Polarities of Exchange

The history of capitalism, in so far as it’s something that emerged out of developments in Italian bookkeeping, is broadly a history of the bill of exchange. This versatile instrument dominated the financial landscape of the West for some 800 years, from the First Crusade on the eve of the 12th century until the First World War at the start of the 20th. Surely, if we are to understand the emergence of the capitalist system, its history and origins, we must study the bill of exchange, and the network of exchange it enabled. Alas, even acclaimed accounts of the history of finance and capitalism get basic facts wrong,¹ while others pay brief lip-service to the importance of the bills.²

Fortunately, there is a foundational literature that seeks to unravel the mystery of the bills.³ And PhDs continue to be written to untangle the records of the medieval Italian bankers who wielded them.⁴ But this literature is dense, fragmented, and incomplete. The story is only told in pieces. Many links are missing. As a result, outside the specialized literature, and perhaps even at times within, confusion tends to abound.

Why should we care about the bills? The bills make up the fabric of the international banking system, from its emergence in the 12th c to its maturity in the 20th, before they are finally supplanted (really, gobbled) by central bank mediated markets in government debt. The bills, and especially the crisis of the 1570s, forms the backdrop for the rise of central banking and the modern monetary constitution. One might observe that the 20th century is the culmination of a near millennium long battle between bills of exchange and government debt instruments - between financing commerce and financing government. Public finance won. But what have we lost? Studying the bills offers a way to answer the question.

The story of the bills is a story of doing more with less, of reducing the need for money to move, of facilitating balanced credit relations that can net or “clear” against each other with no money needed. The story of public finance is a story of just doing more, of a steady increase in money, of permanent imbalances. In the world of the bills, the best money is the money that didn’t need to appear at all (the bills clear). In the world of public finance, the best money is the liabilities of the central bank.

So where did all these banks come from? We predominantly think of banks as institutions of credit, but the origin of banking is in exchange. The word banking comes from the Italian banco, the tables at which certain merchants sat where they offered to exchange different currencies. These merchants were the bancheri (the bankers). We’d call them money changers. The same phenomenon goes back to ancient Greece, their words trapezai (table) and trapezitai (banker). Thus the first bankers were those who would swap your coins. Naturally, some people began leaving their coins with the bankers for safe keeping, and hence the role of deposit developed, and with it the capacity for bankers to effect payments “on their books”. But the origin of the phenomenon is exchange.

There are really two different types of exchange - local and international. Local exchange is done at the benches with small time local firms that deal in coins, deposits, and local payments. They deal in different monies, here and now. But international exchange is a another story - it’s the world of the premier Italian merchant bankers who facilitated long distance exchange, trading money here and now for money elsewhere and later. This type of banking was much bigger and more complicated business than the local money changers, requiring international corporate infrastructure and double-entry bookkeeping. This was the type of banking that didn’t emerge in the ancient world, but came specifically out of medieval Italy. These international firms came to dominate the world of money and finance. And their instrument? The bill of exchange.

In later posts we’ll get into the details of what the bill of exchange actually was, though this changed significantly over time. Because of its international nature, it was both an instrument of exchange (across space), and a granting of credit (across time). In its simplest and earliest form it was a way for a merchant to borrow from a banker in one place (say Genoa, denominated in Genoese money) and to repay in another place (say Champagne, denominated in the money of Champagne). But it also came to be used by exporters to collect on payments owed to them from importers abroad. In the first case the merchant was borrowing to expand his balance sheet and pursue new business. But in the second case he’s not really borrowing, he’s just trying to get paid for old business by selling the money already owed to him abroad.

This difference is the source of a great deal of confusion in the literature regarding which “direction” the bill went, namely, whether it was really a bill (issued by an existing creditor, like an exporter, saying “you owe me, here’s the bill”) or a note (issued by a debtor, “i owe you”). In both cases the merchant drawing the bill gives it to a banker in exchange for local money. But the distinction is important because it reflects a difference in where the credit actually originates and how the credit extension is managed in the banking system. As we’ll see, unlike bills, notes can circulate more easily, and unlike notes, bills can “hide” the potentially blasphemous credit nature of the instrument (lending with interest was mostly illegal for much of this period, but exchange was not).

The problem is that what we call bills of exchange through history sometimes appear to go one way, and sometimes the other. My thesis is that the archetypal polarity actually did reverse, and it did so twice, over the long near millennium of its life, from note to bill and back again.⁵ These polarity reversals occurred, roughly speaking, around 1300 and 1600, and they carve the history into three broad epochs, between which the function of the bill of exchange, and the wider exchange network it supported, was materially distinct. Each epoch is further separated by a transition period marked by a great crisis, which transformed the political and economic environment.

Studying the bills thus allows us to understand the broader structure of the history of finance and capitalism, and how it evolved over these three major phases. In the first phase, the early period, ~1100-1300, what’s referred to as a “bill of exchange” was actually a note, a promise to pay by a debtor. And it was primarily an instrument designed for use with a trade fair, most notably the Fairs of Champagne, where the payment was actually due. These notes were formally notarized and non-transferable. I suggest that the primary purpose of this instrument was for Italians to fetch silver home from Champagne. This period was indeed marked by a flood of new silver from mines across Europe. The period culminates in the crisis of the 1290s.

In the second phase, the classical period, ~1300-1600, the bill of exchange was more properly a bill, at least in its archetypal form - it’s an order to pay, issued by a creditor, to a correspondent abroad that owes him money. As we’ll see it’s more flexible than this, but this archetypal form gave the network a distinct purpose from that of the first period. The bill was still non-transferable, but it’s no longer notarized. One could say these instruments enabled complex and mature management of liquidity across the network of bankers, but they were not liquid (“negotiable”) in themselves. Their primary purpose appears to have been to enable a new kind of international corporation to systematically profit by perpetually “running balances on exchange”, even in the absence of a great fair or the movement of silver. Indeed, the period is marked by a major shortage of silver (until it pours in from the New World). Central fairs did return in the 15th c, climaxing in 16th c Lyons, but the rise of continuous exchange centers like London, Bruges, Paris, Avignon, etc. outside the cycle of the fairs gave the exchange network a very different flavour. The Spanish silver influx ultimately seems to have destroyed the system in the crisis of the 1570s. Out of its ashes rose the Central Banks and a new kind of money market.

In the third phase, the later period of ~1600-1900, the bill again came to resemble a note, a pledge by a debtor to pay. This transformation developed as bills became negotiable, in that they could be accepted by multiple parties, who agreed to be liable for them. Chains of acceptances gave the bills the ability to circulate as, basically, notes, promises to pay by their issuer (in this case, anyone who had accepted it!). Thus they became liquid in their own right, giving rise to discounting markets, where merchants could buy bills at a discount before they’re due, earning the discount as yield. Notably, in this period, the bills also lost the quality of exchange, being denominated in a single currency. That they were still called bills of exchange, even as they came to resemble notes and to lose any element of exchange, is indeed a major source of confusion about their history and operation. This is also the period during which their use was liberated from the monopolization by Italian merchant bankers during a long transition through Antwerp and Amsterdam, pulling silver in from the new world and ultimately landing in London. In London, their primary purpose became to finance the slave trade and the investment capital represented therein. It was in this context that Central Banks grew up, in the discount market for bills of exchange. The system came to a globally devastating end in the First World War, out of which the bills never recovered. The bills retreated into the world of trade financing and invoice factoring, and government debt swallowed the banking system.

One important historical undercurrent through all this is the Church doctrine on usury, which, in its most basic form, made it illegal to issue interest-bearing notes (and thus also made discounting illegal). The usury doctrine is best understood as a kind of financial regulation that varied by time and place, and had a real effect on institutional structures, despite everyone seeking to overcome it (think tax regulation and tax planning today). Notably, Church doctrine on usury strengthens ~1300, and weakens ~1600, in broad alignment with our periods. Many scholars have emphasized the extent to which the archetypal bill of our classical period is decidedly legal and yet able to disguise usurious transactions in numerous ways. One might suppose that what we are seeing is the emergence of a formal credit instrument first as a note, then its temporary disguise as a bill for 300 years under pressure from the Church, and finally its re-emergence as a note once the Church’s prohibitions are relieved. And indeed, this is a part of the story, but it’s also too simplistic. The Church was already strengthening usury prohibitions in the 1100s, and the earliest instruments already seem to be trying to conceal interest. It’s certainly true that the Protestant Reformation and the great weaking of usury laws ~1600 enabled the bills to become notes again. But the epochs themselves also seem to be marked by distinct material conditions that were independent of Church usury doctrine - in particular, the availability of silver - and the form of the bill served primarily a function in relation to those material conditions. That said, as we will see, the Church’s role as a participant in the system, a remitter of funds from foreign realms to the papal treasury, and a receiver of actual precious metal, plays a critical role in the system’s evolution. Indeed, it might even appear that the entire purpose of the international exchange system in the classical period was to finance the Church.

Before wrapping up this intro, a word about money. For much of this history, money was precious metal, either in bullion or physical coins. And the entire story of the bills is one anchored in the dynamics of this precious metal money, yet structured so as to eliminate as much as possible the need for it. Moving metal is expensive, moving paper is cheap. The bankers of the 16th c and earlier managed to facilitate huge volumes of trade with little to no money at all, without any central repositories of collateral or reserve. It was when they got too tied up in the problems of financing government that their system was usurped by government run central banks in the 17th c. The first great innovation of these new banks was to issue a new kind of credit backed by a centralized reserve of precious metal. Their second great innovation was to eliminate the need for the metal all together.

This problem of where money comes from is central to the structure of society. It’s part of the constitution. Money is how we account for the world and denominate value. Today we take for granted that money comes from banks and central banks, whatever that means. But we’re also currently witnessing a historic re-valuation in the precious metals, with significant demand from central banks. The structure of the monetary system is changing. In all likelihood, the metals matter again. In all likelihood, crypto matters too. Exactly how is anyone’s guess. Perhaps the past is a useful guide.

Thus we wish to explore this history, of that 800 year dance between the financing of trade and the financing of sovereigns, told through the eyes of the instrument that lubricated it all, the bill of exchange.