictionary of Economics, credit is defined as follows: “Loans and other deferred payment methods made available to consumers and companies to enable them to purchase goods and services, raw materials, and components.”⁴ In this respect, credit is a form of money, but a deferred type of money and not necessarily in a tangible form, though it is often guaranteed by something, that is, money in the bank, gold, or some tangible good. As James Grant notes of the distinction between money and credit: “The money supply can be counted, and so can the supply of debt. However the potential supply of debt can only be imagined.”⁵ The actual word “credit” comes from the Latin credere, meaning to trust. This trust allows credit to be created and used, while a lack of trust can destroy it. Consequently, credit works because of trust and confidence in the parties involved, which is further related to the concept of a legal or value system that upholds a contract between parties as legal and binding.

The trust or confidence factor cannot be easily dismissed. Francis Fukuyama in his book, Trust: The Social Virtues and the Creation of Property, noted, “Thus, economic activity represents a crucial part of social life and is knit together by a wide variety of norms, rules, moral obligations, and other habits that together shape the society...one of the most important lessons we can learn from an examination of economic life is that a nation’s well-being, as well as its ability to compete, is conditioned by a single, pervasive cultural characteristic: the level of trust inherent in the society.”⁶

In his book, Golden Fetters: The Gold Standard and the Great Depression 1919-1939, Barry Eichengreen added two other elements that are important in any economic activity: The stability of the prewar gold standard “was the result of two factors, credibility and cooperation.”⁷ The point he makes is that governments of the major industrial countries worked together to make certain that the system of international currency flows remained supported by the gold standard. Eichengreen also stated, “The very credibility of the official commitment to gold meant that this commitment was rarely tested.”⁸ In our story about credit, the concept of credibility and cooperation play most significant roles.

Related to credit is the concept of leverage. Leverage often refers to power or influence. In the financial sense, leverage refers to “money borrowed to increase the return on invested capital.”⁹ Stated in another fashion, leverage is when money or credit is borrowed, put to work and provides a profit. For example, a company has $10 million. It wishes to expand and needs more than the $10 million. It goes to a bank and borrows seven times its $10 million, giving it a leverage position of $70 million. Although the money is borrowed and must be paid back at some date, if its application is done well, it allows both repayment and a net gain. Leveraging is an important concept used in modern corporate finance and over time has become an accepted and normal business practice.

To our definition of credit should be added wealth generation. Credit does not come out of thin air nor is it a crop that can be harvested. There must be some form of economic activity, such as trade, that generates a surplus of money. That surplus thus becomes the source of credit to be borrowed. In a sense, credit provides the situation by which surplus money is made available at a cost to people or institutions with a credit deficit. Consequently, the idea of wealth generation is important when thinking about credit.

Our last introductory point about credit is that it has been around for a long time. Indeed, one of the earliest references to credit activities was the Code of Hammurabi. Drawn up by the ancient Babylonian king Hammurabi (1726-1686 B.C.), the code contains about 150 paragraphs dealing with nearly all cases arising from loans, interest, pledges, guarantees, and the presence of evidence.¹⁰ In today’s world, credit is a key lubricant of international commerce. Massive amounts of global, regional, and local commerce of goods and services depend on a credit system that supports a “buy now-pay later” mode of operation. Those societies that have easy access to credit prosper and occupy a leading position in the present world. Consequently, those who control it are ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Contents
• Preface
• Part 1: Introduction
• Part 2: Early Pre-Modern Credit Period
• Part 3: Early Modern Credit Period
• Part 4: Modern Credit Period
• Bibliography
• Index