The libro segreto—literally the secret bookf—of Giovanni di Bicci de’ Medici sheds fascinating light on the family’s rise. In part, this was simply a story of meticulous bookkeeping. By modern standards, to be sure, there were imperfections. The Medici did not systematically use the double-entry method, though it was known in Genoa as early as the 1340s. Still, the modern researcher cannot fail to be impressed by the neatness and orderliness of the Medici accounts. The archives also contain a number of early Medici balance sheets, with reserves and deposits correctly arranged on one side (as liabilities or vostro) and loans to clients or commercial bills on the other side (as assets or nostro). The Medici did not invent these techniques, but they applied them on a larger scale than had hitherto been seen in Florence. The real key to the Medicis’ success, however, was not so much size as diversification. Whereas earlier Italian banks had been monolithic structures, easily brought down by one defaulting debtor, the Medici bank was in fact multiple related partnerships, each based on a special, regularly renegotiated contract. Branch managers were not employees but junior partners who were remunerated with a share of the profits. It was this decentralization that helped make the Medici bank so profitable. With a capital of around 20,000 florins in 1402 and a payroll of at most seventeen people, it made profits of 151,820 florins between 1397 and 1420 - around 6,326 florins a year, a rate of return of 32 per cent. The Rome branch alone was soon posting returns of over 30 per cent. The proof that the model worked can be seen in the Florentine tax records, which list page after page of Giovanni di Bicci’s assets, totalling some 91,000 florins.
The Amsterdam Exchange Bank (Wisselbank) was set up in 1609 to resolve the practical problems created for merchants by the circulation of multiple currencies in the United Provinces, where there were no fewer than fourteen different mints and copious quantities of foreign coins. By allowing merchants to set up accounts denominated in a standardized currency, the Exchange Bank pioneered the system of cheques and direct debits or transfers that we take for granted today. This allowed more and more commercial transactions to take place without the need for the sums involved to materialize in actual coins. One merchant could make a payment to another simply by arranging for his account at the bank to be debited and the counterparty’s account to be credited. The limitation on this system was simply that the Exchange Bank maintained something close to a 100 per cent ratio between its deposits and its reserves of precious metal and coin. As late as 1760, when its deposits stood at just under 19 million florins, its metallic reserve was over 16 million. A run on the bank was therefore a virtual impossibility, since it had enough cash on hand to satisfy nearly all of its depositors if, for some reason, they all wanted to liquidate their deposits at once. This made the bank secure, no doubt, but it prevented it performing what would now be seen as the defining characteristic of a bank, credit creation.
And:
If the South had managed to hold on to New Orleans until the cotton harvest had been offloaded to Europe, they might have managed to sell more than £3 million of cotton bonds in London. Maybe even the risk-averse Rothschilds might have come off the financial fence. As it was, they dismissed the Erlanger loan as being ‘of so speculative a nature that it was very likely to attract all wild speculators . . . we do not hear of any respectable people having anything to do with it’. The Confederacy had overplayed its hand. They had turned off the cotton tap, but then lost the ability to turn it back on. By 1863 the mills of Lancashire had found new sources of cotton in China, Egypt and India. And now investors were rapidly losing faith in the South’s cotton-backed bonds. The consequences for the Confederate economy were disastrous.
With its domestic bond market exhausted and only two paltry foreign loans, the Confederate government was forced to print unbacked paper dollars to pay for the war and its other expenses, 1.7 billion dollars’ worth in all. Both sides in the Civil War had to print money, it is true. But by the end of the war the Union’s ‘greenback’ dollars were still worth about 50 cents in gold, whereas the Confederacy’s ‘greybacks’ were worth just one cent, despite a vain attempt at currency reform in 1864. The situation was worsened by the ability of Southern states and municipalities to print paper money of their own; and by rampant forgery, since Confederate notes were crudely made and easy to copy. With ever more paper money chasing ever fewer goods, inflation exploded. Prices in the South rose by around 4,000 per cent during the Civil War. By contrast, prices in the North rose by just 60 per cent. Even before the surrender of the principal Confederate armies in April 1865, the economy of the South was collapsing, with hyperinflation as the sure harbinger of defeat.
The Rothschilds had been right. Those who had invested in Confederate bonds ended up losing everything, since the victorious North pledged not to honour the debts of the South. In the end, there had been no option but to finance the Southern war effort by printing money. It would not be the last time in history that an attempt to buck the bond market would end in ruinous inflation and military humiliation.
The Medici Bank is pretty interesting. A while ago I wrote https://en.wikipedia.org/wiki/Medici_Bank on the topic; LWers might find it interesting how international finance worked back then.
From Ferguson’s The Ascent of Money:
More (#1) from The Ascent of Money:
And:
The Medici Bank is pretty interesting. A while ago I wrote https://en.wikipedia.org/wiki/Medici_Bank on the topic; LWers might find it interesting how international finance worked back then.