June 2010
Renaissance Leadership in Finance
and its Impact on Enterprise and the
Evolution of a Global Economy
“Banks and the bond market provided the material basis for the splendors of the Italian
Renaissance.”
—Niall Ferguson, The Ascent of Money (p.3)
For further details about Innovation Expedition Inc., see www.innovationexpedition.com
Insight Note
A. The Challenge
To trigger one’s initial understanding and continuing interest in the following
concept: One of the major functional drivers of any major Renaissance period
is the emergence of new types of financial organizations and instruments.
B. References in this Document are Drawn from The Ascent of Money
These notes are drawn primarily from a new book on this topic by Niall Ferguson
(The Ascent of Money) in which he sets out to: (i) cover the history of finance from
ancient Mesopotamia to modern microfinance; and (ii) illuminate the financial secrets
that he suggests lie behind most great historical phenomena. He weaves a wide
range of historical financial stores around some major insights he claims to have
gained from writing this book. Included in these insights are the following:
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“Poverty is not the result of rapacious financiers exploiting the poor. It has more
to do with the lack of financial institutions—not their presence.”
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“If the financial system has a weakness, it is that it reflects and magnifies our
emotional volatility and our tendency to overreact and to swing from exuberance
when things are going well to deep depression when they go wrong. It also
exaggerates the differences between the lucky and smart and the unlucky or notso-smart and with financial globalization the world can no longer be divided
neatly into rich developed countries and poor less developed countries. The
differences within all these countries is as significant as the differences between
countries.”
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“Because financial systems are so complex, with many non-linear relationships, it
is incredibly difficult to predict accurately the timing and magnitude of financial
crises. Financial history can be seen as a fast-paced classic case of evolution in
action. We are now in another period of evolutionary shift in which a number of
institutions in the global financial system are becoming extinct. It has never been
more necessary to break down the barriers between financial knowledge and
other knowledge and to better understand the ascent of money.”
C. The Birth of Banking in Renaissance Italy
“Banks and the bond market provided the material basis for the splendors of the Italian
Renaissance.”
—Niall Ferguson, The Ascent of Money (p.3)
Following an introduction to the early metals and tablets used as coinage and the emergence of the
highly unpopular moneylenders, we pick up his story of money in the 14th century with Ferguson’s
answer to the moneylenders’ question as to how they might overcome a fundamental conflict: “if they
were too generous, they make no money; if they were too hard-nosed—people eventually called in
the police” (p.14).
The answer, according to Ferguson, is to grow big and powerful, which meant establishing strong
banks.
In the early 14th century finance in Italy had been dominated by three Florentine houses, all of which
were wiped out in the 1340s as a result of defaults by two principal clients (King Edward III of the UK
and King Robert of Naples). This set the scene for the rise of the Medici family which demonstrated
the potential power of new types of financial institutions.
D. The Emergence of the Medici Bankers as Revered Community Leaders
Ferguson suggests: “Perhaps no other family left such an impact on an age as the Medici left on the
Renaissance. Two Medici became Popes (Leo X and Clement VII); two became Queens of France
(Catherine and Marie); three became Dukes (of Florence, Venice and Tuscany). Appropriately, it was
that supreme theorist of political power, Niccolò Machiavelli, who wrote their history. Their patronage
of the arts and sciences ran the gamut of genius, from Michelangelo to Galileo. And their dazzling
architectural legacy still surrounds the modern-day visitor to Florence” (p.41).
Ferguson acknowledges that prior to the 1390s, the Medici family was seen as a “small-time clan
notable more for low violence than for high finance” (p. 42). In 1385 Giovanni di Bicci de Medici
became manager of a Rome based lending group organized by one of the family’s moneylenders. His
aim was to make the Medici legitimate. As this was the age of multiple systems of coinage, any long
distance trade or tax payment was complicated by the need to convert from one currency to another.
Working with the papacy as a key client, he build a reputation as a currency trader.
Seeing even greater opportunities in his native Florence, he returned there in 1397 and began to
expand the family banking business from a base in Florence. In 1420 he passed on responsibility for
the family banking interests to his eldest son, Cosimo, and exhorted him and the other heirs to
maintain his standards of finances.
His son did him proud and by the time Pius II became Pope in 1458, Ferguson suggests that “Cosimo
de Medici effectively was the Florentine state” (p. 45). Ferguson supports this claim by quoting the
Pope himself. “Political questions are settled at his house. The man he chooses holds office—he it is
who decides peace and war an controls the laws…he is King in everything but name.”
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Ferguson also draws on the works of the modern-day Florentine historian, Francesco Guicciardini,
who observed, “He had a reputation such as probably no private citizen has ever enjoyed from the fall
of Rome to our own day” (p. 46).
Bankers who had been reviled for much of the world’s history were now close to divinity. Ferguson
supports this idea by informing us that the three wise men in Botticelli’s “Adoration of the Magi” are all
members of the Medici family—the painting was commissioned by the head of the Bankers’ Guild as
a tribute to the family.
E. Innovations in Finance Stimulated by the Italian Renaissance (the Evolution of Banking)
This amazing public success was essentially all based on the Medici’s innovations in banking which
involved the following:
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A recognition that size was important in establishing a powerful banking enterprise—in the
first three decades of the 15th century, the family (led first by Giovanni and then by his son
Cosimo) established branches in Florence, Venice and Rome, and acquired interest in two wool
factories. Later, branches were added in Genoa, Pisa, London and Avignon
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Skill in refining the use of bills of exchange for financing trade—this concept, which
appeared in the middle ages, allowed creditors to draw a bill on the debtor and either use this bill
as a means of payment in its own right or obtain case for it at a discount from a banker willing to
act as a broker. While usury (charging interest) was condemned by the Church, a shrewd trader,
making oral deals with no cheques and keeping a careful personal record, could make profits on
such transactions. This was the essence of the Medici business.
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Expanded and disciplined application of new bookkeeping techniques—the Medici did not
invent double-entry bookkeeping (which appeared in Genoa in the 1340s) or the book of creditors
and debtors, but they did practice neat, orderly, meticulous bookkeeping and applied the new
techniques on a larger scale than had been seen in Florence before.
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A focus on diversification—“The real key to the Medici’s success,” Ferguson claims, “was not
so much size as diversification.” They were determined not to emulate the monolithic structure of
most earlier Italian banks which led to the possibility of collapse through the default of one or two
major clients. The Medici bank was organized as multiple, related partnerships with branch
managers as junior partners who were remunerated with a share of the profits. This
decentralization helped the Medici bank to become extremely profitable with branches often
earning annual profits of over 30 percent.
Through their leadership in creating the largest and most diversified bank ever seen in Europe, the
Medici could spread their risks. And by engaging in currency trading as well as lending, they reduced
their exposure to crippling defaults.
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F. Impact of the Innovative Italian Banks on the broader European Renaissance
Ferguson outlines the wider impact of the Medici banks by stating that, “The Italian banking system
became the model for those North European nations that would achieve the greatest commercial
success in the coming centuries, notably the Dutch, the English but also the Swedes. It was in
Amsterdam, London and Stockholm that the next decisive wave of financial innovations occurred as
the forerunners of modern central banks made their first appearance” (p.48).
He then goes on to describe the foundation in the 17th century of three distinctly novel institutions
that, in their different ways, were intended to serve a public as well as a private financial function.
1. The Amsterdam Exchange Bank (1609)—established in 1609 to resolve the practical problems
faced by merchants because of the circulation of multiple currencies. By allowing them to set up
accounts posted in a standardized currency, the Exchange Bank pioneered the system of
cheques and direct transfers that functions today.
This bank maintained close to a 100 percent ratio between its deposits and its reserves of
precious metal and coins. While this ensured that no “run on the bank” would occur, “it prevented
it performing what would now be seen as the defining characteristic of a bank—credit creation”
(p.49).
2. Stockholm Riksbank (1656)—this credit creation barrier was broken by this Swedish bank. It
operated as both an exchange bank and as a lending bank and it pioneered what became
known as fractional banking (i.e., it assumed not all depositors would ask to redeem their
deposits at the same time so it kept only a fraction of their deposits on hand at any time and lent
out the rest.
3. Bank of England (1694)—designed primarily to assist the government with war financing (by
converting the government’s debt into shares of the bank), this bank was given privileges—to be
the only bank to operate on a joint stock basis—and later it was given a potential monopoly on
the issuance of banknotes (most other European nations followed this British model of
establishing a central bank).
These three banking innovations, which began in the Italian Renaissance, of: (a) cashless
intrabank and interbank transactions; (b) fractional reserve banking; and (c) central bank
monopolies on the issuance of banknotes had accelerated the nature of money from its early
position of involving physical objects (i.e. coins or precious metals) and turned it into the
basis of the modern monetary system wherein the relationships between debtors and
creditors were brokered by increasingly numerous financial institutions called banks.
According to Ferguson, “the core functioning of these institutions was now information
gathering and risk taking” (p.51).
The financial revolution preceded the Industrial Revolution. While Ferguson would not claim that the
economic growth in England and on the continent after the 17th century was mainly due to the
banking innovations, the two processes were interdependent and self-reinforcing.
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He goes on to stress that, “credit and debt, in short, are among the essential building blocks of
economic development as vital to creating the wealth of nations as mining, manufacturing or
mobile telephony” (p.53). The evolution of banking which was stimulated in a major way by the
Italian Renaissance is positioned by Ferguson as the essential first step in the ascent of money.
G. Innovations in Finance Stimulated the Italian Renaissance: The Emergence of a Bond Market
After creation of credit by the banks, Ferguson sees the birth of the bond as the second great
revolution in the ascent of money, reminding readers of a quote from the Greek philosopher,
Heraclitus, suggesting “war is the father of all things.” Ferguson proclaims, “it was certainly the father
of the bond market” (p.69).
For much of the 14th and 15th centuries the medieval city states of Tuscany—Florence, Pisa and
Siena—were involved in costly wars with each other or with other Italian towns. The armies were
organized by mercenary contractors hired by the governments of the city states and the cities which
could mobilize the most money (such as Florence) tended to attract the best contractors.
Nonetheless, these wars led cities such as Florence to borrow huge sums of money to cover their
“mountain of debt.” The innovation in Florence was that it turned its citizens into its biggest investors
by obliging them to lend money to their city’s government. Since these were obligatory loans, interest
payments were then not considered usury by the Church and thus escaped the censure of the
Church.
A critical feature of the Florentine system was that such loans (bonds) could be sold to other citizens
and thus become relatively liquid assets. The more bonds any city issued, the greater the risk that
they might default on their commitments—trust in repayment was critical. A secondary market arose
as investors were all quick to sell their bonds for cash. If the bonds were used to pay for wares, as
they often were, then the investor was obviously taking a risk that the state might not pay the interest.
Since the interest was paid on the face value of the bond, then if you could buy the bond at a
discount, even with small bond interest rates, you could make a large return. The bond market
began to set interest rates for the economy as a whole.
One reason why the system worked so well in Florence was that many of the bonds were purchased
by the leading families (the Medicis and their friends) and that these wealthy families also controlled
the city’s government and hence its finances. Thus others were attracted to Florence’s bonds
believing the risk of default to be low.
The concept of a bond market spread to Northern Europe and the UK from Italy with variations on the
original model. The success of the UK model in London as compared with the model applied in Spain
and France was to have profound political consequences—and led to the emergence in the early 19th
century of a new powerful family force in finance—the Rothschilds.
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Once again the financing of major wars offered the opportunity for financial innovation. Ferguson
goes on to document these innovations with war examples from the Napoleonic wars to the American
Civil War. Through most of these stories, members of the Rothschild family play important roles and
they established themselves as the dominant players in an increasingly international London bond
market. Ferguson notes, “To an extent that even today remains astonishing, the Rothschilds went on
to dominate international finance in the half century after Waterloo” (p.86).
A distinguishing feature of the London bond market after 1815 was the Rothschilds’ insistence that
most borrowers issue bonds in Sterling as opposed to their own currencies and make payments
either in London or in other markets where the Rothschilds had branches.
Ferguson recounts fascinating stories of how the leading family elites of Europe (Rothschild, Baring,
Gladstone) became socially, politically and economically intertwined and to a significant extent
shaped these agendas, including the success of liberal reform efforts and the ability of a country to
engage in war and win (see the story of how the Rothschilds’ decision not to buy Confederate bonds
during the American Civil War helped set the stage for the collapse of the South’s economy and its
eventual defeat). He then explains that what ended the dominance of these elite financiers was not
the rise of democracy or socialism but “a fiscal and monetary catastrophe for which the European
elites were themselves responsible. That catastrophe was the first World War” (p.100) and the
explosion of inflation.
This was not the end of a global bond market however. In the last quarter of the 20th century
technological innovations, the globalization of most economies and the relocation of production to low
wage economies in Asia meant most goods became cheaper and most countries were able to control
inflation. In this manner the bond market which began in the Italian Renaissance resurfaced as a
dominant force and the constituencies with an interest in bonds grew enormously.
In the conclusion to this section in his book (Ascent of Money), Ferguson turns our attention from
the bond market for government debt “to its younger and in many ways more dynamic sibling:
the market for shares in corporate equity, known colloquially as the stock market” (p.118).
H. Innovations in Finance Stimulated by the Italian Renaissance: The Joint-Stock Company and
the Stock Market
After the advent of banking and the birth of the bond market the next major step in the ascent of
money was the rise of the joint-stock company and a related innovation—the stock market.
“Invented almost exactly 400 years ago, the joint-stock limited company is indeed a miraculous
institution as is the stock market where its ownership can be bought and sold” (p.174).
Ferguson outlines how building on the Italian lessons, the Renaissance had taken hold in
Amsterdam, which by the 1690s had become the world capital of financial innovation. The Dutch had
improved on the Italian system of public debt and had reformed their currency by creating the world’s
first central bank, the Amsterdam Exchange Bank which solved the problem of debased coinage by
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creating a reliable form of bank money. But Ferguson argues that, “perhaps the single greatest Dutch
invention of all was the joint-stock company” (p.127).
The first such company (United Dutch Chartered East Company / VOC) was formally created in 1602.
(Note: About the same time a similar company was being created in England, the East India
Company.) The origins of the Dutch VOC were in the efforts of Dutch merchants to wrest control of
the lucrative Asian spice trade from Portugal and Spain and the company was to enjoy a monopoly
on all Dutch trade east of the Cape of Good Hope and west of the Straits of Magellan.
Subscription was open to all Dutch residents with no upper limit on how much was raised. This capital
was needed to build the permanent bases and fortifications necessary to triumph over their
Portuguese and Spanish rivals. Investors were given receipts (the forerunner of stock certificates),
their contribution was noted in a company stock ledger book and shareholders stood to lose only their
investment in the company and no other assets in the event that it failed. The capital of the company
was divided among six regional geographic chambers and ownership was divided accordingly into
multiple “partijen/actiers” (getting a piece of the action). The top investors were also distributed
between these chambers and one of their roles was to appoint 17 people to act as the Lords
Seventeen—a kind of company board.
The original plan had been to liquidate the company in 1612 when the original investors could get
their capital back. Instead the Lords Seventeen (who had paid a dividend in 1611) announced that the
company would not be liquidated in 1612. This meant that investors who wanted their cash back had
no alternative but to sell their shares to another investor. Thus a secondary market (the stock market)
sprang up to allow these shares to be bought and sold.
The VOC market proved to be a remarkably liquid market and a lively futures market emerged which
allowed sales for future deliver. To begin with, share transactions were done in informal open-air
markets but soon a covered “Beurs” was built. Ferguson describes the original building as looking like
a medieval Oxford college in terms of its architecture. “But what went on there between noon and two
o’clock each workday was recognizably revolutionary” (p.1321). He draws on the words of a
contemporary who described the closing moments of a session in this manner.
“Hand shakes are followed by shouting, insults, impudences, pushing and shoving.
Bulls (liefhebbers) did battle with bears (contremines). The anxious spectator chews
his nails, pulls his fingers, closes his eyes, takes four paces and four times to talk to
himself, raises his hand to his cheek as if he has a toothache and all this
accompanied by a mysterious coughing.” (p.132)
Part of the story of the stock market is the historical volatility of the market, the attraction it provides to
fraudulent manipulators and the regular appearance of stock bubbles where a period of rising stock
prices suddenly leads to a crash such as the South Sea Company bubble in the UK, crafted by John
Blount and the French bubble arising from the amazing stock manipulation of John Law. (See the
fascinating story of the ambitious Scot, John Law, “a convicted murderer, a compulsive gambler and
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a flawed financial genius—and the man who invented the stock market bubble” (p.126), who in 1719
had managed to be appointed Controller General of Finances for France which put him in charge of:
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the collection of all of France’s indirect taxes
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the entire French national debt
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the 26 French mints that produced the country’s gold and silver coins
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the Colony of Louisiana
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the Mississippi Company which had a monopoly on the import and sale of tobacco
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the French fur trade with Canada
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all of France’s trade with Africa, Asia and East India
Reviewing his amazing control, Ferguson notes that while “Louis XIV of France had said, ‘l'etat, c'est
moi’ (I am the state), John Law could legitimately say ‘l’economie, c’est moi’ (I am the economy).”
This 18th century stock market crash sets the scene for Ferguson’s description of a number of
bubbles and crashes over the next few hundred years right up to the present. As part of this story he
draws a comparison between the confident, creative, fraudulent work of John Law with similar efforts
by Kenneth Lay of Enron in the late 20th century.
While praising the contribution of joint-stock companies and the stock market to the growth of
individual enterprises and national economies, Ferguson acknowledges that throughout this history
there have been crooked companies and irrational markets. ”Indeed, the two go hand-in-hand, for it is
when the bulls are stampeding most enthusiastically that people are most likely to get taken for the
proverbial ride” (p.174).
Ferguson notes the importance of central banks in controlling the stampede and points to the
emergence of insurance in providing some balance for major risks in the market. But he emphasizes
that the major reason for the volatility of the market is that it reflects the volatility in human behaviour.
“So long as human expectations of the future veer from the over-optimistic to the over-pessimistic—
from greed to fear—stock prices will tend to trace an erratic path” (p.174).
“I remain more than ever convinced that, until we fully understand the origin of financial
species we shall never fully understand the fundamental truth about money; that far from
being a ‘monster that must be put back in its place’ as the German president recently
complained, financial markets are like the mirror of mankind, revealing every hour of
every working day the way we value ourselves and the resources of the world around us.
It is not the fault of the mirror if it reflects our blemishes as clearly as our beauty.” (p.358)
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