The Financial Revolution in Medieval and Early Modern Europe

It is well known that a financial revolution occurred in European economies from the late Middle Ages onwards. Both the financial system and financial asset markets became much more complex and recognisably modern.

I sketch that revolution below in these main points:

(1) There was a renewed religious opposition to usury from the 13th century, especially from the Franciscan and Dominican orders, and affirmed in the Four Lateran Council (1215). This renewed outbreak of religious hostility to usury forced secular authorities to enforce the laws against the interest-bearing money loans, and, paradoxically, the open money loans at interest that had been seen in earlier Medieval times tended to disappear (Munro 2003: 507). The campaign against usury culminated in the early 14th century, and is reflected in Dante’s Divine Comedy, where usurers are imagined in the lowest, worst depths of hell (Munro 2003: 510).

(2) The harsh anti-usury culture encouraged financial innovations to evade the laws. Private debtors and creditors disguised their money loans at interest in the form of sale contacts for some good sold below the present market price and later resold at a higher price (the so-called contractus mohatrae). Another invention was the bill of exchange, a debt instrument where interest was disguised by charging a higher exchange rate in favour of the lender (Munro 2003: 542).

Another area where finance became much more developed was in government borrowing.

Often limited at first to city states and municipal government, government borrowing was one of the causes of the financial revolution of Early Modern Europe.

In Northern Europe, city and municipal governments began to issue special financial contracts, as follows:

(1) the bail à rente, the sale of real estate or fixed property in return for a perpetual annual income, and

(2) the constitution de rente (“annuity purchase”) or rente à prix d’argent (“annuity for money”), by which the property holder sold the right to receive a fixed annual income from his property or real asset to some investor, even though the original property holder retained the ownership rights to his property (Munro 2003: 519). This was the most significant innovation for the financial history of Europe.

It was in Holland and Spain that financial instruments of the second type became very significant: in Holland, there were renten issued by the Dutch provinces to raise revenue, and in Habsburg Spain the monarchy issued juros al quittar, perpetual but redeemable instruments yielding 5% in the later 16th century (Munro 2003: 536).

Both these instruments were assignable or transferable, and it was the development of secondary asset markets for these debts that can be seen as a fundamental cause of the invention of modern financial markets: the Antwerp bourse (opened in 1531) and Amsterdam bourse (established in 1608) were centres for the trading not only of commodities, but also of Dutch renten and Spanish juros al quittar, the precursors of modern government debt (Munro 2003: 541–542, 557).

By the 18th century, government debt annuities – such as the British “Consolidated Annuities” or “Consols,” a form of perpetual bond – had become a major part of financial asset markets and a source of collateral for merchants and industrialists (Munro 2003: 560).

(3) the next step was the creation of legal sanctions for and protections of the negotiability (or transferability) of debt.

This development was aided by the creation of laws for negotiability of bills of exchange, which originally had no legal standing (Munro 2003: 545).

An important step was the emergence full negotiability of debt instruments: this requires that a debt instrument can be made “payable to bearer” or “payable to order” without the necessary consent of the original debtor, so that third parties can accept it as a means of payment and legally enforce their claims on the original debtor (Munro 2003: 546).

Between 1537 and 1543, this was accomplished in the Netherlands, and even earlier in England for bills of exchange in the case of Burton vs Davy (1436) (Munro 2003: 551, 554).

A further step in England was to make all internal promissory notes fully negotiable in 1704 (Munro 2003: 556).

(4) the abolition of Medieval laws against usury soon followed: interest of up to 12% per annum was allowed in Holland in 1543, and up to 10% in England from 1545 (although this was temporarily repealed from 1552–1571; Munro 2003: 554).

(5) The last element of modern financial systems is deposit banking on fractional reserves: this emerged in the northern Italian city states from the late Middle Ages, Holland from the late 16th and early 17th centuries, and England in the mid-17th century (Munro 2003: 547–548).

A final observation I will make is that assignable and then fully negotiable debt instruments, when transferred to third parties and used to effect purchases of goods, have added to the money supply of Western economies for centuries: the West, ever since the Middle ages really, has had an elastic money supply.

Long before fractional reserve banknotes, bills of exchange and promissory notes have been used alongside strict commodity money.

Addendum
There is a fascinating post here by Matias Vernengo on the economic history of the Soviet Union:

“The Soviet Economy: Lessons for Developing Countries,” Naked Keynesianism, March 4, 2013.

Part of the argument is that the Soviet collapse in the 1980s was partly to do with external economic factors that also caused severe crisis in certain Third World nations.


BIBLIOGRAPHY

Munro, John H. 2003. “The Medieval Origins of the Financial Revolution: Usury, Rentes, and Negotiability,” The International History Review 25.3: 505–562.