European Banks and the Rise of International Finance

Carlo Edoardo Altamura

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317276968
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

The banking and financial sector has expanded dramatically in the last forty years, and the consequences of this accelerated growth have been felt by people around the world.

European Banks and the Rise of International Finance examines the historical origins of the financialised world we live in by analysing the transformations in world finance which occurred in the decade from the first oil crisis of 1973, until the debt crisis of 1982. This a crucial and formative decade for understanding the modern financial landscape, but it is still mostly unexplored in economic and financial history. The availability of new archival evidence has allowed for the re-examination of issues such as the progressive privatisation of international financial flows to Less Developed Countries, especially in Latin America and South-East Asia, and its impact on the expansion of the European banking sector, and for the development of an invaluable financial and political history.

This book is well suited for those interested in monetary economics and economic history, as well as those studying international political economy, banking history and Financial history.

1
Halcyon days

If you invest your tuppence wisely in the bank, safe and sound, soon that tuppence, safely invested in the bank, will compound! And you’ll achieve that sense of conquest, as your affluence expands! In the hands of the directors, who invest as propriety demands!

(Dick Van Dyke as Director of the Bank, Mr Dawes Sr., in ‘Mary Poppins’, 1964)

A new world order

The regime designed at the Bretton Woods Conference influenced international finance through the restriction of international capital flows and the marginalisation of the banking and financial sector in favour of the industrial one. This comprehensively critical attitude towards finance and financiers, towards banks and bankers, was reflected in the structure and strategies of banks in Europe.

In the immediate post-war years, international capital flows took the form of direct investment (FDI) by multinational firms. This form of capital ‘was an instrument of marginal financial importance, for it was neither mediated by banks nor traded on markets’.¹ Thus the role of banking institutions was crucially dwarfed.

The system of checks and balances built at the Bretton Woods Conference was designed to insulate domestic policies from external interference and facilitate the process of post-war reconstruction. As Rawi Abdelal summarised:

Capital was to be controlled, and with an important purpose: governments were supposed to be autonomous from market forces, free to pursue expansionary monetary and fiscal policies without endangering their exchange-rate commitments or suffering the outflow of capital in search of a higher rate of interest or a lower rate of inflation. Because almost every country would be committed to fixed exchange rates, the regulation of international finance was the only way to provide some measure of autonomy for domestic policymakers [emphasis added].²

Despite the ‘mythology’ surrounding Bretton Woods (the ‘conference setting, the creative minds, and the visionary task’³), the regime proved to be short-lived. The first cracks in the financially restrictive order devised in New Hampshire had already started to appear in the mid-to-late 1950s when dollar deposits held in Europe were not reinvested in the US but on the Continent, becoming Eurodollars (or continental dollars) – in the words of Howard M. Wachtel ‘the first truly supranational form of money’.⁴ The origins of this market are clouded in mystery and many explanations have been put forward to justify its existence. We can safely posit that the existence of the Eurodollar market depended on mutual advantages to the final borrowers, to the financial intermediaries and to the final owners.

The phenomenon in itself was not revolutionary. Until the First World War, it had been customary to hold foreign currencies outside their country of origin. What was new was the scale of the phenomenon. As reported in the BIS Annual Report of 1964:

Since the mid-1950s, and especially since Europe’s return to external convertibility at the end of 1958, the foreign currency business of banks in Europe and elsewhere has undergone a very considerable expansion. Such business is not in itself new. But banks have been taking deposits and making loans in currencies other than their local currency on a much larger scale than before; and in the process there has also emerged an efficient interbank market in US dollar and other foreign currency deposits, helping to channel short-term funds internationally from lenders to borrowers [emphasis added].⁵

The US market represented the preferred investment market. Consequently, foreign governments, companies and international institutions relied on the US to get the financing they needed, ‘[bonds] issued in New York by certain European countries were, to a large extent, subscribed by residents of those countries’.⁶ It was estimated that around 75 per cent of the bonds issued in New York were subscribed from outside the United States. This practice was interrupted in 1963 when the US market was effectively closed to foreign borrowers as a result of the introduction of a series of restrictive measures on foreign financing, starting with the Interest Equalization Tax (IET) in July, which was designed to reduce the appeal of foreign bonds and equities to American investors by raising their cost (only Canadian and LDCs securities were exempted). The rates of the excise tax ranged from a low of 1.05 per cent of the value of the security for a debt obligation with a term to maturity of between 1 and 1¼ years, to 15 per cent on debt obligations with a term to maturity greater than 28½ years. The tax on foreign stocks was 15 per cent.⁷

Following the implementation of the IET, the total number of issues subject to the IET fell from US$569 million in 1963 to US$26 million in 1964.⁸ In this context it did not take much for a new market to develop in Europe, particularly in London, where monetary authorities and bankers were looking to reposition the City as the truly international capital market it had once been.

London welcomed the Eurodollar market as a way to compensate for the declining role of sterling as an international settlement currency and the relative decline of Britain’s economic fortunes compared to its continental partners who were experiencing a so-called ‘Golden Age’. In October 1962, the Governor of the Bank of England, Rowland Baring, remarked that ‘the City once again might well provide an international capital market’. Sir George Bolton of the Bank of London and South America (BOLSA), the most active bank in the early years of the Eurodollar market, said very clearly during a seminar at King’s College, Cambridge, that the greatest fear amongst British financiers after the Second World War was that ‘the failure of the sterling to survive as an international currency … would reduce London to a backwater’.⁹

Luckily for him and the City of London, his fears proved to be unfounded. Between 1963 and 1969, the number of banks and other institutions operating in the foreign currency business in the UK increased from 132 to 193. As reported by the Bank of England, between the end of 1963 and the end of 1965 UK banks’ gross foreign currency liabilities to overseas residents ‘increased by over 25 per cent per annum’. From the end of 1965 to the end of 1968, they increased by 50 per cent per year.¹⁰

The Eurodollar market gradually modified the corporate strategies of all the major European banks. However, before the revival of the late 1960s and, in particular, the early 1970s, European banking went through a long phase of retreat inside local boundaries. Almost all major commercial banks severed the ties they had created during the first phase of financial globalisation and once again became domestic banks with a limited array of low risk products. This state of affairs came to be epitomised by the legendary ‘3–6–3 rule’: bankers were borrowing at 3 per cent, lending at 6 and were on the golf course by 3 p.m. Maybe this anecdote should be considered more as a legend than a trustworthy representation of banking practices of the immediate post-war years, but, as we know, legends more often than not contain some elements of truth. As financial historian, Youssef Cassis, has argued: ‘Taken in isolation, the 1950s were not a particularly propitious time for European banks’.¹¹

All across Europe a wave of reforms and regulations fettered the banking and financial sector. In France, the four major banks were nationalised in 1945: the reconstruction was firmly in the hands of the government as was the credit mechanism, as the Banque de France was nationalised too. In Britain, the Bank of England was nationalised in 1946, while the Big Five (Barclays Bank, Lloyds Bank, Midland Bank, National Provincial Bank and Westminster Bank), despite remaining de jure independent, were de facto largely influenced by the imperatives of the Treasury. As Cassis noted: ‘They received precise instructions from the Treasury concerning not only their liquidity but also their lending priorities, especially as far as manufacturing investment and the support of exports were concerned’.¹²

As we hinted above, the implication of such policies, attitudes and ideas was that banking practices in Europe in the post-war period were relegated to domestic borders and to what would now be considered conservative practices aimed at making the banking sector a tool in the hands of European reconstruction.¹³ Referring to the French banking sector, Joel Métais pointed out that ‘after the Second World War foreign expansion retained a low profile until the turn of the 1970s’.¹⁴

We are now going to analyse the world of Bretton Woods, its ideological foundations and its impact on the European banking and financial sector. Then we will describe the early years of the Euromarket by looking at its origins, its mechanisms and its impact on the world financial system. Finally, we will study banking strategies under the Bretton Woods regime in order to have a comprehensive view of the banking world in Europe before the turbulent events of the 1970s.

The world of Bretton Woods

The Bretton Woods regime lasted only 30 years if we take 1944 and 1973 as the reference years, but only half that time if we start counting from the return to external convertibility of European currencies in 1958. Nevertheless, the Bretton Woods regime had a remarkable impact on recent economic history and continues to exert a strong fascination on the general public and academics alike. Thus, in order to understand the rise of international finance in the longue durée, it is worth starting our analysis in the peaceful village at the foot of Mount Washington.¹⁵

Post-war planning and the control of finance

The war was still underway when plans started to be elaborated by the American and British Treasuries to devise a new economic regime upon which to build the post-war order.¹⁶ John Maynard Keynes of Britain and Harry Dexter White of the US were the most prominent actors of the negotiations, aiming at ‘devising the specific means by which the objective [post-war financial collaboration] could be achieved’.¹⁷

White had a very adverse reputation, ‘aggressive, irascible, and with a remorseless drive for power’,¹⁸ but despite this he had a remarkable career at the US Treasury. After arriving in Washington in 1930, he started working on the American Stabilization Fund and the Tripartite Stabilization Agreement along with other economists gathered around the Secretary of the Treasury, Henry Morgenthau. He continued to work on important projects such as the failed attempt to create an Inter-American Bank and, by the end of 1941, he had already written an outline of what later would be known as the ‘White Plan’. This bold and idealistic plan marked a departure from the existing practices of political isolation and financial orthodoxy. At the centre of White’s project lay the Fund and the Bank as the main agencies for the conduct of international finance. The Stabilization Fund would have total resources of at least US$5 billion coming from the contributions of member countries in gold, local currencies and government securities. The aim of the Fund was to help its members in the event of temporary balance of payments difficulties. As a counterpart to this source of financing, member countries would have to ‘surrender the right to vary their exchange rates; abolish all forms of exchange control; and submit to Fund supervision over domestic economic policies’.¹⁹ The Bank would have a capital stock of US$10 billion available for t...