For much of the fourteenth and fifteenth centuries, the medieval city-states
of Tuscany – Florence, Pisa and Siena – were at war with each other or with
other Italian towns. This was war waged as much by money as by men. Rather
than require their own citizens to do the dirty work of fighting, each city
hired military contractors (condottieri) who raised armies to annex
land and loot treasure from its rivals. Among the condottieri of the
1360s and 1370s one stood head and shoulders above the others. His
commanding figure can still be seen on the walls of Florence’s Duomo - a
painting originally commissioned by a grateful Florentine public as a
tribute to his “incomparable leadership”.
Unlikely though it may seem, this master mercenary was an Essex boy. So
skilfully did Sir John Hawkwood wage war on their behalf that the Italians
called him Giovanni Acuto, John the Acute. The Castello di Montecchio
outside Florence was one of many pieces of real estate the Florentines gave
him as a reward for his services.
Yet Hawkwood was a mercenary, who was willing to fight for anyone who would
pay him, including Milan, Padua, Pisa or the Pope. Dazzling frescos in
Florence’s Palazzo Vecchio show the armies of Pisa and Florence clashing in
1364, at a time when Hawkwood was fighting for Pisa. Fifteen years later,
however, he had switched to serve Florence, and spent the rest of his
military career in that city’s employ. Why? Because Florence was where the
money was.
The cost of incessant war had plunged Italy’s city-states into crisis.
Expenditures even in years of peace were running at double or more of tax
revenues. To pay the likes of Hawkwood, Florence was drowning in deficits.
You can still see in the records of the Tuscan State Archives how the city’s
debt burden increased a hundredfold from 50,000 florins at the beginning of
the fourteenth century to 5 million by 1427. It was literally a mountain of
debt – hence its name: the monte commune or communal debt
mountain. By the early fifteenth century, borrowed money accounted for
nearly 70 per cent of the city’s revenue. The “mountain” was equivalent to
more than half the Florentine economy’s annual output.
From whom could the Florentines possibly have borrowed such a huge sum? The
answer is, from themselves. Instead of paying a property tax, wealthier
citizens were effectively obliged to lend money to their own city
government. In return for these forced loans (prestanze), they
received interest. Technically, this was not usury (which was banned by the
Church) since the loans were obligatory; interest payments could therefore
be reconciled with canon law as compensation (damnum emergens) for
the real or putative costs arising from a compulsory investment.
As Hostiensis (or Henry) of Susa put it in about 1270: “If some merchant, who
is accustomed to pursue trade and the commerce of fairs, and there profit
from, has, out of charity to me, who needs it badly, lent money with which
he would have done business I remain obliged to his interesse” (note this
early use of the term ‘interest’).
A crucial feature of the Florentine system was that such loans could be sold
to other citizens if an investor needed ready money; in other words, they
were relatively liquid assets, even though the bonds at this time were no
more than a few lines in a leather-bound ledger. In effect, then, Florence
turned its citizens into its biggest investors. By the early fourteenth
century, two thirds of households had contributed in this way to financing
the public debt, though the bulk of subscriptions were accounted for by a
few thousand wealthy individuals.
Ferguson looks at the truth behind the Rothschilds’ involvement with the
Battle of Waterloo.
According to a long-standing legend, the Rothschild family owed the first
millions of their fortune to Nathan’s successful speculation about the
effect of the outcome of the battle on the price of British bonds. In some
versions of the story, Nathan witnessed the battle himself, risked a Channel
storm to reach London before the official news of Wellington’s victory and,
by buying bonds ahead of a huge surge in prices, pocketed between £20
million and £135 million.
Wellington famously called the Battle of Waterloo “the nearest run thing you
ever saw in your life”. After a day of brutal charges, countercharges and
heroic defence, the belated arrival of the Prussian army finally proved
decisive. For Wellington, it was a glorious victory. Not so for the
Rothschilds. No doubt it was gratifying for Nathan Rothschild to receive the
news of Napoleon’s defeat first, thanks to the speed of his couriers, nearly
48 hours before Major Henry Percy delivered Wellington’s official despatch
to the Cabinet. No matter how early it reached him, however, the news was
anything but good from Nathan’s point of view. He had expected nothing as
decisive so soon. Now he and his brothers were sitting on top of a pile of
gold that nobody needed – to pay for a war that was over. With the coming of
peace, the great armies that had fought Napoleon could be disbanded, the
coalition of allies dissolved. That meant no more soldiers’ wages and no
more subsidies to Britain’s wartime allies. The price of gold, which had
soared during the war, would be bound to fall. Nathan was faced not with the
immense profits of legend but with heavy and growing losses.
But there was one possible way out: the Rothschilds could use their gold to
make a hugely risky bet on the bond market. On July 20, 1815, the evening
edition of the London Courierreported that Nathan had made “great
purchases of stock”, meaning British government bonds. Nathan’s gamble was
that the British victory at Waterloo, and the prospect of a reduction in
government borrowing, would send the price of British bonds soaring upwards.
Nathan bought more and, as the price of consols duly began to rise, he kept
on buying. Despite his brothers’ desperate entreaties to realise profits,
Nathan held his nerve for another year. Eventually, in late 1817, with bond
prices up more than 40 per cent, he sold. Allowing for the effects on the
purchasing power of sterling of inflation and economic growth, his profits
were worth about £600 million today. It was one of the most audacious trades
in financial history, one which snatched financial victory from the jaws of
Napoleon’s military defeat.
The stock market collapse of 1914 shows surprising parallels with events of
today’s credit crunch, Ferguson writes.
Financial markets had initially shrugged off the assassination by Gavrilo
Princip of the heir to the Austrian throne, the Archduke Franz Ferdinand, in
Sarajevo, the Bosnian capital, on June 28, 1914. Not until July 22 did the
financial press express any serious anxiety that the Balkan crisis might
escalate into something bigger and more economically threatening. When
investors belatedly grasped the likelihood of a full-scale European war,
however, liquidity was sucked out of the world economy as if the bottom had
dropped out of a bath.
The first symptom of the crisis was a rise in shipping insurance premiums in
the wake of the Austrian ultimatum to Serbia (which demanded, among other
things, that Austrian officials be allowed into Serbia to seek evidence of
Belgrade’s complicity in the assassination). Bond and stock prices began to
slip as prudent investors sought to increase the liquidity of their
positions by shifting into cash. European investors were especially quick to
start selling their Russian securities, followed by Americans. Exchange
rates went haywire as a result of efforts by cross-border creditors to
repatriate their money: sterling and the franc surged, while the rouble and
dollar slumped.
By July 30 panic reigned on most financial markets. The first firms to come
under pressure in London were the so-called jobbers on the Stock Exchange,
who relied heavily on borrowed money to finance their purchases of equities.
As sell orders flooded in, the value of their stocks plunged below the value
of their debts, forcing a number (notably Derenberg & Co.) into
bankruptcy. Also under pressure were the commercial bill brokers in London,
many of whom were owed substantial sums by continental coun-terparties now
unable or unwilling to remit funds. Their difficulties in turn impacted on
the acceptance houses (the elite merchant banks), who were first in line if
the foreigners defaulted, since they had accepted the bills. If the
acceptance houses went bust, the bill-brokers would go down with them, and
possibly also the larger joint-stock banks, which lent millions every day
short-term to the discount market.
The joint-stock banks’ decision to call in loans deepened what we would now
call the credit crunch. As everyone scrambled to sell assets and increase
their liquidity, stock prices fell, compromising brokers and others who had
borrowed money using shares as collateral. Domestic customers began to fear
a banking crisis. Queues formed as people sought to exchange banknotes for
gold coins at the Bank of England. The effective suspension of London’s role
as the hub of international credit helped to spread the crisis from Europe
to the rest of the world.
Perhaps the most remarkable feature of the crisis of 1914 was the closure of
the world’s main stock markets for periods of up to five months. The Vienna
market was the first to close (on July 27). By July 30 all the continental
European exchanges had shut their doors. The next day London and New York
felt compelled to follow suit. Although a belated settlement day went ahead
smoothly on 18 November, the London Stock Exchange did not reopen until
January 4, 1915. Nothing like this had happened since its foundation in
1773. The New York market reopened for limited trading (bonds for cash only)
on November 28, but wholly unrestricted trading did not resume until April
1, 1915.
Nor were stock exchanges the only markets to close in the crisis. Most US
commodity markets had to suspend trading, as did most European foreign
exchange markets. The London Royal Exchange, for example, remained shut
until September 17. It seems likely that, had the markets not closed, the
collapse in prices would have been as extreme as in 1929, if not worse. No
act of state-sponsored terrorism has had greater financial consequences than
Gavrilo Princip’s in 1914.
© Niall Ferguson 2008 Extracted from The Ascent of Money , published by
Penguin on October 30 at £25. Copies can be ordered for £22.50 with free
delivery from The Times BooksFirst on 0870-160-8080
