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Working paper MUNRO-01-02

John H. Munro, "The Origins of the Modern Financial Revolution: Responses to Impediments from Church and State in Western Europe, 1200 - 1600", 2001-07-11
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Abstract: The basic thesis is that the modern 'financial revolution', usually dated to eighteenth century England, but far more properly to the sixteenth-century Netherlands, in terms of those institutions for both government finance (borrowing) and international finance (bills of exchange), owed its essential origins to the impediments of Church and State that reached their harmful fruition in the later thirteenth and early fourteenth century. The major obstacle that came from the Church was of course the usury doctrine, and more accurately the final evolution of this doctrine in Scholastic theology and canon law, along with the intensification of the campaign against usury in the thirteenth century. The major obstacles that the State provided, with the spreading stain of ever more disruptive international warfare from the 1290s, was the development of nationalistic bullionist philosophies and of monetary-fiscal policies (to finance warfare) that hindered the international flow of specie in later medieval Europe. For public borrowing, one must begin with the contentious policies of Venice, Florence, and other Italian city states in basing their finances on forced loans, which did pay interest, and thus with the usury controversies that erupted, over not just the loans, but the sale of interest-bearing debt certificates in secondary markets. The alternative solution, found elsewhere - first in Flemish towns from the 1270s -- and one that would govern European public finance up to the nineteenth century, was to raise funds for urban governments through the sale of rentes, for one or more lifetimes (lijfrenten, erfelijkrenten). These were not loans, and hence they were not usurious, because the buyer of rentes had no expectation of repayment (unless the government chose to redeem them); instead they represented the purchase of a future stream of income, either lifetime or perpetual (heritable). Those rentiers who sought to regain some part of their invested capital had only one recourse: to seek out buyers in secondary markets. The true efficiency of modern public finance also rested upon the development of such markets and thus upon the development of full-fledged negotiablity; and public finance also depends upon satisfactory instruments to permit low risk, low cost international remittances. The solution to both problems lay in the development of the negotiable bill of exchange. Such bills, at first non-negotiable, emerged in the late thirteenth century as a response to circumvent not only the usury doctrine (to 'disguise' interest payments in the exchange rate) but also the almost universal bans on bullion exports. Yet another barrier that medieval English merchants faced was the virtual absence of deposit-banking because of the crown's strict monopoly on the coinage and money supply, so that the usual origin of such banking, in private money-changing, was unavailable. Although English merchants sought remedies by using transferable commercial bills, they were not truly negotiable, for they had no legal standing in Common Law courts. But from the late thirteenth century, the Crown was incorporating the then evolving international Law Merchant into statutory law, and it also established law merchant courts, which did give such financial instruments some legal standing. In 1437, a London law-merchant court was the first, in Europe, to establish the principle that the bearer of a bill of exchange, on its maturity, had full rights to sue the 'acceptor' or payer, on whom it was drawn, for full payment and to receive compensation for damages. From that precedent, and then from those provided by similar law-merchant court verdicts in Antwerp and Bruges (1507, 1527), the Estates General of the Habsburg Low Countries (1537-1541) produced Europe's first national legislation to ensure the full legal requirements of true negotiability - including the right to sue intervening assignees to whom bills had been transferred in payment. These Estates-General also legalized interest payments (up to 12%), thus permitting open discounting, another obviously essential feature of modern finance, private and public. Antwerp itself, with the foundation of its Bourse in 1531, became the international financial capital of Europe, especially as a secondary market in national rentes - the very instrument that became the foundation of English public finance, in the form of annuities, from the 1690s.

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