Mountains of Debt

'War', declared the ancient Greek philosopher Heraclitus, 'is the father of all things.' It was certainly the father of the bond market. In Pieter van der Heyden's extraordinary engraving, The Battle about Money, piggy banks, money bags, barrels of coins, and treasure chests - most of them heavily armed with swords, knives and lances - attack each other in a chaotic free-for-all. The Dutch verses below the engraving say: 'It's all for money and goods, this fighting and quarrelling.' But what the inscription could equally well have said is: 'This fighting is possible only if you can raise the money to pay for it.' The ability to finance war through a market for government debt was, like so much else in financial
history, an invention of the Italian Renaissance. 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 13 60s and 13 70s 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 Floren­ tine public as a tribute to his 'incomparable leadership'. Unlikely though it may seem, this master mercenary was an Essex boy
born and raised in Sible Hedingham. 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.

Pieter van der Heyden after Pieter Bruegel the Elder, The Battle

about Money, after 1570. The Dutch inscription reads: 'It's all

for money and goods, this fighting and quarrelling.'

Nevertheless, there was a limit to how many more or less unproductive wars could be waged in this way. The larger the debts of the Italian cities became, the more bonds they had to issue; and the more bonds they issued, the greater the risk that they might default on their commitments. Venice had in fact

developed a system of public debt even earlier than Florence, in the late twelfth century. The monte vecchio (Old Mountain) as the consolidated debt was known, played a key role in funding Venice's fourteenth-century wars with Genoa and other rivals. A new mountain of debt arose after the protracted war with the Turks that raged between 1 4 6 3 and 1 4 7 9 : the monte  nuovo.

Investors received annual interest of 5 per cent, paid twice yearly from the city's various excise taxes (which were levied on articles of consumption like salt). Like the Florentine prestanze, the Venetian prestiti were forced loans, but with a secondary market which allowed investors to sell their bonds to other investors for cash. In the late fifteenth century, however, a series of Venetian military reverses greatly weakened the market for prestiti. Having stood at 80 (20 per cent below their face value) in 1497 , the bonds of the Venetian monte nuovo were worth just 52 by 1500, recovering to 75 by the end of 1 5 0 2 and then collapsing from 102 to 40 in 1509. At their low points in the years 1509 to 1 5 2 9 ,

monte vecchio sold at just 3 and monte nuovo at i o . 

Now, if you buy a government bond while war is raging you are obviously taking a risk, the risk that the state in question may not pay your interest. On the other hand, remember that the interest is paid on the face value of the bond, so if you can buy a 5 per cent bond at just 1 0 per cent of its face value you can earn a handsome yield of 50 per cent. In essence, you expect a return proportional to the risk you are prepared to take. At the same time, as we have seen, it is the bond market that sets interest rates

for the economy as a whole. If the state has to pay 50 per cent, then even reliable commercial borrowers are likely to pay some kind of war premium. It is no coincidence that the year 1 4 9 9 , when Venice was fighting both on land in Lombardy and at sea against the Ottoman Empire, saw a severe financial crisis as bonds crashed in value and interest rates soared. Likewise, the bond market rout of 1509 was a direct result of the defeat of the Venetian armies at Agnadello. The result in each case was the same: business ground to a halt.

It was not only the Italian city-states that contributed to the rise of the bond market. In Northern Europe, too, urban polities grappled with the problem of financing their deficits without falling foul of the Church. Here a somewhat different solution was arrived at. Though they prohibited the charging of interest on a loan (mutuum), the usury laws did not apply to the medieval contract known as the census, which allowed one party to buy a stream of annual payments from another. In the thirteenth century,

such annuities started to be issued by northern French towns like Douai and Calais and Flemish towns like Ghent. They took one of two forms: rentes heritables or erfelijkrenten, perpetual revenue streams which the purchaser could bequeath to his heirs, or rentes viagères or lijfrenten, which ended with the purchaser's death. The seller, but not the buyer, had the right to redeem the rente by repaying the principal. By the mid sixteenth century, the sale of annuities was raising roughly 7 per cent of the revenues of the province of Holland.

With the Glorious Revolution of 1688, which ousted the Cath­olic James II from the English throne in favour of the Dutch Protestant Prince of Orange, these and other innovations crossed the English Channel from Amsterdam to London. The English fiscal system was already significantly different from that of the continental monarchies. The lands owned by the crown had been sold off earlier than elsewhere, increasing the power of parliaments to control royal expenditure at a time when their powers were waning in Spain, France and the German lands. There was already an observable move in the direction of a professional civil service, reliant on salaries rather than peculation. The Glorious Revolution accentuated this divergence. From now on there would be no more regular defaulting (the 'Stop of Exchequer' of 1 6 7 2 , when, with the crown deep in debt, Charles II had suspended payment of his bills, was still fresh in the memories of London investors). There would be no more debasement of the coinage, particularly after the adoption of the gold standard in 1 7 1 7 . There would be parliamen­tary scrutiny of royal finances. And there would be a sustained effort to consolidate the various debts that the Stuart dynasty had incurred over the years, a process that culminated in 1 7 4 9 with the creation by Sir Henry Pelham of the Consolidated Fund.

 This was the very opposite of the financial direction taken in France, where defaults continued to happen regularly; offices were sold to raise money rather than to staff the civil service; tax collection

was privatized or farmed out; budgets were rare and scarcely intelligible; the Estates General (the nearest thing to a French parliament) had ceased to meet; and successive controllers-general struggled to raise money by issuing rentes and tontines (annuities sold on the lives of groups of people) on terms that

were excessively generous to investors. In London by the mideighteenth century there was a thriving bond market, in which government consols were the dominant securities traded, bonds that were highly liquid - in other words easy to sell - and attrac­tive to foreign (especially Dutch) investors.

 In Paris, by contrast, there was no such thing. It was a financial divergence that would prove to have profound political consequences. Since it was arguably the most successful bond ever issued, it is

worth pausing to look more closely at the famed British consol. By the late eighteenth century it was possible to invest in two types: those bearing a 3 per cent coupon, and those bearing a 5 per cent coupon. They were otherwise identical, in that they were perpetual bonds, without a fixed maturity date, which could be bought back (redeemed) by the government only if their market price equalled or exceeded their face value (par). The illustration opposite shows a typical consol, a partially printed,

partially handwritten receipt, stating the amount invested, the face value of the security, the investor's name and the date:

Received this 2 2 Day of January 1 7 9 6 of Mrs. Anna Hawes the Sum of One hundred and one pounds being the Consideration for One hundred pounds Interest or Share in the Capital or Joint Stock of Five per Cent Annuities, consolidated July 6th, 1 7 8 5 . . . transferable at the Bank of England . . .

A 5 per cent con sol purchased by Anna Hawes in January 1796

The meteoric rise of a diminutive Corsican to be Emperor of Franee and master of the European continent was an event few could have predicted in 1796, least of all Mrs Anna Hawes. Yet an even more remarkable (and more enduring) feat of social mobility was to happen in almost exactly the same timeframe. Within just a few years of Napoleon's final defeat at Waterloo, a man who had grown up amid the gloom of the Frankfurt ghetto had emerged as a financial Bonaparte: the master of the bond

market and, some ventured to suggest, the master of European politics as well. That man's name was Nathan Rothschild.