Larry Neal's book delivers both more and less than the promise of its title. Why less? Chapter 2, “Distant Beginnings: The First 3,000 Years”—which might be called “From Babylon to Frederick Barbarossa”—is a mere (and sketchy) thirteen pages. I would direct anyone wanting a fuller treatment of those three millennia to William Goetzmann's equally excellent new book, Money Changes Everything: How Finance Made Civilization Possible (2016).
Why more? Once Neal gets to chapter 3, “The Italians Invent Modern Finance,” he hits his stride by delivering not only a detailed history of international finance from the Crusades to our most recent crises, but also an original and subtle analysis of why innovative finance usually succeeds but now and then fails to deliver beneficial economic outcomes. Neal thinks most folks, even economists and historians, underappreciate how financial innovations have “increased trade, enabled technical progress, and improved standards of living in general” (p. 2). Amen, says this reviewer—as, most likely, would Goetzmann and other financial historians.
The medieval Italian city-states, little republics in a world of emperors and monarchies, invented modern finance in part by inventing the first modern banks (“bank” derives from the Italian banco). Popes encouraged some banks to become international by using them to collect Church revenues in distant places, transmit them to Rome, and disburse the proceeds to near and far-off places at the Church's direction. But the key innovation, in Neal's view, was sovereign debt issued by the city-states that could be traded in markets—the first capital markets—and thus become a liquid asset. More important still, and Neal stresses this throughout the book, sovereign debt issued by governments was an ideal form of collateral its owners could post for loans from banks. So banks, money markets, capital markets, and government finance and regulation became complementary institutions realizing financial synergies. The modern “battle of the systems” over whether bank-based (e.g., continental Europe) or market-based (e.g., the “Anglosphere”) financial systems are better is ill-directed and now passé; banks and capital markets are complements, not substitutes. When banks, capital markets, and governments work in tandem, economies prosper. But sometimes financial innovations destabilize the entire system, causing temporary breakdowns we call financial crises.
From medieval and Renaissance Italy, Neal guides us successively through the financial innovations of the Netherlands, Great Britain, and the United States. Each of these key followers adopted and improved on the innovations of its predecessors. Spain, France, and Germany were less-innovative laggards that either failed to latch on to the synergies of the combination of banks, capital markets, and sovereign debt or did so quite late. It took centuries and numerous financial crises, Neal says, before the combination of financial institutions, markets, and instruments first developed in Italy became “accepted as the most desirable way for economies to operate” (p. 43).
By the second half of the nineteenth century, acceptance of the combination characterized most of the leading economies, and international financial coordination became based on the classical gold standard. The world prospered. But globalization collapsed in what Neal terms the Thirty Years War of 1914–1944, only to be revived under U.S. tutelage in the Bretton Woods era, from 1945 to 1973. Of course, Bretton Woods operated as intended for only about a decade, from the late 1950s to the late 1960s. It ended in turmoil, and that turmoil continued into the 1980s. Then in the developed world we had the Great Moderation—reductions of inflation and exchange rate fluctuations along with greater economic stability and growth—although punctuated by a few crises in emerging markets. That moderation ended harshly in 2007 in a world financial crisis, and growth still has not returned to precrisis levels. Neal's explanation for this, based on his historical analysis, is that so much good collateral—the sovereign bonds of leading economies—has been bought up by central banks that not enough of it is available for the rest of the financial system to function smoothly. It is a message that ought to be heeded by contemporary policymakers, who seem overly obsessed with fears of rising national debts, deflation, secular stagnation, and a “new normal.”
Neal's deft command of European—especially British, Dutch, and French—financial history is not quite matched when he discusses the United States. Rather than “discarding a vital element of Hamilton's system,” James Madison as president sided with his treasury secretary, Albert Gallatin, in supporting a renewed charter in 1811 for the first Bank of the United States (BUS), a central bank that, contrary to Neal's assertion, did not have “branch offices in each state” (pp. 141–42). It was Congress, reflecting narrow state-banking interests, and not Madison that ended the first BUS.
A quarter century later, another president, Andrew Jackson, did kill a later version of the central bank, the second BUS, after Congress had approved its rechartering. But that hardly “undid all of Hamilton's system” (p. 143). Federal government debt continued to be demanded (and to serve as collateral), the dollar stayed stable, and the American banking system, securities markets, and business corporations all continued to grow by leaps and bounds, all as Hamilton had intended. Even the central bank, in the form of the Federal Reserve System, returned eventually and is still with us a century later.
Finally, it seems a stretch to say that federal lands were “an ultimate resource for finance of the new government” and that after Jackson, “future revenues would come mainly from land sales, rather than rising customs revenues” (pp. 143, 182). Between 1790 and 1860, land-sale revenues exceeded customs revenues in just one year (1836) and, even then, by just a little. In most other years, customs revenues were vastly greater than land revenues.
These, however, are minor complaints. Neal's original account of the last millennium of international financial development represents the mature analysis of a seminal scholar and a major financial historian. Few people besides Neal could tie together so much history so neatly, concisely, and instructively.
