Part II of IV—A Brief History of World Credit & Interest Rates
by Martin A. Armstrong
500 AD-1700 AD
The fate of the Roman Empire of the West had been cast with the sack of Rome in 410 AD by the Goths followed by the Vandals in 455 AD. What was once Rome was divided with the Franks in Gaul (France), Visigoths in Spain, Angles, Saxons and Jutes in Britain and theOstrogoths followed later by the Lombards in Italy. However, the barbarians had long admired Roman culture and subsequently became civilized. Much of the Roman culture and monetary system was thereby retained. While many of these new barbarian states continued to mint coinage in Roman style and denomination, eventually gold began to disappear from the money supply to be replaced by silver coinage in the form of a denier, denaro, phenig and penny all taking their name from the old Roman denarius.
The Byzantine Empire was certainly not immune to crisis concerned debt. The moneylenders and moneychangers were quite unpopular. They were forbidden to hold public office as time went by. The empress Sophia in 567 A.D. summoned the moneylenders before her and confiscated all agreements to, and pledges of, debt thereby simply forgiving all debts – a move that was obviously welcomed by the populace.
By the year 622, the Arab nations were on the rise. They had conquered Egypt, Syria and Persia and in 669 they took Asia Minor by storm. In 698, the Arab armies captured even Carthage and followed with an invasion of Spain in the year 711. The Arab goal to conquer the balance of Europe was finally thwarted at the Battle of Tours in 732. Nevertheless, the Arabs controlled the Mediterranean, which had essentially cut off all trade in Western Europe. The economy diverted to one of agriculture and mercantilism died a quite death. Cut off from world trade, the Latin tongue began to disappear and the emergence of independent languages began throughout Western Europe.
This was the atmosphere that history has labeled the “Dark Ages” and while coinage existed, the lack of commerce and increased hoarding had seriously reduced circulation. It was the rise of Charlemagne that brought light to this dark period in man’s history. Much of the circulating currency was still old Roman coins. Charlemagne brought forth a great monetary reform that has survived into our present day. He introduced the “denier” which was a silver coin eventually referred to as a penny. Twelve of these silver pennies equaled one “sou” which later became known as a shilling in many parts of Europe. Twenty shillings equaled one pound.
The Capitularies of Charlemagne, circa 800 A.D., also dealt with the issue of credit. Undoubtedly, this legal code had been highly influenced by the severe inflationary trends and debt crises that had plagued the final years of the Roman Empire. The charge of interest on loans was strictly forbidden. It was during this period when the evils of excessive debt were viewed not only as destructive socially but as a sin under church law known as usury. Any exception to this view on charging interest remained highly controversial for the following thousand years well into the Middle Ages.
The tenth century was a period of slow advance. While much of central Europe did not benefit, the Venetians gained major concessions in trade from Constantinople and the uptrend in trade brought with it wealth. Moneylenders in Venice were actually respected while banking facilities re-emerged out of the need to finance maritime ventures. The Vikings began to settle back into the position of traders rather than raiders and secure a dominant role in maritime trade between Northern Europe and the Mediterranean. Meanwhile, the Arab power, that had dominated the previous century and brought about the Dark Ages in Western European culture, gave way to decay. By the eleventh century, the Europeans were pushing the Arabs out of Sicily and Sardinia. By 1096, the First Crusade had re-established Italian dominance in the Mediterranean once again.
Nonetheless, the eleventh century was not void of its speculations and inflations. Currency was in a constant state of confusion and the practice of debasing the precious metal content, which had been absent in the West since the final days of Rome, reappeared. Merchants became wealthy enough that they emerged as the new bankers capable of lending to the king. The economic power of Venice had continued to expand and more sophisticated financial transactions, such as insurance, began to emerge.
Records of interest rates in Western Europe during this time are hard to find. When transactions were recorded, most have not survived unlike the clay tablets of Babylon. But documents have survived largely beginning with the late twelfth century. Of the evidence that has emerged, again we find that interest rates were rather high in poor nations, such as Britain, and significantly lower in the major trading nations. Although interest rates in Britain were 43% per annum or much higher, it must be kept in mind that long-term loans were not the norm. Interest rates were typically quoted on a weekly basis – 2 pence on the pound per week (43 1/3% per annum). This was the going rate for the best-secured loan. Those with poor collateral or credit were paying 80-120% per annum.
The thirteenth century was an age of accelerated economic expansion. The Mongol conquest of Asia played the final role in destroying the Arab Empire. This also opened the door for trade with China and it was the era of Marco Polo. Genoa rose to challenge Venice and Florence emerged as the strong international banking center. But even in the thirteenth century, the credit of merchants and landowners was viewed to be much better than that of government. Nobles were on the decline and much of the land became freehold.
Interest rates to a prince were often 30-40% as in the case of the Emperor Frederic II. Legal limits on interest rates began to rise once again. In Modena, the maximum rate was set at 20% while in Milan and Genoa the maximum rate was established at 15%. The trading cities remained quite wealthy and the legal maximum rates of interest were typically much less. In Verona, the maximum rate was 12.5% while in Sicily it was set at 10%. The maximum legal rate in Britain, however, remained at 43 1/3%. Germany perhaps had the highest during this period – 173%.
The prosperity of the thirteenth century brought with it inflation and speculation once again. Commodity speculating was common and many bankers participated with depositor’s funds. Currency was still being debased and new gold coinage was struck in Florence (florin) and in Venice (ducat). Economic prosperity had reached it peak.
The fourteenth century brought with it the Hundred Years War and the Black Plague. Both the kings of England and France defaulted on their national debts and most of the banks in Italy went broke. Financial chaos had become so widespread that in Venice, the bankers were forbidden from speculating in commodities and the government required that two fifths of all deposits be invested in the public debt. The world economy was in severe decline. Interest rates during the fourteenth century rose dramatically. Italy often charged 50% on loans to the once prosperous Netherlands and questionable loans demanded rates of interest as much as 100% per annum.
The fifteenth century was one of transition and expansion. The early part of this century still suffered from periodic plagues and the evils of unsound finance. But the wealth of nations also began to shift. Both the Dutch and English began to emerge as important international traders. In the central part of Europe, the cities of Geneva, Augsburg and Nuremberg rose in importance serving as the trade bridge between the new economic powers of the Dutch and English linking them with the Italians. Florence regained her glory and the Medici Bank of that city became the largest in Europe with branch offices scattered throughout Europe and into Northern Africa and Levant. Venice, however, continued to lead in trade ahead of Genoa.
Contemporary writers of the era have recorded much of the atmosphere. Once again this century brought forth the re-emergence of the capitalist. These were individuals who were extremely wealthy and no longer needed to be merchants or traders. They profited as moneylenders and were held in high esteem once again. This set the tone for a new age of capitalism. Trade was no longer the main goal – everyone wanted to acquire more money instead of land. This was a similar atmosphere that had existed in Socrates day. Nations sought new gold deposits more so than trade, which resulted in wars that were often fought for financial consideration.
The credit of government or the crown was still very dubious. In both France and England loans to the crown were forced upon the people who were paid no interest whatsoever. This quickly laid the foundation for greater organized taxation that followed in the centuries thereafter. Those who were willing to lend to the crown did so at high rates of interests. Charles VIII of France was reported to have paid 42% to 100% on a loan to the Genoa banking house of Sauli to fund his invasion of Italy after the Medici refused.
Commercial business rates declined from the 10-12% range in Italy down to 5%-8%. The emergence of local savings and loans known as “montes pietatis” were formed in many towns beginning around 1462. The montes pietatis were intended to provide much more reasonable rates charging 6% in comparison to the normal pawn rates of 32.5%-43.5%. Some pawnshops during this period were legally limited to 20% as was the case in Florence.
The sixteenth century was a powerful period in time. This was the century that opened the world leading with the discovery of the Americas. But the vast hoards of precious metals brought back from the Americas created sharp increases in inflation. Commodity prices rose dramatically – nearly 300% during 1550 to 1620. England, Spain and France all competed for dominance in the Americas and in Europe. This rapid rise in inflation and the loss of a monopoly on trade through the Mediterranean caused a decline in Italian influence. Royal debtors defaulted on the Italian banks and Italy was on its way toward becoming a second class economic power.
Despite the fact that usury laws still prevailed in church doctrine, the expansion of debt was prolific. Much of the debt was incurred for war. There were but only 25 years during this century when large-scale wars in Europe were absent. Local towns and cities had gained in credit worthiness and when funds ran out, the crown exploited the credit of the towns and cities sending most of them into financial ruin.
There was a sufficient quantity of debt issued from around Europe that the first major exchange emerged in Antwerp. The exchange grew to 5000 members and bills of exchange, bonds, demand notes, deposit certificates and credit instruments of all sorts were traded back and forth daily. An exchange emerged trading commodities in Antwerp and the city became the new financial capital of Europe with hundreds of ships visiting its port each day.
The ravages of debt were soon to worsen. Antwerp was forced into default by the unsound finances of the Spanish Crown in 1570. In 1576, unpaid Spanish mercenary armies sacked Antwerp and the exchange was destroyed. The marauding armies also sacked Rome and financial chaos grew. The financial turmoil in Italy and Spain, combined with the surge in inflation, aided greatly in creating the Protestant Reformation.
The French & Spanish Defaults
During the seventeenth century, the practices of unsound finance finally took their toll. The Crowns of Spain and France defaulted on all their debts and they destroyed their Italian and German bankers in the process. In fact Spain defaulted on her debts in 1607, 1627 and again in 1649. Despite the seemingly rich gold and silver flows coming from the New World, everything had been pledged as collateral often five to ten years in advance. All the gold and silver flowed straight to the Genoa bankers and the Spanish money supply became greatly debased and reduced to a mere copper standard.
The Spanish default destroyed the Fuggers who had risen during the sixteenth century to be perhaps the largest banker up until that time. They were located in Augsburg and had been the first great German bankers with a reported capital base of 5 million guilders. This once great banking establishment was completely ruined by the defaults of Spain.
The French defaults were also dramatic. There were two main periods of severe debt crisis in France in 1589 and 1648. The crisis of 1648 essentially destroyed the remaining Italian bankers – primarily Florentines. An exchange in Paris had emerged in 1639 where credit instruments traded regularly. The French government “rentes” (perpetual loans) traded rather well until the debt crisis of 1648. The French finances were again reformed where interest rates on previous government notes was arbitrarily reduced to 5% while other perpetual notes were simply paid off at a fraction of the previous agreements.
Out of this turmoil, the Dutch gained independence from Spain. The southern provinces had been given to Spain in 1598 as a dowry for the daughter of Philip II who history recalls as Isabella. Quickly after independence, the Dutch built a trading empire instituting new rules and banking practices that would serve as a model for other nations decades later. Germany went through the Thirty Year’s War (1618-1648) which was largely a struggle between Protestant and Catholic factions. This kept Germany as a collection of small states and the demise of the Fugger banking house more or less sealed the fate of Germany during this period in time.
England was ruled by the Stuarts and practiced reasonably sound finance in comparison to that of France and Spain. Gresham had revised the finances of the British government actually instilling a sense of honor to finance. His famous law for which he is best known, bad money drives out good, struck at the heart of depreciating currencies through debasement. Another major advantage of Britain was that it stayed away from foreign moneylenders for the most part. This helped to concentrate wealth within the domestic economy. However, England had practiced the art of forced loans to the Crown so one should not look upon England as a well managed affair during this period. Debts began to rise but the practice of forced loans came to an end under Charles II during the last quarter of this century.
The phrase most commonly used for two people going out to dinner when each party pays their own way is “going dutch.” This saying has its roots in the seventeenth century. The small Dutch Republic fought wars against England and France. The French actually invaded Holland but were defeated when the Dutch opened the dikes. But a large part of the success of the Dutch was owed to their efficient credit system within which even the government enjoyed honorable status and low interest rates.
The efficient Dutch government brought much faith and prosperity. There was more capital in Holland than borrowers. Speculation emerged as always whenever capital has concentrated to such an extent. The first stock market trading emerged in Amsterdam in 1613. Debt issues began trading on the exchange in 1672. Of course one has to mention the famous Tulip Speculation. The highest recorded price paid for a single tulip bulb took place in 1636 for the incredible sum of 4600 florins. In 1985 U.S. dollars, this would be close to $460,000 using gold at $400 per ounce.
The financial transformation of Britain came with the revolution of 1688. Previously, the Stuarts and Tudors restricted and controlled affairs. England never had a significant bank, exchange or organized money market and its national debt was never organized either. As capital began to concentrate during the later part of the seventeenth and primarily during the eighteenth century, prosperity and the emergence of the capitalist developed.
Prior to the revolution of 1688, banking began to evolve in the form of goldsmiths. These chaps quickly began to learn what the Italian bankers had discovered more than a hundred years before that only a small portion of the deposits needed to be retained to cover withdrawals. The large part of the deposits could be lent for interest or invested. Goldsmiths began to pay interest on deposits once this was discovered. But still many of the most prominent goldsmiths were ruined when Charles II suspended all payments on his debts to them in 1672.
Nonetheless, English banking contributed to the evolution of the industry. Checks were known to have been used dating as far back as the 1670’s. Receipts for deposits of gold with the goldsmiths circulated as paper money transferring assets from one person to another without physically handling the gold. The charging of interest had been considered to be a sin under the Catholic Church doctrine. Most Italian bankers got around this through clever means of disguising the interest as foreign exchange fees or transfer costs. In Britain, however, there were legal limitations on how much interest could be charged, but there were no laws against usury. Therefore, the receipts and contracts of debt circulated much more freely since they were drafted in British pounds rather than in some confusing foreign exchange contango.