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A History of Futures Trading in the United States

Joseph Santos, South Dakota State University

Many contemporary [nineteenth century] critics were suspicious of a form of business in which one man sold what he did not own to another who did not want it… Morton Rothstein (1966)

Anatomy of a Futures Market

The Futures Contract

A futures contract is a standardized agreement between a buyer and a seller to exchange an amount and grade of an item at a specific price and future date. The item or underlying asset may be an agricultural commodity, a metal, mineral or energy commodity, a financial instrument or a foreign currency. Because futures contracts are derived from these underlying assets, they belong to a family of financial instruments called derivatives.

Traders buy and sell futures contracts on an exchange – a marketplace that is operated by a voluntary association of members. The exchange provides buyers and sellers the infrastructure (trading pits or their electronic equivalent), legal framework (trading rules, arbitration mechanisms), contract specifications (grades, standards, time and method of delivery, terms of payment) and clearing mechanisms (see section titled The Clearinghouse) necessary to facilitate futures trading. Only exchange members are allowed to trade on the exchange. Nonmembers trade through commission merchants – exchange members who service nonmember trades and accounts for a fee.

The September 2004 light sweet crude oil contract is an example of a petroleum (mineral) future. It trades on the New York Mercantile exchange (NYM). The contract is standardized – every one is an agreement to trade 1,000 barrels of grade light sweet crude in September, on a day of the seller’s choosing. As of May 25, 2004 the contract sold for $40,120=$40.12x1000 and debits Member S’s margin account the same amount.

The Clearinghouse

The clearinghouse is the counterparty to every trade – its members buy every contract that traders sell on the exchange and sell every contract that traders buy on the exchange. Absent a clearinghouse, traders would interact directly, and this would introduce two problems. First, traders. concerns about their counterparty’s credibility would impede trading. For example, Trader A might refuse to sell to Trader B, who is supposedly untrustworthy.

Second, traders would lose track of their counterparties. This would occur because traders typically settle their contractual obligations by offset – traders buy/sell the contracts that they sold/bought earlier. For example, Trader A sells a contract to Trader B, who sells a contract to Trader C to offset her position, and so on.

The clearinghouse eliminates both of these problems. First, it is a guarantor of all trades. If a trader defaults on a futures contract, the clearinghouse absorbs the loss. Second, clearinghouse members, and not outside traders, reconcile offsets at the end of trading each day. Margin accounts and a process called marking-to-market all but assure the clearinghouse’s solvency.

A margin account is a balance that a trader maintains with a commission merchant in order to offset the trader’s daily unrealized loses in the futures markets. Commission merchants also maintain margins with clearinghouse members, who maintain them with the clearinghouse. The margin account begins as an initial lump sum deposit, or original margin.

To understand the mechanics and merits of marking-to-market, consider that the values of the long and short positions of an existing futures contract change daily, even though futures trading is a zero-sum game – a buyer’s gain/loss equals a seller’s loss/gain. So, the clearinghouse breaks even on every trade, while its individual members. positions change in value daily.

With this in mind, suppose Trader B buys a 5,000 bushel soybean contract for $9.70 from Trader S. Technically, Trader B buys the contract from Clearinghouse Member S and Trader S sells the contract to Clearinghouse Member B. Now, suppose that at the end of the day the contract is priced at $9.71. That evening the clearinghouse marks-to-market each member’s account. That is to say, the clearinghouse credits Member B’s margin account $50 and debits Member S’s margin account the same amount.

Member B is now in a position to draw on the clearinghouse $50, while Member S must pay the clearinghouse a $50 variation margin – incremental margin equal to the difference between a contract’s price and its current market value. In turn, clearinghouse members debit and credit accordingly the margin accounts of their commission merchants, who do the same to the margin accounts of their clients (i.e., traders). This iterative process all but assures the clearinghouse a sound financial footing. In the unlikely event that a trader defaults, the clearinghouse closes out the position and loses, at most, the trader’s one day loss.

Active Futures Markets

Futures exchanges create futures contracts. And, because futures exchanges compete for traders, they must create contracts that appeal to the financial community. For example, the New York Mercantile Exchange created its light sweet crude oil contract in order to fill an unexploited niche in the financial marketplace.

Not all contracts are successful and those that are may, at times, be inactive – the contract exists, but traders are not trading it. For example, of all contracts introduced by U.S. exchanges between 1960 and 1977, only 32% traded in 1980 (Stein 1986, 7). Consequently, entire exchanges can become active – e.g., the New York Futures Exchange opened in 1980 – or inactive – e.g., the New Orleans Exchange closed in 1983 (Leuthold 1989, 18). Government price supports or other such regulation can also render trading inactive (see Carlton 1984, 245).

Futures contracts succeed or fail for many reasons, but successful contracts do share certain basic characteristics (see for example, Baer and Saxon 1949, 110-25; Hieronymus 1977, 19-22). To wit, the underlying asset is homogeneous, reasonably durable, and standardized (easily describable); its supply and demand is ample, its price is unfettered, and all relevant information is available to all traders. For example, futures contracts have never derived from, say, artwork (heterogeneous and not standardized) or rent-controlled housing rights (supply, and hence price is fettered by regulation).

Purposes and Functions

Futures markets have three fundamental purposes. The first is to enable hedgers to shift price risk – asset price volatility – to speculators in return for basis risk – changes in the difference between a futures price and the cash, or current spot price of the underlying asset. Because basis risk is typically less than asset price risk, the financial community views hedging as a form of risk management and speculating as a form of risk taking.

Generally speaking, to hedge is to take opposing positions in the futures and cash markets. Hedgers include (but are not restricted to) farmers, feedlot operators, grain elevator operators, merchants, millers, utilities, export and import firms, refiners, lenders, and hedge fund managers (see Peck 1985, 13-21). Meanwhile, to speculate is to take a position in the futures market with no counter-position in the cash market. Speculators may not be affiliated with the underlying cash markets.

To demonstrate how a hedge works, assume Hedger A buys, or longs, 5,000 bushels of corn, which is currently worth $2.40 per bushel, or $12,000=$2.40×5000; the date is May 1st and Hedger A wishes to preserve the value of his corn inventory until he sells it on June 1st. To do so, he takes a position in the futures market that is exactly opposite his position in the spot – current cash – market. For example, Hedger A sells, or shorts, a July futures contract for 5,000 bushels of corn at a price of $2.50 per bushel; put differently, Hedger A commits to sell in July 5,000 bushels of corn for $12,500=$2.50×5000. Recall that to sell (buy) a futures contract means to commit to sell (buy) an amount and grade of an item at a specific price and future date.

Absent basis risk, Hedger A’s spot and futures markets positions will preserve the value of the 5,000 bushels of corn that he owns, because a fall in the spot price of corn will be matched penny for penny by a fall in the futures price of corn. For example, suppose that by June 1st the spot price of corn has fallen five cents to $2.35 per bushel. Absent basis risk, the July futures price of corn has also fallen five cents to $2.45 per bushel.

So, on June 1st, Hedger A sells his 5,000 bushels of corn and loses $250=($2.35-$2.40)x5000 in the spot market. At the same time, he buys a July futures contract for 5,000 bushels of corn and gains $250=($2.50-$2.45)x5000 in the futures market. Notice, because Hedger A has both sold and bought a July futures contract for 5,000 bushels of corn, he has offset his commitment in the futures market.

This example of a textbook hedge – one that eliminates price risk entirely – is instructive but it is also a bit misleading because: basis risk exists; hedgers may choose to hedge more or less than 100% of their cash positions; and hedgers may cross hedge – trade futures contracts whose underlying assets are not the same as the assets that the hedger owns. So, in reality hedgers cannot immunize entirely their cash positions from market fluctuations and in some cases they may not wish to do so. Again, the purpose of a hedge is not to avoid risk, but rather to manage or even profit from it.

The second fundamental purpose of a futures market is to facilitate firms’ acquisitions of operating capital – short term loans that finance firms’ purchases of intermediate goods such as inventories of grain or petroleum. For example, lenders are relatively more likely to finance, at or near prime lending rates, hedged (versus non-hedged) inventories. The futures contact is an efficient form of collateral because it costs only a fraction of the inventory’s value, or the margin on a short position in the futures market.

Speculators make the hedge possible because they absorb the inventory’s price risk; for example, the ultimate counterparty to the inventory dealer’s short position is a speculator. In the absence of futures markets, hedgers could only engage in forward contracts – unique agreements between private parties, who operate independently of an exchange or clearinghouse. Hence, the collateral value of a forward contract is less than that of a futures contract.3

The third fundamental purpose of a futures market is to provide information to decision makers regarding the market’s expectations of future economic events. So long as a futures market is efficient – the market forms expectations by taking into proper consideration all available information – its forecasts of future economic events are relatively more reliable than an individual’s. Forecast errors are expensive, and well informed, highly competitive, profit-seeking traders have a relatively greater incentive to minimize them.

The Evolution of Futures Trading in the U.S.

Early Nineteenth Century Grain Production and Marketing

Into the early nineteenth century, the vast majority of American grains – wheat, corn, barley, rye and oats – were produced throughout the hinterlands of the United States by producers who acted primarily as subsistence farmers – agricultural producers whose primary objective was to feed themselves and their families. Although many of these farmers sold their surplus production on the market, most lacked access to large markets, as well as the incentive, affordable labor supply, and myriad technologies necessary to practice commercial agriculture – the large scale production and marketing of surplus agricultural commodities.

At this time, the principal trade route to the Atlantic seaboard was by river through New Orleans4; though the South was also home to terminal markets – markets of final destination – for corn, provisions and flour. Smaller local grain markets existed along the tributaries of the Ohio and Mississippi Rivers and east-west overland routes. The latter were used primarily to transport manufactured (high valued and nonperishable) goods west.

Most farmers, and particularly those in the East North Central States – the region consisting today of Illinois, Indiana, Michigan, Ohio and Wisconsin – could not ship bulk grains to market profitably (Clark 1966, 4, 15).5 Instead, most converted grains into relatively high value flour, livestock, provisions and whiskies or malt liquors and shipped them south or, in the case of livestock, drove them east (14).6 Oats traded locally, if at all; their low value-to-weight ratios made their shipment, in bulk or otherwise, prohibitive (15n).

The Great Lakes provided a natural water route east to Buffalo but, in order to ship grain this way, producers in the interior East North Central region needed local ports to receive their production. Although the Erie Canal connected Lake Erie to the port of New York by 1825, water routes that connected local interior ports throughout northern Ohio to the Canal were not operational prior to the mid-1830s. Indeed, initially the Erie aided the development of the Old Northwest, not because it facilitated eastward grain shipments, but rather because it allowed immigrants and manufactured goods easy access to the West (Clark 1966, 53).

By 1835 the mouths of rivers and streams throughout the East North Central States had become the hubs, or port cities, from which farmers shipped grain east via the Erie. By this time, shippers could also opt to go south on the Ohio River and then upriver to Pittsburgh and ultimately to Philadelphia, or north on the Ohio Canal to Cleveland, Buffalo and ultimately, via the Welland Canal, to Lake Ontario and Montreal (19).

By 1836 shippers carried more grain north on the Great Lakes and through Buffalo, than south on the Mississippi through New Orleans (Odle 1964, 441). Though, as late as 1840 Ohio was the only state/region who participated significantly in the Great Lakes trade. Illinois, Indiana, Michigan, and the region of modern day Wisconsin either produced for their respective local markets or relied upon Southern demand. As of 1837 only 4,107 residents populated the “village” of Chicago, which became an official city in that year (Hieronymus 1977, 72).7

Antebellum Grain Trade Finance in the Old Northwest

Before the mid-1860s, a network of banks, grain dealers, merchants, millers and commission houses – buying and selling agents located in the central commodity markets – employed an acceptance system to finance the U.S. grain trade (see Clark 1966, 119; Odle 1964, 442). For example, a miller who required grain would instruct an agent in, say, New York to establish, on the miller’s behalf, a line of credit with a merchant there. The merchant extended this line of credit in the form of sight drafts, which the merchant made payable, in sixty or ninety days, up to the amount of the line of credit.

With this credit line established, commission agents in the hinterland would arrange with grain dealers to acquire the necessary grain. The commission agent would obtain warehouse receipts – dealer certified negotiable titles to specific lots and quantities of grain in store – from dealers, attach these to drafts that he drew on the merchant’s line of credit, and discount these drafts at his local bank in return for banknotes; the local bank would forward these drafts on to the New York merchant’s bank for redemption. The commission agents would use these banknotes to advance – lend – grain dealers roughly three quarters of the current market value of the grain. The commission agent would pay dealers the remainder (minus finance and commission fees) when the grain was finally sold in the East. That is, commission agents and grain dealers entered into consignment contracts.

Unfortunately, this approach linked banks, grain dealers, merchants, millers and commission agents such that the “entire procedure was attended by considerable risk and speculation, which was assumed by both the consignee and consignor” (Clark 1966, 120). The system was reasonably adequate if grain prices went unchanged between the time the miller procured the credit and the time the grain (bulk or converted) was sold in the East, but this was rarely the case. The fundamental problem with this system of finance was that commission agents were effectively asking banks to lend them money to purchase as yet unsold grain. To be sure, this inadequacy was most apparent during financial panics, when many banks refused to discount these drafts (Odle 1964, 447).

Grain Trade Finance in Transition: Forward Contracts and Commodity Exchanges

In 1848 the Illinois-Michigan Canal connected the Illinois River to Lake Michigan. The canal enabled farmers in the hinterlands along the Illinois River to ship their produce to merchants located along the river. These merchants accumulated, stored and then shipped grain to Chicago, Milwaukee and Racine. At first, shippers tagged deliverables according to producer and region, while purchasers inspected and chose these tagged bundles upon delivery. Commercial activity at the three grain ports grew throughout the 1850s. Chicago emerged as a dominant grain (primarily corn) hub later that decade (Pierce 1957, 66).8

Amidst this growth of Lake Michigan commerce, a confluence of innovations transformed the grain trade and its method of finance. By the 1840s, grain elevators and railroads facilitated high volume grain storage and shipment, respectively. Consequently, country merchants and their Chicago counterparts required greater financing in order to store and ship this higher volume of grain.9 And, high volume grain storage and shipment required that inventoried grains be fungible – of such a nature that one part or quantity could be replaced by another equal part or quantity in the satisfaction of an obligation. For example, because a bushel of grade No. 2 Spring Wheat was fungible, its price did not depend on whether it came from Farmer A, Farmer B, Grain Elevator C, or Train Car D.

Merchants could secure these larger loans more easily and at relatively lower rates if they obtained firm price and quantity commitments from their buyers. So, merchants began to engage in forward (not futures) contracts. According to Hieronymus (1977), the first such “time contract” on record was made on March 13, 1851. It specified that 3,000 bushels of corn were to be delivered to Chicago in June at a price of one cent below the March 13th cash market price (74).10

Meanwhile, commodity exchanges serviced the trade’s need for fungible grain. In the 1840s and 1850s these exchanges emerged as associations for dealing with local issues such as harbor infrastructure and commercial arbitration (e.g., Detroit in 1847, Buffalo, Cleveland and Chicago in 1848 and Milwaukee in 1849) (see Odle 1964). By the 1850s they established a system of staple grades, standards and inspections, all of which rendered inventory grain fungible (Baer and Saxon 1949, 10; Chandler 1977, 211). As collection points for grain, cotton, and provisions, they weighed, inspected and classified commodity shipments that passed from west to east. They also facilitated organized trading in spot and forward markets (Chandler 1977, 211; Odle 1964, 439).11

The largest and most prominent of these exchanges was the Board of Trade of the City of Chicago, a grain and provisions exchange established in 1848 by a State of Illinois corporate charter (Boyle 1920, 38; Lurie 1979, 27); the exchange is known today as the Chicago Board of Trade (CBT). For at least its first decade, the CBT functioned as a meeting place for merchants to resolve contract disputes and discuss commercial matters of mutual concern. Participation was part-time at best. The Board’s first directorate of 25 members included “a druggist, a bookseller, a tanner, a grocer, a coal dealer, a hardware merchant, and a banker” and attendance was often encouraged by free lunches (Lurie 1979, 25).

However, in 1859 the CBT became a state- (of Illinois) chartered private association. As such, the exchange requested and received from the Illinois legislature sanction to establish rules “for the management of their business and the mode in which it shall be transacted, as they may think proper;” to arbitrate over and settle disputes with the authority as “if it were a judgment rendered in the Circuit Court;” and to inspect, weigh and certify grain and grain trades such that these certifications would be binding upon all CBT members (Lurie 1979, 27).

Nineteenth Century Futures Trading

By the 1850s traders sold and resold forward contracts prior to actual delivery (Hieronymus 1977, 75). A trader could not offset, in the futures market sense of the term, a forward contact. Nonetheless, the existence of a secondary market – market for extant, as opposed to newly issued securities – in forward contracts suggests, if nothing else, speculators were active in these early time contracts.

On March 27, 1863, the Chicago Board of Trade adopted its first rules and procedures for trade in forwards on the exchange (Hieronymus 1977, 76). The rules addressed contract settlement, which was (and still is) the fundamental challenge associated with a forward contract – finding a trader who was willing to take a position in a forward contract was relatively easy to do; finding that trader at the time of contract settlement was not.

The CBT began to transform actively traded and reasonably homogeneous forward contracts into futures contracts in May, 1865. At this time, the CBT: restricted trade in time contracts to exchange members; standardized contract specifications; required traders to deposit margins; and specified formally contract settlement, including payments and deliveries, and grievance procedures (Hieronymus 1977, 76).

The inception of organized futures trading is difficult to date. This is due, in part, to semantic ambiguities – e.g., was a “to arrive” contract a forward contract or a futures contract or neither? However, most grain trade historians agree that storage (grain elevators), shipment (railroad), and communication (telegraph) technologies, a system of staple grades and standards, and the impetus to speculation provided by the Crimean and U.S. Civil Wars enabled futures trading to ripen by about 1874, at which time the CBT was the U.S.’s premier organized commodities (grain and provisions) futures exchange (Baer and Saxon 1949, 87; Chandler 1977, 212; CBT 1936, 18; Clark 1966, 120; Dies 1925, 15; Hoffman 1932, 29; Irwin 1954, 77, 82; Rothstein 1966, 67).

Nonetheless, futures exchanges in the mid-1870s lacked modern clearinghouses, with which most exchanges began to experiment only in the mid-1880s. For example, the CBT’s clearinghouse got its start in 1884, and a complete and mandatory clearing system was in place at the CBT by 1925 (Hoffman 1932, 199; Williams 1982, 306). The earliest formal clearing and offset procedures were established by the Minneapolis Grain Exchange in 1891 (Peck 1985, 6).

Even so, rudiments of a clearing system – one that freed traders from dealing directly with one another – were in place by the 1870s (Hoffman 1920, 189). That is to say, brokers assumed the counter-position to every trade, much as clearinghouse members would do decades later. Brokers settled offsets between one another, though in the absence of a formal clearing procedure these settlements were difficult to accomplish.

Direct settlements were simple enough. Here, two brokers would settle in cash their offsetting positions between one another only. Nonetheless, direct settlements were relatively uncommon because offsetting purchases and sales between brokers rarely balanced with respect to quantity. For example, B1 might buy a 5,000 bushel corn future from B2, who then might buy a 6,000 bushel corn future from B1; in this example, 1,000 bushels of corn remain unsettled between B1 and B2. Of course, the two brokers could offset the remaining 1,000 bushel contract if B2 sold a 1,000 bushel corn future to B1. But what if B2 had already sold a 1,000 bushel corn future to B3, who had sold a 1,000 bushel corn future to B1? In this case, each broker’s net futures market position is offset, but all three must meet in order to settle their respective positions. Brokers referred to such a meeting as a ring settlement. Finally, if, in this example, B1 and B3 did not have positions with each other, B2 could settle her position if she transferred her commitment (which she has with B1) to B3. Brokers referred to this method as a transfer settlement. In either ring or transfer settlements, brokers had to find other brokers who held and wished to settle open counter-positions. Often brokers used runners to search literally the offices and corridors for the requisite counter-parties (see Hoffman 1932, 185-200).

Finally, the transformation in Chicago grain markets from forward to futures trading occurred almost simultaneously in New York cotton markets. Forward contracts for cotton traded in New York (and Liverpool, England) by the 1850s. And, like Chicago, organized trading in cotton futures began on the New York Cotton Exchange in about 1870; rules and procedures formalized the practice in 1872. Futures trading on the New Orleans Cotton Exchange began around 1882 (Hieronymus 1977, 77).

Other successful nineteenth century futures exchanges include the New York Produce Exchange, the Milwaukee Chamber of Commerce, the Merchant’s Exchange of St. Louis, the Chicago Open Board of Trade, the Duluth Board of Trade, and the Kansas City Board of Trade (Hoffman 1920, 33; see Peck 1985, 9).

Early Futures Market Performance

Volume

Data on grain futures volume prior to the 1880s are not available (Hoffman 1932, 30). Though in the 1870s “[CBT] officials openly admitted that there was no actual delivery of grain in more than ninety percent of contracts” (Lurie 1979, 59). Indeed, Chart 1 demonstrates that trading was relatively voluminous in the nineteenth century.

An annual average of 23,600 million bushels of grain futures traded between 1884 and 1888, or eight times the annual average amount of crops produced during that period. By comparison, an annual average of 25,803 million bushels of grain futures traded between 1966 and 1970, or four times the annual average amount of crops produced during that period. In 2002, futures volume outnumbered crop production by a factor of eleven.

The comparable data for cotton futures are presented in Chart 2. Again here, trading in the nineteenth century was significant. To wit, by 1879 futures volume had outnumbered production by a factor of five, and by 1896 this factor had reached eight.

Price of Storage

Nineteenth century observers of early U.S. futures markets either credited them for stabilizing food prices, or discredited them for wagering on, and intensifying, the economic hardships of Americans (Baer and Saxon 1949, 12-20, 56; Chandler 1977, 212; Ferris 1988, 88; Hoffman 1932, 5; Lurie 1979, 53, 115). To be sure, the performance of early futures markets remains relatively unexplored. The extant research on the subject has generally examined this performance in the context of two perspectives on the theory of efficiency: the price of storage and futures price efficiency more generally.

Holbrook Working pioneered research into the price of storage – the relationship, at a point in time, between prices (of storable agricultural commodities) applicable to different future dates (Working 1949, 1254).12 For example, what is the relationship between the current spot price of wheat and the current September 2004 futures price of wheat? Or, what is the relationship between the current September 2004 futures price of wheat and the current May 2005 futures price of wheat?

Working reasoned that these prices could not differ because of events that were expected to occur between these dates. For example, if the May 2004 wheat futures price is less than the September 2004 price, this cannot be due to, say, the expectation of a small harvest between May 2004 and September 2004. On the contrary, traders should factor such an expectation into both May and September prices. And, assuming that they do, then this difference can only reflect the cost of carrying – storing – these commodities over time.13 Though this strict interpretation has since been modified somewhat (see Peck 1985, 44).

So, for example, the September 2004 price equals the May 2004 price plus the cost of storing wheat between May 2004 and September 2004. If the difference between these prices is greater or less than the cost of storage, and the market is efficient, arbitrage will bring the difference back to the cost of storage – e.g., if the difference in prices exceeds the cost of storage, then traders can profit if they buy the May 2004 contract, sell the September 2004 contract, take delivery in May and store the wheat until September. Working (1953) demonstrated empirically that the theory of the price of storage could explain quite satisfactorily these inter-temporal differences in wheat futures prices at the CBT as early as the late 1880s (Working 1953, 556).

Futures Price Efficiency

Many contemporary economists tend to focus on futures price efficiency more generally (for example, Beck 1994; Kahl and Tomek 1986; Kofi 1973; McKenzie, et al. 2002; Tomek and Gray, 1970). That is to say, do futures prices shadow consistently (but not necessarily equal) traders’ rational expectations of future spot prices? Here, the research focuses on the relationship between, say, the cash price of wheat in September 2004 and the September 2004 futures price of wheat quoted two months earlier in July 2004.

Figure 1illustrates the behavior of corn futures prices and their corresponding spot prices between 1877 and 1890. The data consist of the average month t futures price in the last full week of month t-2 and the average cash price in the first full week of month t.

The futures price and its corresponding spot price need not be equal; futures price efficiency does not mean that the futures market is clairvoyant. But, a difference between the two series should exist only because of an unpredictable forecast error and a risk premium – futures prices may be, say, consistently below the expected future spot price if long speculators require an inducement, or premium, to enter the futures market. Recent work finds strong evidence that these early corn (and corresponding wheat) futures prices are, in the long run, efficient estimates of their underlying spot prices (Santos 2002, 35). Although these results and Working’s empirical studies on the price of storage support, to some extent, the notion that early U.S. futures markets were efficient, this question remains largely unexplored by economic historians.

The Struggle for Legitimacy

Nineteenth century America was both fascinated and appalled by futures trading. This is apparent from the litigation and many public debates surrounding its legitimacy (Baer and Saxon 1949, 55; Buck 1913, 131, 271; Hoffman 1932, 29, 351; Irwin 1954, 80; Lurie 1979, 53, 106). Many agricultural producers, the lay community and, at times, legislatures and the courts, believed trading in futures was tantamount to gambling. The difference between the latter and speculating, which required the purchase or sale of a futures contract but not the shipment or delivery of the commodity, was ostensibly lost on most Americans (Baer and Saxon 1949, 56; Ferris 1988, 88; Hoffman 1932, 5; Lurie 1979, 53, 115).

Many Americans believed that futures traders frequently manipulated prices. From the end of the Civil War until 1879 alone, corners – control of enough of the available supply of a commodity to manipulate its price – allegedly occurred with varying degrees of success in wheat (1868, 1871, 1878/9), corn (1868), oats (1868, 1871, 1874), rye (1868) and pork (1868) (Boyle 1920, 64-65). This manipulation continued throughout the century and culminated in the Three Big Corners – the Hutchinson (1888), the Leiter (1898), and the Patten (1909). The Patten corner was later debunked (Boyle 1920, 67-74), while the Leiter corner was the inspiration for Frank Norris’s classic The Pit: A Story of Chicago (Norris 1903; Rothstein 1982, 60).14 In any case, reports of market corners on America’s early futures exchanges were likely exaggerated (Boyle 1920, 62-74; Hieronymus 1977, 84), as were their long term effects on prices and hence consumer welfare (Rothstein 1982, 60).

By 1892 thousands of petitions to Congress called for the prohibition of “speculative gambling in grain” (Lurie, 1979, 109). And, attacks from state legislatures were seemingly unrelenting: in 1812 a New York act made short sales illegal (the act was repealed in 1858); in 1841 a Pennsylvania law made short sales, where the position was not covered in five days, a misdemeanor (the law was repealed in 1862); in 1882 an Ohio law and a similar one in Illinois tried unsuccessfully to restrict cash settlement of futures contracts; in 1867 the Illinois constitution forbade dealing in futures contracts (this was repealed by 1869); in 1879 California’s constitution invalidated futures contracts (this was effectively repealed in 1908); and, in 1882, 1883 and 1885, Mississippi, Arkansas, and Texas, respectively, passed laws that equated futures trading with gambling, thus making the former a misdemeanor (Peterson 1933, 68-69).

Two nineteenth century challenges to futures trading are particularly noteworthy. The first was the so-called Anti-Option movement. According to Lurie (1979), the movement was fueled by agrarians and their sympathizers in Congress who wanted to end what they perceived as wanton speculative abuses in futures trading (109). Although options were (are) not futures contracts, and were nonetheless already outlawed on most exchanges by the 1890s, the legislation did not distinguish between the two instruments and effectively sought to outlaw both (Lurie 1979, 109).

In 1890 the Butterworth Anti-Option Bill was introduced in Congress but never came to a vote. However, in 1892 the Hatch (and Washburn) Anti-Option bills passed both houses of Congress, and failed only on technicalities during reconciliation between the two houses. Had either bill become law, it would have effectively ended options and futures trading in the United States (Lurie 1979, 110).

A second notable challenge was the bucket shop controversy, which challenged the legitimacy of the CBT in particular. A bucket shop was essentially an association of gamblers who met outside the CBT and wagered on the direction of futures prices. These associations had legitimate-sounding names such as the Christie Grain and Stock Company and the Public Grain Exchange. To most Americans, these “exchanges” were no less legitimate than the CBT. That some CBT members were guilty of “bucket shopping” only made matters worse!

The bucket shop controversy was protracted and colorful (see Lurie 1979, 138-167). Between 1884 and 1887 Illinois, Iowa, Missouri and Ohio passed anti-bucket shop laws (Lurie 1979, 95). The CBT believed these laws entitled them to restrict bucket shops access to CBT price quotes, without which the bucket shops could not exist. Bucket shops argued that they were competing exchanges, and hence immune to extant anti-bucket shop laws. As such, they sued the CBT for access to these price quotes.15

The two sides and the telegraph companies fought in the courts for decades over access to these price quotes; the CBT’s very survival hung in the balance. After roughly twenty years of litigation, the Supreme Court of the U.S. effectively ruled in favor of the Chicago Board of Trade and against bucket shops (Board of Trade of the City of Chicago v. Christie Grain & Stock Co., 198 U.S. 236, 25 Sup. Ct. (1905)). Bucket shops disappeared completely by 1915 (Hieronymus 1977, 90).

Regulation

The anti-option movement, the bucket shop controversy and the American public’s discontent with speculation masks an ironic reality of futures trading: it escaped government regulation until after the First World War; though early exchanges did practice self-regulation or administrative law.16 The absence of any formal governmental oversight was due in large part to two factors. First, prior to 1895, the opposition tried unsuccessfully to outlaw rather than regulate futures trading. Second, strong agricultural commodity prices between 1895 and 1920 weakened the opposition, who blamed futures markets for low agricultural commodity prices (Hieronymus 1977, 313).

Grain prices fell significantly by the end of the First World War, and opposition to futures trading grew once again (Hieronymus 1977, 313). In 1922 the U.S. Congress enacted the Grain Futures Act, which required exchanges to be licensed, limited market manipulation and publicized trading information (Leuthold 1989, 369).17 However, regulators could rarely enforce the act because it enabled them to discipline exchanges, rather than individual traders. To discipline an exchange was essentially to suspend it, a punishment unfit (too harsh) for most exchange-related infractions.

The Commodity Exchange Act of 1936 enabled the government to deal directly with traders rather than exchanges. It established the Commodity Exchange Authority (CEA), a bureau of the U.S. Department of Agriculture, to monitor and investigate trading activities and prosecute price manipulation as a criminal offense. The act also: limited speculators’ trading activities and the sizes of their positions; regulated futures commission merchants; banned options trading on domestic agricultural commodities; and restricted futures trading – designated which commodities were to be traded on which licensed exchanges (see Hieronymus 1977; Leuthold, et al. 1989).

Although Congress amended the Commodity Exchange Act in 1968 in order to increase the regulatory powers of the Commodity Exchange Authority, the latter was ill-equipped to handle the explosive growth in futures trading in the 1960s and 1970s. So, in 1974 Congress passed the Commodity Futures Trading Act, which created far-reaching federal oversight of U.S. futures trading and established the Commodity Futures Trading Commission (CFTC).

Like the futures legislation before it, the Commodity Futures Trading Act seeks “to ensure proper execution of customer orders and to prevent unlawful manipulation, price distortion, fraud, cheating, fictitious trades, and misuse of customer funds” (Leuthold, et al. 1989, 34). Unlike the CEA, the CFTC was given broad regulator powers over all futures trading and related exchange activities throughout the U.S. The CFTC oversees and approves modifications to extant contracts and the creation and introduction of new contracts. The CFTC consists of five presidential appointees who are confirmed by the U.S. Senate.

The Futures Trading Act of 1982 amended the Commodity Futures Trading Act of 1974. The 1982 act legalized options trading on agricultural commodities and identified more clearly the jurisdictions of the CFTC and Securities and Exchange Commission (SEC). The regulatory overlap between the two organizations arose because of the explosive popularity during the 1970s of financial futures contracts. Today, the CFTC regulates all futures contracts and options on futures contracts traded on U.S. futures exchanges; the SEC regulates all financial instrument cash markets as well as all other options markets.

Finally, in 2000 Congress passed the Commodity Futures Modernization Act, which reauthorized the Commodity Futures Trading Commission for five years and repealed an 18-year old ban on trading single stock futures. The bill also sought to increase competition and “reduce systematic risk in markets for futures and over-the-counter derivatives” (H.R. 5660, 106th Congress 2nd Session).

Modern Futures Markets

The growth in futures trading has been explosive in recent years (Chart 3).

Futures trading extended beyond physical commodities in the 1970s and 1980s – currency futures in 1972; interest rate futures in 1975; and stock index futures in 1982 (Silber 1985, 83). The enormous growth of financial futures at this time was likely because of the breakdown of the Bretton Woods exchange rate regime, which essentially fixed the relative values of industrial economies’ exchange rates to the American dollar (see Bordo and Eichengreen 1993), and relatively high inflation from the late 1960s to the early 1980s. Flexible exchange rates and inflation introduced, respectively, exchange and interest rate risks, which hedgers sought to mitigate through the use of financial futures. Finally, although futures contracts on agricultural commodities remain popular, financial futures and options dominate trading today. Trading volume in metals, minerals and energy remains relatively small.

Trading volume in agricultural futures contracts first dropped below 50% in 1982. By 1985 this volume had dropped to less than one fourth all trading. In the same year the volume of futures trading in the U.S. Treasury bond contract alone exceeded trading volume in all agricultural commodities combined (Leuthold et al. 1989, 2). Today exchanges in the U.S. actively trade contracts on several underlying assets (Table 1). These range from the traditional – e.g., agriculture and metals – to the truly innovative – e.g. the weather. The latter’s payoff varies with the number of degree-days by which the temperature in a particular region deviates from 65 degrees Fahrenheit.

Table 1: Select Futures Contracts Traded as of 2002

Agriculture Currencies Equity Indexes Interest Rates Metals & Energy
Corn British pound S&P 500 index Eurodollars Copper
Oats Canadian dollar Dow Jones Industrials Euroyen Aluminum
Soybeans Japanese yen S&P Midcap 400 Euro-denominated bond Gold
Soybean meal Euro Nasdaq 100 Euroswiss Platinum
Soybean oil Swiss franc NYSE index Sterling Palladium
Wheat Australian dollar Russell 2000 index British gov. bond (gilt) Silver
Barley Mexican peso Nikkei 225 German gov. bond Crude oil
Flaxseed Brazilian real FTSE index Italian gov. bond Heating oil
Canola CAC-40 Canadian gov. bond Gas oil
Rye DAX-30 Treasury bonds Natural gas
Cattle All ordinary Treasury notes Gasoline
Hogs Toronto 35 Treasury bills Propane
Pork bellies Dow Jones Euro STOXX 50 LIBOR CRB index
Cocoa EURIBOR Electricity
Coffee Municipal bond index Weather
Cotton Federal funds rate
Milk Bankers’ acceptance
Orange juice
Sugar
Lumber
Rice

Source: Bodie, Kane and Marcus (2005), p. 796.

Table 2 provides a list of today’s major futures exchanges.

Table 2: Select Futures Exchanges as of 2002

Exchange Exchange
Chicago Board of Trade CBT Montreal Exchange ME
Chicago Mercantile Exchange CME Minneapolis Grain Exchange MPLS
Coffee, Sugar & Cocoa Exchange, New York CSCE Unit of Euronext.liffe NQLX
COMEX, a division of the NYME CMX New York Cotton Exchange NYCE
European Exchange EUREX New York Futures Exchange NYFE
Financial Exchange, a division of the NYCE FINEX New York Mercantile Exchange NYME
International Petroleum Exchange IPE OneChicago ONE
Kansas City Board of Trade KC Sydney Futures Exchange SFE
London International Financial Futures Exchange LIFFE Singapore Exchange Ltd. SGX
Marche a Terme International de France MATIF

Source: Wall Street Journal, 5/12/2004, C16.

Modern trading differs from its nineteenth century counterpart in other respects as well. First, the popularity of open outcry trading is waning. For example, today the CBT executes roughly half of all trades electronically. And, electronic trading is the rule, rather than the exception throughout Europe. Second, today roughly 99% of all futures contracts are settled prior to maturity. Third, in 1982 the Commodity Futures Trading Commission approved cash settlement – delivery that takes the form of a cash balance – on financial index and Eurodollar futures, whose underlying assets are not deliverable, as well as on several non-financial contracts including lean hog, feeder cattle and weather (Carlton 1984, 253). And finally, on Dec. 6, 2002, the Chicago Mercantile Exchange became the first publicly traded financial exchange in the U.S.

References and Further Reading

Baer, Julius B. and Olin. G. Saxon. Commodity Exchanges and Futures Trading. New York: Harper & Brothers, 1949.

Bodie, Zvi, Alex Kane and Alan J. Marcus. Investments. New York: McGraw-Hill/Irwin, 2005.

Bordo, Michael D. and Barry Eichengreen, editors. A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform. Chicago: University of Chicago Press, 1993.

Boyle, James. E. Speculation and the Chicago Board of Trade. New York: MacMillan Company, 1920.

Buck, Solon. J. The Granger Movement: A Study of Agricultural Organization and Its Political,

Carlton, Dennis W. “Futures Markets: Their Purpose, Their History, Their Growth, Their Successes and Failures.” Journal of Futures Markets 4, no. 3 (1984): 237-271.

Chicago Board of Trade Bulletin. The Development of the Chicago Board of Trade. Chicago: Chicago Board of Trade, 1936.

Chandler, Alfred. D. The Visible Hand: The Managerial Revolution in American Business. Cambridge: Harvard University Press, 1977.

Clark, John. G. The Grain Trade in the Old Northwest. Urbana: University of Illinois Press, 1966.

Commodity Futures Trading Commission. Annual Report. Washington, D.C. 2003.

Dies, Edward. J. The Wheat Pit. Chicago: The Argyle Press, 1925.

Ferris, William. G. The Grain Traders: The Story of the Chicago Board of Trade. East Lansing, MI: Michigan State University Press, 1988.

Hieronymus, Thomas A. Economics of Futures Trading for Commercial and Personal Profit. New York: Commodity Research Bureau, Inc., 1977.

Hoffman, George W. Futures Trading upon Organized Commodity Markets in the United States. Philadelphia: University of Pennsylvania Press, 1932.

Irwin, Harold. S. Evolution of Futures Trading. Madison, WI: Mimir Publishers, Inc., 1954

Leuthold, Raymond M., Joan C. Junkus and Jean E. Cordier. The Theory and Practice of Futures Markets. Champaign, IL: Stipes Publishing L.L.C., 1989.

Lurie, Jonathan. The Chicago Board of Trade 1859-1905. Urbana: University of Illinois Press, 1979.

National Agricultural Statistics Service. “Historical Track Records.” Agricultural Statistics Board, U.S. Department of Agriculture, Washington, D.C. April 2004.

Norris, Frank. The Pit: A Story of Chicago. New York, NY: Penguin Group, 1903.

Odle, Thomas. “Entrepreneurial Cooperation on the Great Lakes: The Origin of the Methods of American Grain Marketing.” Business History Review 38, (1964): 439-55.

Peck, Anne E., editor. Futures Markets: Their Economic Role. Washington D.C.: American Enterprise Institute for Public Policy Research, 1985.

Peterson, Arthur G. “Futures Trading with Particular Reference to Agricultural Commodities.” Agricultural History 8, (1933): 68-80.

Pierce, Bessie L. A History of Chicago: Volume III, the Rise of a Modern City. New York: Alfred A. Knopf, 1957.

Rothstein, Morton. “The International Market for Agricultural Commodities, 1850-1873.” In Economic Change in the Civil War Era, edited by David. T. Gilchrist and W. David Lewis, 62-71. Greenville DE: Eleutherian Mills-Hagley Foundation, 1966.

Rothstein, Morton. “Frank Norris and Popular Perceptions of the Market.” Agricultural History 56, (1982): 50-66.

Santos, Joseph. “Did Futures Markets Stabilize U.S. Grain Prices?” Journal of Agricultural Economics 53, no. 1 (2002): 25-36.

Silber, William L. “The Economic Role of Financial Futures.” In Futures Markets: Their Economic Role, edited by Anne E. Peck, 83-114. Washington D.C.: American Enterprise Institute for Public Policy Research, 1985.

Stein, Jerome L. The Economics of Futures Markets. Oxford: Basil Blackwell Ltd, 1986.

Taylor, Charles. H. History of the Board of Trade of the City of Chicago. Chicago: R. O. Law, 1917.

Werner, Walter and Steven T. Smith. Wall Street. New York: Columbia University Press, 1991.

Williams, Jeffrey C. “The Origin of Futures Markets.” Agricultural History 56, (1982): 306-16.

Working, Holbrook. “The Theory of the Price of Storage.” American Economic Review 39, (1949): 1254-62.

Working, Holbrook. “Hedging Reconsidered.” Journal of Farm Economics 35, (1953): 544-61.

1 The clearinghouse is typically a corporation owned by a subset of exchange members. For details regarding the clearing arrangements of a specific exchange, go to www.cftc.gov and click on “Clearing Organizations.”

2 The vast majority of contracts are offset. Outright delivery occurs when the buyer receives from, or the seller “delivers” to the exchange a title of ownership, and not the actual commodity or financial security – the urban legend of the trader who neglected to settle his long position and consequently “woke up one morning to find several car loads of a commodity dumped on his front yard” is indeed apocryphal (Hieronymus 1977, 37)!

3 Nevertheless, forward contracts remain popular today (see Peck 1985, 9-12).

4 The importance of New Orleans as a point of departure for U.S. grain and provisions prior to the Civil War is unquestionable. According to Clark (1966), “New Orleans was the leading export center in the nation in terms of dollar volume of domestic exports, except for 1847 and a few years during the 1850s, when New York’s domestic exports exceeded those of the Crescent City” (36).

5 This area was responsible for roughly half of U.S. wheat production and a third of U.S. corn production just prior to 1860. Southern planters dominated corn output during the early to mid- 1800s.

6 Millers milled wheat into flour; pork producers fed corn to pigs, which producers slaughtered for provisions; distillers and brewers converted rye and barley into whiskey and malt liquors, respectively; and ranchers fed grains and grasses to cattle, which were then driven to eastern markets.

7 Significant advances in transportation made the grain trade’s eastward expansion possible, but the strong and growing demand for grain in the East made the trade profitable. The growth in domestic grain demand during the early to mid-nineteenth century reflected the strong growth in eastern urban populations. Between 1820 and 1860, the populations of Baltimore, Boston, New York and Philadelphia increased by over 500% (Clark 1966, 54). Moreover, as the 1840’s approached, foreign demand for U.S. grain grew. Between 1845 and 1847, U.S. exports of wheat and flour rose from 6.3 million bushels to 26.3 million bushels and corn exports grew from 840,000 bushels to 16.3 million bushels (Clark 1966, 55).

8 Wheat production was shifting to the trans-Mississippi West, which produced 65% of the nation’s wheat by 1899 and 90% by 1909, and railroads based in the Lake Michigan port cities intercepted the Mississippi River trade that would otherwise have headed to St. Louis (Clark 1966, 95). Lake Michigan port cities also benefited from a growing concentration of corn production in the West North Central region – Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota and South Dakota, which by 1899 produced 40% percent of the country’s corn (Clark 1966, 4).

9 Corn had to be dried immediately after it was harvested and could only be shipped profitably by water to Chicago, but only after rivers and lakes had thawed; so, country merchants stored large quantities of corn. On the other hand, wheat was more valuable relative to its weight, and it could be shipped to Chicago by rail or road immediately after it was harvested; so, Chicago merchants stored large quantities of wheat.

10 This is consistent with Odle (1964), who adds that “the creators of the new system of marketing [forward contracts] were the grain merchants of the Great Lakes” (439). However, Williams (1982) presents evidence of such contracts between Buffalo and New York City as early as 1847 (309). To be sure, Williams proffers an intriguing case that forward and, in effect, future trading was active and quite sophisticated throughout New York by the late 1840s. Moreover, he argues that this trading grew not out of activity in Chicago, whose trading activities were quite primitive at this early date, but rather trading in London and ultimately Amsterdam. Indeed, “time bargains” were common in London and New York securities markets in the mid- and late 1700s, respectively. A time bargain was essentially a cash-settled financial forward contract that was unenforceable by law, and as such “each party was forced to rely on the integrity and credit of the other” (Werner and Smith 1991, 31). According to Werner and Smith, “time bargains prevailed on Wall Street until 1840, and were gradually replaced by margin trading by 1860” (68). They add that, “margin trading … had an advantage over time bargains, in which there was little protection against default beyond the word of another broker. Time bargains also technically violated the law as wagering contracts; margin trading did not” (135). Between 1818 and 1840 these contracts comprised anywhere from 0.7% (49-day average in 1830) to 34.6% (78-day average in 1819) of daily exchange volume on the New York Stock & Exchange Board (Werner and Smith 1991, 174).

11 Of course, forward markets could and indeed did exist in the absence of both grading standards and formal exchanges, though to what extent they existed is unclear (see Williams 1982).

12 In the parlance of modern financial futures, the term cost of carry is used instead of the term storage. For example, the cost of carrying a bond is comprised of the cost of acquiring and holding (or storing) it until delivery minus the return earned during the carry period.

13 More specifically, the price of storage is comprised of three components: (1) physical costs such as warehouse and insurance; (2) financial costs such as borrowing rates of interest; and (3) the convenience yield – the return that the merchant, who stores the commodity, derives from maintaining an inventory in the commodity. The marginal costs of (1) and (2) are increasing functions of the amount stored; the more the merchant stores, the greater the marginal costs of warehouse use, insurance and financing. Whereas the marginal benefit of (3) is a decreasing function of the amount stored; put differently, the smaller the merchant’s inventory, the more valuable each additional unit of inventory becomes. Working used this convenience yield to explain a negative price of storage – the nearby contract is priced higher than the faraway contract; an event that is likely to occur when supplies are exceptionally low. In this instance, there is little for inventory dealers to store. Hence, dealers face extremely low physical and financial storage costs, but extremely high convenience yields. The price of storage turns negative; essentially, inventory dealers are willing to pay to store the commodity.

14 Norris’ protagonist, Curtis Jadwin, is a wheat speculator emotionally consumed and ultimately destroyed, while the welfare of producers and consumers hang in the balance, when a nineteenth century CBT wheat futures corner backfires on him.

15 One particularly colorful incident in the controversy came when the Supreme Court of Illinois ruled that the CBT had to either make price quotes public or restrict access to everyone. When the Board opted for the latter, it found it needed to “prevent its members from running (often literally) between the [CBT and a bucket shop next door], but with minimal success. Board officials at first tried to lock the doors to the exchange…However, after one member literally battered down the door to the east side of the building, the directors abandoned this policy as impracticable if not destructive” (Lurie 1979, 140).

16 Administrative law is “a body of rules and doctrines which deals with the powers and actions of administrative agencies” that are organizations other than the judiciary or legislature. These organizations affect the rights of private parties “through either adjudication, rulemaking, investigating, prosecuting, negotiating, settling, or informally acting” (Lurie 1979, 9).

17 In 1921 Congress passed The Futures Trading Act, which was declared unconstitutional.

Citation: Santos, Joseph. “A History of Futures Trading in the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/a-history-of-futures-trading-in-the-united-states/

An Economic History of Denmark

Ingrid Henriksen, University of Copenhagen

Denmark is located in Northern Europe between the North Sea and the Baltic. Today Denmark consists of the Jutland Peninsula bordering Germany and the Danish Isles and covers 43,069 square kilometers (16,629 square miles). 1 The present nation is the result of several cessions of territory throughout history. The last of the former Danish territories in southern Sweden were lost to Sweden in 1658, following one of the numerous wars between the two nations, which especially marred the sixteenth and seventeenth centuries. Following defeat in the Napoleonic Wars, Norway was separated from Denmark in 1814. After the last major war, the Second Schleswig War in 1864, Danish territory was further reduced by a third when Schleswig and Holstein were ceded to Germany. After a regional referendum in 1920 only North-Schleswig returned to Denmark. Finally, Iceland, withdrew from the union with Denmark in 1944. The following will deal with the geographical unit of today’s Denmark.

Prerequisites of Growth

Throughout history a number of advantageous factors have shaped the Danish economy. From this perspective it may not be surprising to find today’s Denmark among the richest societies in the world. According to the OECD, it ranked seventh in 2004, with income of $29.231 per capita (PPP). Although we can identify a number of turning points and breaks, for the time period over which we have quantitative evidence this long-run position has changed little. Thus Maddison (2001) in his estimate of GDP per capita around 1600 places Denmark as number six. One interpretation could be that favorable circumstances, rather than ingenious institutions or policies, have determined Danish economic development. Nevertheless, this article also deals with time periods in which the Danish economy was either diverging from or converging towards the leading economies.

Table 1:
Average Annual GDP Growth (at factor costs)
Total Per capita
1870-1880 1.9% 0.9%
1880-1890 2.5% 1.5%
1890-1900 2.9% 1.8%
1900-1913 3.2% 2.0%
1913-1929 3.0% 1.6%
1929-1938 2.2% 1.4%
1938-1950 2.4% 1.4%
1950-1960 3.4% 2.6%
1960-1973 4.6% 3.8%
1973-1982 1.5% 1.3%
1982-1993 1.6% 1.5%
1993-2004 2.2% 2.0%

Sources: Johansen (1985) and Statistics Denmark ‘Statistikbanken’ online.

Denmark’s geographical location in close proximity of the most dynamic nations of sixteenth-century Europe, the Netherlands and the United Kingdom, no doubt exerted a positive influence on the Danish economy and Danish institutions. The North German area influenced Denmark both through long-term economic links and through the Lutheran Protestant Reformation which the Danes embraced in 1536.

The Danish economy traditionally specialized in agriculture like most other small and medium-sized European countries. It is, however, rather unique to find a rich European country in the late-nineteenth and mid-twentieth century which retained such a strong agrarian bias. Only in the late 1950s did the workforce of manufacturing industry overtake that of agriculture. Thus an economic history of Denmark must take its point of departure in agricultural development for quite a long stretch of time.

Looking at resource endowments, Denmark enjoyed a relatively high agricultural land-to-labor ratio compared to other European countries, with the exception of the UK. This was significant for several reasons since it, in this case, was accompanied by a comparatively wealthy peasantry.

Denmark had no mineral resources to speak of until the exploitation of oil and gas in the North Sea began in 1972 and 1984, respectively. From 1991 on Denmark has been a net exporter of energy although on a very modest scale compared to neighboring Norway and Britain. The small deposits are currently projected to be depleted by the end of the second decade of the twenty-first century.

Figure 1. Percent of GDP in selected=

Source: Johansen (1985) and Statistics Denmark ’Nationalregnskaber’

Good logistic can be regarded as a resource in pre-industrial economies. The Danish coast line of 7,314 km and the fact that no point is more than 50 km from the sea were advantages in an age in which transport by sea was more economical than land transport.

Decline and Transformation, 1500-1750

The year of the Lutheran Reformation (1536) conventionally marks the end of the Middle Ages in Danish historiography. Only around 1500 did population growth begin to pick up after the devastating effect of the Black Death. Growth thereafter was modest and at times probably stagnant with large fluctuations in mortality following major wars, particularly during the seventeenth century, and years of bad harvests. About 80-85 percent of the population lived from subsistence agriculture in small rural communities and this did not change. Exports are estimated to have been about 5 percent of GDP between 1550 and 1650. The main export products were oxen and grain. The period after 1650 was characterized by a long lasting slump with a marked decline in exports to the neighboring countries, the Netherlands in particular.

The institutional development after the Black Death showed a return to more archaic forms. Unlike other parts of northwestern Europe, the peasantry on the Danish Isles afterwards became a victim of a process of re-feudalization during the last decades of the fifteenth century. A likely explanation is the low population density that encouraged large landowners to hold on to their labor by all means. Freehold tenure among peasants effectively disappeared during the seventeenth century. Institutions like bonded labor that forced peasants to stay on the estate where they were born, and labor services on the demesne as part of the land rent bring to mind similar arrangements in Europe east of the Elbe River. One exception to the East European model was crucial, however. The demesne land, that is the land worked directly under the estate, never made up more than nine percent of total land by the mid eighteenth century. Although some estate owners saw an interest in encroaching on peasant land, the state protected the latter as production units and, more importantly, as a tax base. Bonded labor was codified in the all-encompassing Danish Law of Christian V in 1683. It was further intensified by being extended, though under another label, to all Denmark during 1733-88, as a means for the state to tide the large landlords over an agrarian crisis. One explanation for the long life of such an authoritarian institution could be that the tenants were relatively well off, with 25-50 acres of land on average. Another reason could be that reality differed from the formal rigor of the institutions.

Following the Protestant Reformation in 1536, the Crown took over all church land, thereby making it the owner of 50 percent of all land. The costs of warfare during most of the sixteenth century could still be covered by the revenue of these substantial possessions. Around 1600 the income from taxation and customs, mostly Sound Toll collected from ships that passed the narrow strait between Denmark and today’s Sweden, on the one hand and Crown land revenues on the other were equally large. About 50 years later, after a major fiscal crisis had led to the sale of about half of all Crown lands, the revenue from royal demesnes declined relatively to about one third, and after 1660 the full transition from domain state to tax state was completed.

The bulk of the former Crown land had been sold to nobles and a few common owners of estates. Consequently, although the Danish constitution of 1665 was the most stringent version of absolutism found anywhere in Europe at the time, the Crown depended heavily on estate owners to perform a number of important local tasks. Thus, conscription of troops for warfare, collection of land taxes and maintenance of law and order enhanced the landlords’ power over their tenants.

Reform and International Market Integration, 1750-1870

The driving force of Danish economic growth, which took off during the late eighteenth century was population growth at home and abroad – which triggered technological and institutional innovation. Whereas the Danish population during the previous hundred years grew by about 0.4 percent per annum, growth climbed to about 0.6 percent, accelerating after 1775 and especially from the second decade of the nineteenth century (Johansen 2002). Like elsewhere in Northern Europe, accelerating growth can be ascribed to a decline in mortality, mainly child mortality. Probably this development was initiated by fewer spells of epidemic diseases due to fewer wars and to greater inherited immunity against contagious diseases. Vaccination against smallpox and formal education of midwives from the early nineteenth century might have played a role (Banggård 2004). Land reforms that entailed some scattering of the farm population may also have had a positive influence. Prices rose from the late eighteenth century in response to the increase in populations in Northern Europe, but also following a number of international conflicts. This again caused a boom in Danish transit shipping and in grain exports.

Population growth rendered the old institutional set up obsolete. Landlords no longer needed to bind labor to their estate, as a new class of landless laborers or cottagers with little land emerged. The work of these day-laborers was to replace the labor services of tenant farmers on the demesnes. The old system of labor services obviously presented an incentive problem all the more since it was often carried by the live-in servants of the tenant farmers. Thus, the labor days on the demesnes represented a loss to both landlords and tenants (Henriksen 2003). Part of the land rent was originally paid in grain. Some of it had been converted to money which meant that real rents declined during the inflation. The solution to these problems was massive land sales both from the remaining crown lands and from private landlords to their tenants. As a result two-thirds of all Danish farmers became owner-occupiers compared to only ten percent in the mid-eighteenth century. This development was halted during the next two and a half decades but resumed as the business cycle picked up during the 1840s and 1850s. It was to become of vital importance to the modernization of Danish agriculture towards the end of the nineteenth century that 75 percent of all agricultural land was farmed by owners of middle-sized farms of about 50 acres. Population growth may also have put a pressure on common lands in the villages. At any rate enclosure begun in the 1760s, accelerated in the 1790s supported by legislation and was almost complete in the third decade of the nineteenth century.

The initiative for the sweeping land reforms from the 1780s is thought to have come from below – that is from the landlords and in some instances also from the peasantry. The absolute monarch and his counselors were, however, strongly supportive of these measures. The desire for peasant land as a tax base weighed heavily and the reforms were believed to enhance the efficiency of peasant farming. Besides, the central government was by now more powerful than in the preceding centuries and less dependent on landlords for local administrative tasks.

Production per capita rose modestly before the 1830s and more pronouncedly thereafter when a better allocation of labor and land followed the reforms and when some new crops like clover and potatoes were introduced at a larger scale. Most importantly, the Danes no longer lived at the margin of hunger. No longer do we find a correlation between demographic variables, deaths and births, and bad harvest years (Johansen 2002).

A liberalization of import tariffs in 1797 marked the end of a short spell of late mercantilism. Further liberalizations during the nineteenth and the beginning of the twentieth century established the Danish liberal tradition in international trade that was only to be broken by the protectionism of the 1930s.

Following the loss of the secured Norwegian market for grain in 1814, Danish exports began to target the British market. The great rush forward came as the British Corn Law was repealed in 1846. The export share of the production value in agriculture rose from roughly 10 to around 30 percent between 1800 and 1870.

In 1849 absolute monarchy was peacefully replaced by a free constitution. The long-term benefits of fundamental principles such as the inviolability of private property rights, the freedom of contracting and the freedom of association were probably essential to future growth though hard to quantify.

Modernization and Convergence, 1870-1914

During this period Danish economic growth outperformed that of most other European countries. A convergence in real wages towards the richest countries, Britain and the U.S., as shown by O’Rourke and Williamsson (1999), can only in part be explained by open economy forces. Denmark became a net importer of foreign capital from the 1890s and foreign debt was well above 40 percent of GDP on the eve of WWI. Overseas emigration reduced the potential workforce but as mortality declined population growth stayed around one percent per annum. The increase in foreign trade was substantial, as in many other economies during the heyday of the gold standard. Thus the export share of Danish agriculture surged to a 60 percent.

The background for the latter development has featured prominently in many international comparative analyses. Part of the explanation for the success, as in other Protestant parts of Northern Europe, was a high rate of literacy that allowed a fast spread of new ideas and new technology.

The driving force of growth was that of a small open economy, which responded effectively to a change in international product prices, in this instance caused by the invasion of cheap grain to Western Europe from North America and Eastern Europe. Like Britain, the Netherlands and Belgium, Denmark did not impose a tariff on grain, in spite of the strong agrarian dominance in society and politics.

Proposals to impose tariffs on grain, and later on cattle and butter, were turned down by Danish farmers. The majority seems to have realized the advantages accruing from the free imports of cheap animal feed during the ongoing process of transition from vegetable to animal production, at a time when the prices of animal products did not decline as much as grain prices. The dominant middle-sized farm was inefficient for wheat but had its comparative advantage in intensive animal farming with the given technology. O’Rourke (1997) found that the grain invasion only lowered Danish rents by 4-5 percent, while real wages rose (according to expectation) but more than in any other agrarian economy and more than in industrialized Britain.

The move from grain exports to exports of animal products, mainly butter and bacon, was to a great extent facilitated by the spread of agricultural cooperatives. This organization allowed the middle-sized and small farms that dominated Danish agriculture to benefit from the economy of scale in processing and marketing. The newly invented steam-driven continuous cream separator skimmed more cream from a kilo of milk than conventional methods and had the further advantage of allowing transported milk brought together from a number of suppliers to be skimmed. From the 1880s the majority of these creameries in Denmark were established as cooperatives and about 20 years later, in 1903, the owners of 81 percent of all milk cows supplied to a cooperative (Henriksen 1999). The Danish dairy industry captured over a third of the rapidly expanding British butter-import market, establishing a reputation for consistent quality that was reflected in high prices. Furthermore, the cooperatives played an active role in persuading the dairy farmers to expand production from summer to year-round dairying. The costs of intensive feeding during the wintertime were more than made up for by a winter price premium (Henriksen and O’Rourke 2005). Year-round dairying resulted in a higher rate of utilization of agrarian capital – that is of farm animals and of the modern cooperative creameries. Not least did this intensive production mean a higher utilization of hitherto underemployed labor. From the late 1890’s, in particular, labor productivity in agriculture rose at an unanticipated speed at par with productivity increase in the urban trades.

Industrialization in Denmark took its modest beginning in the 1870s with a temporary acceleration in the late 1890s. It may be a prime example of an industrialization process governed by domestic demand for industrial goods. Industry’s export never exceeded 10 percent of value added before 1914, compared to agriculture’s export share of 60 percent. The export drive of agriculture towards the end of the nineteenth century was a major force in developing other sectors of the economy not least transport, trade and finance.

Weathering War and Depression, 1914-1950

Denmark, as a neutral nation, escaped the devastating effects of World War I and was even allowed to carry on exports to both sides in the conflict. The ensuing trade surplus resulted in a trebling of the money supply. As the monetary authorities failed to contain the inflationary effects of this development, the value of the Danish currency slumped to about 60 percent of its pre-war value in 1920. The effects of monetary policy failure were aggravated by a decision to return to the gold standard at the 1913 level. When monetary policy was finally tightened in 1924, it resulted in fierce speculation in an appreciation of the Krone. During 1925-26 the currency returned quickly to its pre-war parity. As this was not counterbalanced by an equal decline in prices, the result was a sharp real appreciation and a subsequent deterioration in Denmark’s competitive position (Klovland 1997).

Figure 2. Indices of the Krone Real Exchange Rate and Terms Of Trade (1980=100; Real rates based on Wholesale Price Index

Source: Abildgren (2005)

Note: Trade with Germany is included in the calculation of the real effective exchange rate for the whole period, including 1921-23.

When, in September 1931, Britain decided to leave the gold standard again, Denmark, together with Sweden and Norway, followed only a week later. This move was beneficial as the large real depreciation lead to a long-lasting improvement in Denmark’s competitiveness in the 1930s. It was, no doubt, the single most important policy decision during the depression years. Keynesian demand management, even if it had been fully understood, was barred by a small public sector, only about 13 percent of GDP. As it was, fiscal orthodoxy ruled and policy was slightly procyclical as taxes were raised to cover the deficit created by crisis and unemployment (Topp 1995).

Structural development during the 1920s, surprisingly for a rich nation at this stage, was in favor of agriculture. The total labor force in Danish agriculture grew by 5 percent from 1920 to 1930. The number of employees in agriculture was stagnating whereas the number of self-employed farmers increased by a larger number. The development in relative incomes cannot account for this trend but part of the explanation must be found in a flawed Danish land policy, which actively supported a further parceling out of land into small holdings and restricted the consolidation into larger more viable farms. It took until the early 1960s before this policy began to be unwound.

When the world depression hit Denmark with a minor time lag, agriculture still employed one-third of the total workforce while its contribution to total GDP was a bit less than one-fifth. Perhaps more importantly, agricultural goods still made up 80 percent of total exports.

Denmark’s terms of trade, as a consequence, declined by 24 percent from 1930 to 1932. In 1933 and 1934 bilateral trade agreements were forced upon Denmark by Britain and Germany. In 1932 Denmark had adopted exchange control, a harsh measure even for its time, to stem the net flow of foreign exchange out of the country. By rationing imports exchange control also offered some protection of domestic industry. At the end of the decade manufacture’s GDP had surpassed that of agriculture. In spite of the protectionist policy, unemployment soared to 13-15 percent of the workforce.

The policy mistakes during World War I and its immediate aftermath served as a lesson for policymakers during World War II. The German occupation force (April 9, 1940 until May 5, 1945) drew the funds for its sustenance and for exports to Germany on the Danish central bank whereby the money supply more than doubled. In response the Danish authorities in 1943 launched a policy of absorbing money through open market operations and, for the first time in history, through a surplus on the state budget.

Economic reconstruction after World War II was swift, as again Denmark had been spared the worst consequences of a major war. In 1946 GDP recovered its highest pre-war level. In spite of this, Denmark received relatively generous support through the Marshall Plan of 1948-52, when measured in dollars per capita.

From Riches to Crisis, 1950-1973: Liberalizations and International Integration Once Again

The growth performance during 1950-1957 was markedly lower than the Western European average. The main reason was the high share of agricultural goods in Danish exports, 63 percent in 1950. International trade in agricultural products to a large extent remained regulated. Large deteriorations in the terms of trade caused by the British devaluation 1949, when Denmark followed suit, the outbreak of the Korean War in 1950, and the Suez-crisis of 1956 made matters worse. The ensuing deficits on the balance of payment led the government to contractionary policy measures which restrained growth.

The liberalization of the flow of goods and capital in Western Europe within the framework of the OEEC (the Organization for European Economic Cooperation) during the 1950s probably dealt a blow to some of the Danish manufacturing firms, especially in the textile industry, that had been sheltered through exchange control and wartime. Nevertheless, the export share of industrial production doubled from 10 percent to 20 percent before 1957, at the same time as employment in industry surpassed agricultural employment.

On the question of European economic integration Denmark linked up with its largest trading partner, Britain. After the establishment of the European Common Market in 1958 and when the attempts to create a large European free trade area failed, Denmark entered the European Free Trade Association (EFTA) created under British leadership in 1960. When Britain was finally able to join the European Economic Community (EEC) in 1973, Denmark followed, after a referendum on the issue. Long before admission to the EEC, the advantages to Danish agriculture from the Common Agricultural Policy (CAP) had been emphasized. The higher prices within the EEC were capitalized into higher land prices at the same time that investments were increased based on the expected gains from membership. As a result the most indebted farmers who had borrowed at fixed interests rates were hit hard by two developments from the early 1980s. The EEC started to reduce the producers’ benefits of the CAP because of overproduction and, after 1982, the Danish economy adjusted to a lower level of inflation, and therefore, nominal interest rates. According to Andersen (2001) Danish farmers were left with the highest interest burden of all European Union (EU) farmers in the 1990’s.

Denmark’s relations with the EU, while enthusiastic at the beginning, have since been characterized by a certain amount of reserve. A national referendum in 1992 turned down the treaty on the European Union, the Maastricht Treaty. The Danes, then, opted out of four areas, common citizenship, a common currency, common foreign and defense politics and a common policy on police and legal matters. Once more, in 2000, adoption of the common currency, the Euro, was turned down by the Danish electorate. In the debate leading up to the referendum the possible economic advantages of the Euro in the form of lower transaction costs were considered to be modest, compared to the existent regime of fixed exchange rates vis-à-vis the Euro. All the major political parties, nevertheless, are pro-European, with only the extreme Right and the extreme Left being against. It seems that there is a discrepancy between the general public and the politicians on this particular issue.

As far as domestic economic policy is concerned, the heritage from the 1940s was a new commitment to high employment modified by a balance of payment constraint. The Danish policy differed from that of some other parts of Europe in that the remains of the planned economy from the war and reconstruction period in the form of rationing and price control were dismantled around 1950 and that no nationalizations took place.

Instead of direct regulation, economic policy relied on demand management with fiscal policy as its main instrument. Monetary policy remained a bone of contention between politicians and economists. Coordination of policies was the buzzword but within that framework monetary policy was allotted a passive role. The major political parties for a long time were wary of letting the market rate of interest clear the loan market. Instead, some quantitative measures were carried out with the purpose of dampening the demand for loans.

From Agricultural Society to Service Society: The Growth of the Welfare State

Structural problems in foreign trade extended into the high growth period of 1958-73, as Danish agricultural exports were met with constraints both from the then EEC-member countries and most EFTA countries, as well. During the same decade, the 1960s, as the importance of agriculture was declining the share of employment in the public sector grew rapidly until 1983. Building and construction also took a growing share of the workforce until 1970. These developments left manufacturing industry with a secondary position. Consequently, as pointed out by Pedersen (1995) the sheltered sectors in the economy crowded out the sectors that were exposed to international competition, that is mostly industry and agriculture, by putting a pressure on labor and other costs during the years of strong expansion.

Perhaps the most conspicuous feature of the Danish economy during the Golden Age was the steep increase in welfare-related costs from the mid 1960s and not least the corresponding increases in the number of public employees. Although the seeds of the modern Scandinavian welfare state were sown at a much earlier date, the 1960s was the time when public expenditure as a share of GDP exceeded that of most other countries.

As in other modern welfare states, important elements in the growth of the public sector during the 1960s were the expansion in public health care and education, both free for all citizens. The background for much of the increase in the number of public employees from the late 1960s was the rise in labor participation by married women from the late 1960s until about 1990, partly at least as a consequence. In response, the public day care facilities for young children and old people were expanded. Whereas in 1965 7 percent of 0-6 year olds were in a day nursery or kindergarten, this share rose to 77 per cent in 2000. This again spawned more employment opportunities for women in the public sector. Today the labor participation for women, around 75 percent of 16-66 year olds, is among the highest in the world.

Originally social welfare programs targeted low income earners who were encouraged to take out insurance against sickness (1892), unemployment (1907) and disability (1922). The public subsidized these schemes and initiated a program for the poor among old people (1891). The high unemployment period in the 1930s inspired some temporary relief and some administrative reform, but little fundamental change.

Welfare policy in the first four decades following World War II is commonly believed to have been strongly influenced by the Social Democrat party which held around 30 percent of the votes in general elections and was the party in power for long periods of time. One of the distinctive features of the Danish welfare state has been its focus on the needs of the individual person rather than on the family context. Another important characteristic is the universal nature of a number of benefits starting with a basic old age pension for all in 1956. The compensation rates in a number of schedules are high in international comparison, particularly for low income earners. Public transfers gained a larger share in total public outlays both because standards were raised – that is benefits became higher – and because the number of recipients increased dramatically following the high unemployment regime from the mid 1970s to the mid 1990s. To pay for the high transfers and the large public sector – around 30 percent of the work force – the tax load is also high in international perspective. The share public sector and social expenditure has risen to above 50 percent of GDP, only second to the share in Sweden.

Figure 3. Unemployment, Denmark (percent of total labor force)

Source: Statistics Denmark ‘50 års-oversigten’ and ADAM’s databank

The Danish labor market model has recently attracted favorable international attention (OECD 2005). It has been declared successful in fighting unemployment – especially compared to the policies of countries like Germany and France. The so-called Flexicurity model rests on three pillars. The first is low employment protection, the second is relatively high compensation rates for the unemployed and the third is the requirement for active participation by the unemployed. Low employment protection has a long tradition in Denmark and there is no change in this factor when comparing the twenty years of high unemployment – 8-12 per cent of the labor force – from the mid 1970s to the mid 1990s, to the past ten years when unemployment has declined to a mere 4.5 percent in 2006. The rules governing compensation to the unemployed were tightened from 1994, limiting the number of years the unemployed could receive benefits from 7 to 4. Most noticeably labor market policy in 1994 turned from ‘passive’ measures – besides unemployment benefits, an early retirement scheme and a temporary paid leave scheme – toward ‘active’ measures that were devoted to getting people back to work by providing training and jobs. It is commonly supposed that the strengthening of economic incentives helped to lower unemployment. However, as Andersen and Svarer (2006) point out, while unemployment has declined substantially a large and growing share of Danes of employable age receives transfers other than unemployment benefit – that is benefits related to sickness or social problems of various kinds, early retirement benefits, etc. This makes it hazardous to compare the Danish labor market model with that of many other countries.

Exchange Rates and Macroeconomic Policy

Denmark has traditionally adhered to a fixed exchange rate regime. The belief is that for a small and open economy, a floating exchange rate could lead to very volatile exchange rates which would harm foreign trade. After having abandoned the gold standard in 1931, the Danish currency (the Krone) was, for a while, pegged to the British pound, only to join the IMF system of fixed but adjustable exchange rates, the so-called Bretton Woods system after World War II. The close link with the British economy still manifested itself when the Danish currency was devaluated along with the pound in 1949 and, half way, in 1967. The devaluation also reflected that after 1960, Denmark’s international competitiveness had gradually been eroded by rising real wages, corresponding to a 30 percent real appreciation of the currency (Pedersen 1996).

When the Bretton Woods system broke down in the early 1970s, Denmark joined the European exchange rate cooperation, the “Snake” arrangement, set up in 1972, an arrangement that was to be continued in the form of the Exchange Rate Mechanism within the European Monetary System from 1979. The Deutschmark was effectively the nominal anchor in European currency cooperation until the launch of the Euro in 1999, a fact that put Danish competitiveness under severe pressure because of markedly higher inflation in Denmark compared to Germany. In the end the Danish government gave way before the pressure and undertook four discrete devaluations from 1979 to 1982. Since compensatory increases in wages were held back, the balance of trade improved perceptibly.

This improvement could, however, not make up for the soaring costs of old loans at a time when the international real rates of interests were high. The Danish devaluation strategy exacerbated this problem. The anticipation of further devaluations was mirrored in a steep increase in the long-term rate of interest. It peaked at 22 percent in nominal terms in 1982, with an interest spread to Germany of 10 percent. Combined with the effects of the second oil crisis on the Danish terms of trade, unemployment rose to 10 percent of the labor force. Given the relatively high compensation ratios for the unemployed, the public deficit increased rapidly and public debt grew to about 70 percent of GDP.

Figure 4. Current Account and Foreign Debt (Denmark)

Source: Statistics Denmark Statistical Yearbooks and ADAM’s Databank

In September 1982 the Social Democrat minority government resigned without a general election and was relieved by a Conservative-Liberal minority government. The new government launched a program to improve the competitiveness of the private sector and to rebalance public finances. An important element was a disinflationary economic policy based on fixed exchange rates pegging the Krone to the participants of the EMS and, from 1999, to the Euro. Furthermore, automatic wage indexation that had occurred, with short interruptions since 1920 (with a short lag and high coverage), was abolished. Fiscal policy was tightened, thus bringing an end to the real increases in public expenditure that had lasted since the 1960’s.

The stabilization policy was successful in bringing down inflation and long interest rates. Pedersen (1995) finds that this process, nevertheless, was slower than might have been expected. In view of former Danish exchange rate policy it took some time for the market to believe in the credible commitment to fixed exchange rates. From the late 1990s the interest spread to Germany/ Euroland has been negligible, however.

The initial success of the stabilization policy brought a boom to the Danish economy that, once again, caused overheating in the form of high wage increases (in 1987) and a deterioration of the current account. The solution to this was a number of reforms in 1986-87 aiming at encouraging private savings that had by then fallen to an historical low. Most notable was the reform that reduced tax deductibility of private interest on debts. These measures resulted in a hard landing to the economy caused by the collapse of the housing market.

The period of low growth was further prolonged by the international recession in 1992. In 1993 yet another shift of regime occurred in Danish economic policy. A new Social Democrat government decided to ‘kick start’ the economy by means of a moderate fiscal expansion whereas, in 1994, the same government tightened labor market policies substantially, as we have seen. Mainly as a consequence of these measures the Danish economy from 1994 entered a period of moderate growth with unemployment steadily falling to the level of the 1970s. A new feature that still puzzles Danish economists is that the decline in unemployment over these years has not yet resulted in any increase in wage inflation.

Denmark at the beginning of the twenty-first century in many ways fits the description of a Small Successful European Economy according to Mokyr (2006). Unlike in most of the other small economies, however, Danish exports are broad based and have no “niche” in the world market. Like some other small European countries, Ireland, Finland and Sweden, the short term economic fluctuations as described above have not followed the European business cycle very closely for the past thirty years (Andersen 2001). Domestic demand and domestic economic policy has, after all, played a crucial role even in a very small and very open economy.

References

Abildgren, Kim. “Real Effective Exchange Rates and Purchasing-Power-parity Convergence: Empirical Evidence for Denmark, 1875-2002.” Scandinavian Economic History Review 53, no. 3 (2005): 58-70.

Andersen, Torben M. et al. The Danish Economy: An international Perspective. Copenhagen: DJØF Publishing, 2001.

Andersen, Torben M. and Michael Svarer. “Flexicurity: den danska arbetsmarknadsmodellen.” Ekonomisk debatt 34, no. 1 (2006): 17-29.

Banggaard, Grethe. Befolkningsfremmende foranstaltninger og faldende børnedødelighed. Danmark, ca. 1750-1850. Odense: Syddansk Universitetsforlag, 2004

Hansen, Sv. Aage. Økonomisk vækst i Danmark: Volume I: 1720-1914 and Volume II: 1914-1983. København: Akademisk Forlag, 1984.

Henriksen, Ingrid. “Avoiding Lock-in: Cooperative Creameries in Denmark, 1882-1903.” European Review of Economic History 3, no. 1 (1999): 57-78

Henriksen, Ingrid. “Freehold Tenure in Late Eighteenth-Century Denmark.” Advances in Agricultural Economic History 2 (2003): 21-40.

Henriksen, Ingrid and Kevin H. O’Rourke. “Incentives, Technology and the Shift to Year-round Dairying in Late Nineteenth-century Denmark.” Economic History Review 58, no. 3 (2005):.520-54.

Johansen, Hans Chr. Danish Population History, 1600-1939. Odense: University Press of Southern Denmark, 2002.

Johansen, Hans Chr. Dansk historisk statistik, 1814-1980. København: Gyldendal, 1985.

Klovland, Jan T. “Monetary Policy and Business Cycles in the Interwar Years: The Scandinavian Experience.” European Review of Economic History 2, no. 3 (1998): 309-44.

Maddison, Angus. The World Economy: A Millennial Perspective. Paris: OECD, 2001

Mokyr, Joel. “Successful Small Open Economies and the Importance of Good Institutions.” In The Road to Prosperity. An Economic History of Finland, edited by Jari Ojala, Jari Eloranta and Jukka Jalava, 8-14. Helsinki: SKS, 2006.

Pedersen, Peder J. “Postwar Growth of the Danish Economy.” In Economic Growth in Europe since 1945, edited by Nicholas Crafts and Gianni Toniolo. Cambridge: Cambridge University Press, 1995.

OECD, Employment Outlook, 2005.

O’Rourke, Kevin H. “The European Grain Invasion, 1870-1913.” Journal of Economic History 57, no. 4 (1997): 775-99.

O’Rourke, Kevin H. and Jeffrey G. Williamson. Globalization and History: The Evolution of a Nineteenth-century Atlantic Economy. Cambridge, MA: MIT Press, 1999

Topp, Niels-Henrik. “Influence of the Public Sector on Activity in Denmark, 1929-39.” Scandinavian Economic History Review 43, no. 3 (1995): 339-56.


Footnotes

1 Denmark also includes the Faeroe Islands, with home rule since 1948, and Greenland, with home rule since 1979, both in the North Atlantic. These territories are left out of this account.

Citation: Henriksen, Ingrid. “An Economic History of Denmark”. EH.Net Encyclopedia, edited by Robert Whaples. October 6, 2006. URL http://eh.net/encyclopedia/an-economic-history-of-denmark/

Economic History of Premodern China (from 221 BC to c. 1800 AD)

Kent Deng, London School of Economics (LSE)

China has the longest continually recorded history in the premodern world. For economic historians, it makes sense to begin with the formation of China’s national economy in the wake of China’s unification in 221 BC under the Qin. The year 1800 AD coincides with the beginning of the end for China’s premodern era, which was hastened by the First Opium War (1839–42). Hence, the time span of this article is two millennia.

Empire-building

Evidence indicates that there was a sharp difference in the economy between China’s pre-imperial era (until 220 BC) and its imperial era. There can be little doubt that the establishment of the Empire of China (to avoid the term of “the Chinese Empire” as it was not always an empire by and for the Chinese) served as a demarcation line in the history of the East Asian Mainland.

The empire was a result of historical contingency rather than inevitability. First of all, before the unification, China’s multiple units successfully accommodated a mixed economy of commerce, farming, handicrafts and pastoralism. Internal competition also allowed science and technology as well as literature and art to thrive on the East Asian Mainland. This was known as “a hundred flowers blossoming” (baijia zhengming, literally “a grand song contest with one hundred contenders”). Feudalism was widely practiced. Unifying such diverse economic and political units incurred inevitably huge social costs. Secondly, the winner of the bloody war on the East Asian Mainland, the Qin Dukedom and then the Qin Kingdom (840–222 BC), was not for a long time a rich or strong unit during the Spring and Autumn Period (840–476 BC) and the following Warring States Period (475–222 BC). It was only during the last three decades of the Warring States Period that the Qin eventually managed to overpower its rivals by force and consequently unified China. Moreover, although it unified China, the Qin was the worse-managed dynasty in the entire history of China: it crumbled after only fifteen years. So, it was not an easy birth; and the empire system was in serious jeopardy from the start. The main justification of China’s unification seems to have been a geopolitical reason, hence an external reason – the nomadic threat from the steppes (Deng 1999).

Nevertheless, empire-building in China marked a major discontinuity in history. Under the Western Han (206 BC– 24 AD), the successor of the Qin, empire-building not only sharply reduced internal competition among various political and economic centers on the East Asian Mainland, it also remolded the previous political and economic systems into a more integrated and more homogeneous type characterized by a package of an imperial bureaucracy under a fiscal state hand in hand with an economy under agricultural dominance. With such a package imposed by empire-builders, the economy deviated from its mixed norm. Feudalism lost its footing in China. This fundamentally changed the growth and development trajectory of China for the rest of the imperial period until c. 1800.

It is fair to state that private landholding property rights, including free-holding (dominant in North China over the long run) and lease-holding (paralleled with freeholding in South China during the post-Southern Song, i.e. 1279–1840) in imperial China laid the very corner stone of the empire’s economy since the Qin unification. Chinese laws clearly defined and protected such rights. In return, the imperial state had the mandate to tax the population of whom the vast majority (some 80 percent of the total population) were peasants. The state also depended on the rural population for army recruits. Peasants on the other hand regularly acted as the main force to populate newly captured areas along the empire’s long frontiers. Such a symbiotic relationship between the imperial state and China’s population was crystallized by a mutually beneficial state-peasant alliance in the long run. China’s lasting Confucian learning and Confucian meritocracy served as a social bonding agent for the alliance.

It was such an alliance that formed the foundations of China’s political economy which in turn created a centripetal force to hold the empire together against the restoration of feudalism and political decentralization (Deng 1999). It also served as a constant drive for China’s geographic expansion and an effective force against run-away proto-industrialization, commercialization and urbanization. So, to a great extent, China’s political economy was circumscribed by this alliance. Occasionally, this state-peasant alliance did break up and political and economic turmoil followed. The ultimate internal cause for the break-up was excessive rent-seeking by the state, seen as a deviation from the Confucian norm. It was often the peasantry that reversed this deviation and put society back on its track by the way of armed mass rebellions which replaced the old regime with a new one. This pattern is known, superficially, as the “dynastic cycle” of China.

The Empire’s Expansion

China’s fiscal state and landholding peasantry both had strong incentives and tendencies to increase the land territory of the empire. This was simply because more land meant more resource endowments for the peasantry and more tax revenue for the state. The Chinese non-feudal equal-inheritance practice perpetuated such incentives and tendencies at the grass roots level: unless more and more land was brought in for farming, the Chinese farms faced the constant problem of a shrinking size. Not surprisingly, the empire gradually expanded in all directions from its hub along the Yellow River in the north. It colonized the “near south” (around the Yangtze Valley) and to the West (oases along the Silk Road) during the Western Han (206 BC – 24 AD). It reached the “far south,” including part of modern-day Vietnam, under the Tang (618–907). The Ming (1368–1644) annexed off-shore Taiwan. The Qing (1644–1911) doubled China’s territory by going further in China’s “far north” and “far west” (Deng 1993: xxiii). At each step of this internal colonization, landholding peasants, shoulder to shoulder with the Chinese army and bureaucrats, duplicated the cells of China’s agricultural economy. The state often provided emigrant farmers who resettled in new regions with material and finance aid, typically free passages, seed and basic farming tools and tax holidays. The geographic expansion of the empire stopped only at the point when it reached the physical limits for farming.

So, in essence, the expansion of the Chinese empire was the result of dynamics of the Chinese institutions characterized by a fiscal state and a landholding peasantry, as this pattern suited well with China’s landholding property rights and non-feudal equal-inheritance practice. Thus, one of the two growth dimensions of the Chinese agricultural sector was this extensive pattern in geographic terms.

Agrarian Success

In this context, the success of the geographic expansion of the Chinese empire was at the same time a success in the growth of the Chinese agricultural sector. Firstly, regardless of its ten main soil types, the empire’s territory was converted to a huge farming zone. Secondly, the agricultural sector was by far the single most important source of employment for the majority Chinese. Thirdly, taxes from the agricultural sector made up the lion’s share of the state’s revenue.

Private property rights over land also created incentives for the ordinary farmers to produce more and better. In doing so, the agricultural total factor productivity increased. Growth became intensive. This was the other dimension in the Chinese agricultural sector. It is not so surprising that premodern China had at least three main “green revolutions.” The first such green revolution, the dry farming type, appeared in the Western Han Period (206 BC–24 AD) with the aggressive introduction of iron ploughs in the north by the state (Bray 1984). The result was an increase in the agricultural total factor productivity as land was better and more efficiently tilled and more marginal regions were brought under cultivation. The second green revolution took place during the Northern Song (960–1127) with the state promotion of early-ripening rice in the south (Ho 1956). This ushered in the era of multiple cropping in the empire. The third green revolution occurred during the late Ming throughout mid-Qing Period (Ming: 1368–1644; Qing: 1644–1911) with the spread of the “New World crops,” namely maize and sweet potatoes and the re-introduction of early-ripening rice (Deng 1993: ch. 3). The New World crops helped to convert more marginal land into farming areas. Earlier, under the Yuan, cotton was deliberately introduced by the Mongols as a substitute for silk in the Chinese consumption of clothing to save the silk for the Mongols’ international trade. All these green revolutions had high participation rates in the general population.

These green revolutions significantly and permanently changed China’s economic landscape. It was not a sheer accident that China’s population growth became particularly strong during and shortly after these revolutions (Deng 2003).

Markets and the Market Economy

With a fiscal state which taxed the economy and spent its revenue in the economy and with a high-yield agriculture which produced a constant surplus, the market economy developed in premodern China. By the end of the Qing, as much as one-third of China’s post-tax agricultural output was subject to market exchange (Perkins 1969: 115; Myers 1970: 12–13). If ten percent is taken as the norm for the tax rate born by the agricultural sector, the aggregate surplus of the agricultural sector was likely to be some forty percent of its total output. This magnitude of agricultural surplus was the foundation of growth and development of other sectors/activities in the economy.

Monetization in China had the same life span as the empire itself. The state mints mass-produced coins on a regular basis for the domestic economy and beyond. Due to the lack of monetary metals, token currencies made of cloth or paper were used on large scales, especially during the Song and Yuan periods (Northern Song: 960–1127; Southern Song: 1127–1279; Yuan: 1279–1368). Consequently, inflations resulted. Perhaps the most spectacular market phenomenon was China’s persistent importation of foreign silver from the fifteenth to nineteenth centuries during the Ming-Qing Period. It has been estimated that a total of one-third of silver output from the New World ended up in China, not to mention the amount imported from neighboring Japan (Flynn and Giráldez 1995). The imported silver consequently made China a silver-standard economy, eventually causing a price revolution after the market was saturated with foreign silver which in turn led to devaluation of the currency (Deng 1997: Appendix C).

Rudimentary credit systems, often of the short-term type, also appeared in China. Houses and farming land were often used as collateral to raise money. But there is no sign that there was a significant reduction of business risks for the creditor. Frequent community and/or state interference with contracts by blocking land transfers from debtors to creditors was counter-productive. So, to a great extent, China’s customary economy and command economy overruled the market one.

The nature of this surplus-based market exchange determined the multi-layered structure of the Chinese domestic market. At the grass-roots level, the market was localized, decentralized and democratic (Skinner 1964–5). This was highly compatible with the de facto village autonomy across the empire, as the imperial administration stopped at the county level (with a total number of roughly 1,000–1,500 such counties in all under the Qing). At the top of the market structure, the state controlled to a great extent some “key commodities” including salt (as during Ming and Qing), wine and iron and steel (as under the Han). Foreign trade was customarily under the state monopoly or partial monopoly, too. This left a limited platform for professional merchants to operate, a factor that ultimately determined the weakness of merchants’ influence in the economy and state politics.

So, paradoxically, China had a long history of market activities but a weak merchant class tradition. China’s social mobility and meritocracy, the antitheses of a feudal aristocracy, directed the talent and wealth to officialdom (Ho 1962; Rawski 1979). The existence of factor markets for land also allowed merchants to join the landholding class. Both undermined the rise of the merchant class.

Handicrafts and Urbanization

The sheer quantities of China’s handicrafts were impressive. It has been estimated that in the early nineteenth century, as much as one-third of the world’s total manufactures were produced by China (Kennedy 1987: 149; Huntington 1996: 86). In terms of ceramics and silk, China was able to supply the outside world almost single-handedly at times. Asia was traditionally China’s selling market for paper, stationary and cooking pots. All these are highly consistent with China’s intake of silver during the same period.

However, the growth in China’s handicrafts and urbanization was a function of the surpluses produced from the agricultural sector. This judgment is based on (1) the fact that not until the end of the Qing Period did China begin importing moderate quantities of foodstuffs from outside world to help feed the population; and (2) the fact that the handicraft sector never challenged agricultural dominance in the economy despite a symbiotic relationship between them.

By the same token, urbanization rarely exceeded ten percent of the total population although large urban centers were established. For example, during the Song, the northern capital Kaifeng (of the Northern Song) and southern capital Hangzhou (of the Southern Song) had 1.4 million and one million inhabitants, respectively (Jones et al. 1993: ch. 9). In addition, it was common that urban residents also had one foot in the rural sector due to private landholding property rights.

Science and Technology

In the context of China’s high yield agriculture (hence surpluses in the economy which were translated into leisure time for other pursuits) and Confucian meritocracy (hence a continued over-supply of the literate vis-à-vis the openings in officialdom and persistent record keeping by the premodern standards) (Chang 1962: ch. 1; Deng 1993: Appendix 1), China became one of the hotbeds of scientific discoveries and technological development of the premodern world (Needham 1954–95). It is commonly agreed that China led the world in science and technology from about the tenth century to about the fifteenth century.

The Chinese sciences and technologies were concentrated in several fields, mainly material production, transport, weaponry and medicine. A common feature of all Chinese discoveries was their trial-and-error basis and incremental improvement. Here, China’s continued history and large population became an advantage. However, this trial-and-error approach had its developmental ceiling. And, incremental improvement faced diminishing returns (Elvin 1973: ch. 17). So, although China once led the world, it was unable to realize what is known as the “Scientific Revolution” whose origin may well have been oriental/Chinese (Hobson 2004).

Living Standards

It has been argued that in the Ming-Qing Period the standards of living reached and stayed at a high level, comparable with the most wealthy parts of Western Europe by 1800 in material terms (Pomeranz 2000) and perhaps in education as well (Rawski 1979). Although the evidence is not conclusive, the claims certainly are compatible with China’s wealth in the context of (1) the rationality of private property rights-led growth, (2) total factor productivity growth associated with China’s green revolutions from the Han to the Ming-Qing and the economic revolution under the Song, and (3) China’s export capacity (hence China’s surplus output) and China’s silver imports (hence the purchasing power of China’s surplus).

Debates about China’s Long-term Economic History

The pivotal point of the debate about China’s long-term economic history has been why and how China did not go any further from its premodern achievements. Opinions have been divided and the debate goes on (Deng 2000). Within the wide spectrum of views, some are regarded as Eurocentric; some, Sinocentric (Hobson 2004). But a great many are neither, using some universally applicable criteria such as factor productivity (labor, land and capital), economic optimization/maximization, organizational efficiency, and externalities.

In a nutshell, the debate is whether to view China as a bottle “half empty” (hence China did not realize its full growth potential by the post-Renaissance Western European standard) or “half full” (hence China over-performed by the premodern world standard). In any case, China was “extra-ordinary” either in terms of its outstanding performance for a premodern civilization or in terms of its shortfall for modern growth despite its possession of many favorable preconditions to do so.

The utility of China’s premodern history is indeed indispensable in the understanding of how a dominant traditional economy (in terms of its sheer size and longevity) perpetuated and how the modern economy emerged in the world history.

References

Bray, Francesca. “Section 41: Agriculture.” In Science and Civilisation in China, edited by Joseph Needham, Volume 6. Cambridge: Cambridge University Press, 1984.

Chang, Chung-li. The Income of the Chinese Gentry. Seattle: University of Washington Press, 1962.

Deng, Gang. Chinese Maritime Activities and Socio-economic Consequences, c. 2100 BC – 1900 AD. Westport, CT: Greenwood Publishing, 1997.

Deng, Gang. Development versus Stagnation: Technological Continuity and Agricultural Progress in Premodern China. Westport, CT: Greenwood Publishing, 1993.

Deng, Gang. The Premodern Chinese Economy – Structural Equilibrium and Capitalist Sterility. London: Routledge, 1999.

Deng, K. G. “A Critical Survey of Recent Research in of Chinese Economic History.” Economic History Review 53, no. 1 (2000): 1–28.

Deng, K. G. “Fact or Fiction? Re-Examination of Chinese Premodern Population Statistics.” Economic History Department Working Papers no. 68, London School of Economics, 2003.

Elvin, Mark. The Pattern of the Chinese Past. Stanford: Stanford University Press, 1973.

Flynn, D. O. and Giráldez, Arturo. “Born with a ‘Silver Spoon’: The Origin of World Trade.” Journal of World History 6 no. 2 (1995): 201–21.

Ho, Ping-ti. “Early-Ripening Rice in Chinese History.” Economic History Review Ser. 2 (1956): 200–18.

Ho, Ping-ti. The Ladder of Success in Imperial China: Aspects of Social Mobility, 1368–1911. New York: Columbia University Press, 1962.

Hobson, J. M. The Eastern Origins of Western Civilisation. Cambridge: Cambridge University Press, 2004.

Huntington, S. P. The Clash of Civilisations and the Remaking of World Order. New York: Simon and Schuster, 1996.

Jones, E. L., Lionel Frost and Colin White. Coming Full Circle: An Economic History of the Pacific Rim. Melbourne and Oxford: Oxford University Press, 1993.

Kennedy, Paul. The Rise and Fall of the Great Powers. New York: Random House, 1987.

Myers, R. H. The Chinese Peasant Economy: Agricultural Development in Hopei and Shangtung, 1890–1949. Cambridge, MA: Harvard University Press, 1970.

Needham, Joseph, editor. Science and Civilisation in China. Cambridge: Cambridge University Press, 1954–2000.

Perkins, Dwight. Agricultural Development in China, 1368–1968. Edinburgh: Edinburgh University Press, 1969.

Pomeranz, Kenneth. The Great Divergence: Europe, China and the Making of the Modern World Economy. Princeton: Princeton University Press, 2000.

Rawski, E. S. Education and Popular Literacy in Ch’ing China. Ann Arbor: University of Michigan Press, 1979.

Skinner, G. W. “Marketing and Social Structure in Rural China.” Journal of Asian Studies 24 (1964–65): 3–44, 195–228, 363–400.

Citation: Deng, Kent. “Economic History of Premodern China”. EH.Net Encyclopedia, edited by Robert Whaples. November 7, 2004. URL
http://eh.net/encyclopedia/economic-history-of-premodern-china-from-221-bc-to-c-1800-ad/

The Economic History of Australia from 1788: An Introduction

Bernard Attard, University of Leicester

Introduction

The economic benefits of establishing a British colony in Australia in 1788 were not immediately obvious. The Government’s motives have been debated but the settlement’s early character and prospects were dominated by its original function as a jail. Colonization nevertheless began a radical change in the pattern of human activity and resource use in that part of the world, and by the 1890s a highly successful settler economy had been established on the basis of a favorable climate in large parts of the southeast (including Tasmania ) and the southwest corner; the suitability of land for European pastoralism and agriculture; an abundance of mineral wealth; and the ease with which these resources were appropriated from the indigenous population. This article will focus on the creation of a colonial economy from 1788 and its structural change during the twentieth century. To simplify, it will divide Australian economic history into four periods, two of which overlap. These are defined by the foundation of the ‘bridgehead economy’ before 1820; the growth of a colonial economy between 1820 and 1930; the rise of manufacturing and the protectionist state between 1891 and 1973; and the experience of liberalization and structural change since 1973. The article will conclude by suggesting briefly some of the similarities between Australia and other comparable settler economies, as well as the ways in which it has differed from them.

The Bridgehead Economy, 1788-1820

The description ‘bridgehead economy’ was used by one of Australia’s foremost economic historians, N. G. Butlin to refer to the earliest decades of British occupation when the colony was essentially a penal institution. The main settlements were at Port Jackson (modern Sydney, 1788) in New South Wales and Hobart (1804) in what was then Van Diemen’s Land (modern Tasmania). The colony barely survived its first years and was largely neglected for much of the following quarter-century while the British government was preoccupied by the war with France. An important beginning was nevertheless made in the creation of a private economy to support the penal regime. Above all, agriculture was established on the basis of land grants to senior officials and emancipated convicts, and limited freedoms were allowed to convicts to supply a range of goods and services. Although economic life depended heavily on the government Commissariat as a supplier of goods, money and foreign exchange, individual rights in property and labor were recognized, and private markets for both started to function. In 1808, the recall of the New South Wales Corps, whose officers had benefited most from access to land and imported goods (thus hopelessly entangling public and private interests), coupled with the appointment of a new governor, Lachlan Macquarie, in the following year, brought about a greater separation of the private economy from the activities and interests of the colonial government. With a significant increase in the numbers transported after 1810, New South Wales’ future became more secure. As laborers, craftsmen, clerks and tradesmen, many convicts possessed the skills required in the new settlements. As their terms expired, they also added permanently to the free population. Over time, this would inevitably change the colony’s character.

Natural Resources and the Colonial Economy, 1820-1930

Pastoral and Rural Expansion

For Butlin, the developments around 1810 were a turning point in the creation of a ‘colonial’ economy. Many historians have preferred to view those during the 1820s as more significant. From that decade, economic growth was based increasingly upon the production of fine wool and other rural commodities for markets in Britain and the industrializing economies of northwestern Europe. This growth was interrupted by two major depressions during the 1840s and 1890s and stimulated in complex ways by the rich gold discoveries in Victoria in 1851, but the underlying dynamics were essentially unchanged. At different times, the extraction of natural resources, whether maritime before the 1840s or later gold and other minerals, was also important. Agriculture, local manufacturing and construction industries expanded to meet the immediate needs of growing populations, which concentrated increasingly in the main urban centers. The colonial economy’s structure, growth of population and significance of urbanization are illustrated in tables 1 and 2. The opportunities for large profits in pastoralism and mining attracted considerable amounts of British capital, while expansion generally was supported by enormous government outlays for transport, communication and urban infrastructures, which also depended heavily on British finance. As the economy expanded, large-scale immigration became necessary to satisfy the growing demand for workers, especially after the end of convict transportation to the eastern mainland in 1840. The costs of immigration were subsidized by colonial governments, with settlers coming predominantly from the United Kingdom and bringing skills that contributed enormously to the economy’s growth. All this provided the foundation for the establishment of free colonial societies. In turn, the institutions associated with these — including the rule of law, secure property rights, and stable and democratic political systems — created conditions that, on balance, fostered growth. In addition to New South Wales, four other British colonies were established on the mainland: Western Australia (1829), South Australia (1836), Victoria (1851) and Queensland (1859). Van Diemen’s Land (Tasmania after 1856) became a separate colony in 1825. From the 1850s, these colonies acquired responsible government. In 1901, they federated, creating the Commonwealth of Australia.

Table 1
The Colonial Economy: Percentage Shares of GDP, 1891 Prices, 1861-1911

Pastoral Other rural Mining Manuf. Building Services Rent
1861 9.3 13.0 17.5 14.2 8.4 28.8 8.6
1891 16.1 12.4 6.7 16.6 8.5 29.2 10.3
1911 14.8 16.7 9.0 17.1 5.3 28.7 8.3

Source: Haig (2001), Table A1. Totals do not sum to 100 because of rounding.

Table 2
Colonial Populations (thousands), 1851-1911

Australia Colonies Cities
NSW Victoria Sydney Melbourne
1851 257 100 46 54 29
1861 669 198 328 96 125
1891 1,704 608 598 400 473
1911 2,313 858 656 648 593

Source: McCarty (1974), p. 21; Vamplew (1987), POP 26-34.

The process of colonial growth began with two related developments. First, in 1820, Macquarie responded to land pressure in the districts immediately surrounding Sydney by relaxing restrictions on settlement. Soon the outward movement of herdsmen seeking new pastures became uncontrollable. From the 1820s, the British authorities also encouraged private enterprise by the wholesale assignment of convicts to private employers and easy access to land. In 1831, the principles of systematic colonization popularized by Edward Gibbon Wakefield (1796-1862) were put into practice in New South Wales with the substitution of land sales for grants in order to finance immigration. This, however, did not affect the continued outward movement of pastoralists who simply occupied land where could find it beyond the official limits of settlement. By 1840, they had claimed a vast swathe of territory two hundred miles in depth running from Moreton Bay in the north (the site of modern Brisbane) through the Port Phillip District (the future colony of Victoria, whose capital Melbourne was marked out in 1837) to Adelaide in South Australia. The absence of any legal title meant that these intruders became known as ‘squatters’ and the terms of their tenure were not finally settled until 1846 after a prolonged political struggle with the Governor of New South Wales, Sir George Gipps.

The impact of the original penal settlements on the indigenous population had been enormous. The consequences of squatting after 1820 were equally devastating as the land and natural resources upon which indigenous hunter-gathering activities and environmental management depended were appropriated on a massive scale. Aboriginal populations collapsed in the face of disease, violence and forced removal until they survived only on the margins of the new pastoral economy, on government reserves, or in the arid parts of the continent least touched by white settlement. The process would be repeated again in northern Australia during the second half of the century.

For the colonists this could happen because Australia was considered terra nullius, vacant land freely available for occupation and exploitation. The encouragement of private enterprise, the reception of Wakefieldian ideas, and the wholesale spread of white settlement were all part of a profound transformation in official and private perceptions of Australia’s prospects and economic value as a British colony. Millennia of fire-stick management to assist hunter-gathering had created inland grasslands in the southeast that were ideally suited to the production of fine wool. Both the physical environment and the official incentives just described raised expectations of considerable profits to be made in pastoral enterprise and attracted a growing stream of British capital in the form of organizations like the Australian Agricultural Company (1824); new corporate settlements in Western Australia (1829) and South Australia (1836); and, from the 1830s, British banks and mortgage companies formed to operate in the colonies. By the 1830s, wool had overtaken whale oil as the colony’s most important export, and by 1850 New South Wales had displaced Germany as the main overseas supplier to British industry (see table 3). Allowing for the colonial economy’s growing complexity, the cycle of growth based upon land settlement, exports and British capital would be repeated twice. The first pastoral boom ended in a depression which was at its worst during 1842-43. Although output continued to grow during the 1840s, the best land had been occupied in the absence of substantial investment in fencing and water supplies. Without further geographical expansion, opportunities for high profits were reduced and the flow of British capital dried up, contributing to a wider downturn caused by drought and mercantile failure.

Table 3
Imports of Wool into Britain (thousands of bales), 1830-50

German Australian
1830 74.5 8.0
1840 63.3 41.0
1850 30.5 137.2

Source: Sinclair (1976), p. 46

When pastoral growth revived during the 1860s, borrowed funds were used to fence properties and secure access to water. This in turn allowed a further extension of pastoral production into the more environmentally fragile semi-arid interior districts of New South Wales, particularly during the 1880s. As the mobs of sheep moved further inland, colonial governments increased the scale of their railway construction programs, some competing to capture the freight to ports. Technical innovation and government sponsorship of land settlement brought greater diversity to the rural economy (see table 4). Exports of South Australian wheat started in the 1870s. The development of drought resistant grain varieties from the turn of the century led to an enormous expansion of sown acreage in both the southeast and southwest. From the 1880s, sugar production increased in Queensland, although mainly for the domestic market. From the 1890s, refrigeration made it possible to export meat, dairy products and fruit.

Table 4
Australian Exports (percentages of total value of exports), 1881-1928/29

Wool Minerals Wheat,flour Butter Meat Fruit
1881-90 54.1 27.2 5.3 0.1 1.2 0.2
1891-1900 43.5 33.1 2.9 2.4 4.1 0.3
1901-13 34.3 35.4 9.7 4.1 5.1 0.5
1920/21-1928/29 42.9 8.8 20.5 5.6 4.6 2.2

Source: Sinclair (1976), p. 166

Gold and Its Consequences

Alongside rural growth and diversification, the remarkable gold discoveries in central Victoria in 1851 brought increased complexity to the process of economic development. The news sparked an immediate surge of gold seekers into the colony, which was soon reinforced by a flood of overseas migrants. Until the 1870s, gold displaced wool as Australia’s most valuable export. Rural industries either expanded output (wheat in South Australia) or, in the case of pastoralists, switched production to meat and tallow, to supply a much larger domestic market. Minerals had been extracted since earliest settlement and, while yields on the Victorian gold fields soon declined, rich mineral deposits continued to be found. During the 1880s alone these included silver, lead and zinc at Broken Hill in New South Wales; copper at Mount Lyell in Tasmania; and gold at Charters Towers and Mount Morgan in Queensland. From 1893, what eventually became the richest goldfields in Australia were discovered at Coolgardie in Western Australia. The mining industry’s overall contribution to output and exports is illustrated in tables 1 and 4.

In Victoria, the deposits of easily extracted alluvial gold were soon exhausted and mining was taken over by companies that could command the financial and organizational resources needed to work the deep lodes. But the enormous permanent addition to the colonial population caused by the gold rush had profound effects throughout eastern Australia, dramatically accelerating the growth of the local market and workforce, and deeply disturbing the social balance that had emerged during the decade before. Between 1851 and 1861, the Australian population more than doubled. In Victoria it increased sevenfold; Melbourne outgrew Sydney, Chicago and San Francisco (see table 2). Significantly enlarged populations required social infrastructure, political representation, employment and land; and the new colonial legislatures were compelled to respond. The way this was played out varied between colonies but the common outcomes were the introduction of manhood suffrage, access to land through ‘free selection’ of small holdings, and, in the Victorian case, the introduction of a protectionist tariff in 1865. The particular age structure of the migrants of the 1850s also had long-term effects on the building cycle, notably in Victoria. The demand for housing accelerated during the 1880s, as the children of the gold generation matured and established their own households. With pastoral expansion and public investment also nearing their peaks, the colony experienced a speculative boom which added to the imbalances already being caused by falling export prices and rising overseas debt. The boom ended with the wholesale collapse of building companies, mortgage banks and other financial institutions during 1891-92 and the stoppage of much of the banking system during 1893.

The depression of the 1890s was worst in Victoria. Its impact on employment was softened by the Western Australian gold discoveries, which drew population away, but the colonial economy had grown to such an extent since the 1850s that the stimulus provided by the earlier gold finds could not be repeated. Severe drought in eastern Australia from the mid-1890s until 1903 caused the pastoral industry to contract. Yet, as we have seen, technological innovation also created opportunities for other rural producers, who were now heavily supported by government with little direct involvement by foreign investors. The final phase of rural expansion, with its associated public investment in rural (and increasingly urban) infrastructure continued until the end of the 1920s. Yields declined, however, as farmers moved onto the most marginal land. The terms of trade also deteriorated with the oversupply of several commodities in world markets after the First World War. As a result, the burden of servicing foreign debt rose once again. Australia’s position as a capital importer and exporter of natural resources meant that the Great Depression arrived early. From late 1929, the closure of overseas capital markets and collapse of export prices forced the Federal Government to take drastic measures to protect the balance of payments. The falls in investment and income transmitted the contraction to the rest of the economy. By 1932, average monthly unemployment amongst trade union members was over 22 percent. Although natural resource industries continued to have enduring importance as earners of foreign exchange, the Depression finally ended the long period in which land settlement and technical innovation had together provided a secure foundation for economic growth.

Manufacturing and the Protected Economy, 1891-1973

The ‘Australian Settlement’

There is a considerable chronological overlap between the previous section, which surveyed the growth of a colonial economy during the nineteenth century based on the exploitation of natural resources, and this one because it is a convenient way of approaching the two most important developments in Australian economic history between Federation and the 1970s: the enormous increase in government regulation after 1901 and, closely linked to this, the expansion of domestic manufacturing, which from the Second World War became the most dynamic part of the Australian economy.

The creation of the Commonwealth of Australia on 1 January 1901 broadened the opportunities for public intervention in private markets. The new Federal Government was given clearly-defined but limited powers over obviously ‘national’ matters like customs duties. The rest, including many affecting economic development and social welfare, remained with the states. The most immediate economic consequence was the abolition of inter-colonial tariffs and the establishment of a single Australian market. But the Commonwealth also soon set about transferring to the national level several institutions that different the colonies had experimented with during the 1890s. These included arrangements for the compulsory arbitration of industrial disputes by government tribunals, which also had the power to fix wages, and a discriminatory ‘white Australia’ immigration policy designed to exclude non-Europeans from the labor market. Both were partly responses to organized labor’s electoral success during the 1890s. Urban business and professional interests had always been represented in colonial legislatures; during the 1910s, rural producers also formed their own political parties. Subsequently, state and federal governments were typically formed by the either Australian Labor Party or coalitions of urban conservatives and the Country Party. The constituencies they each represented were thus able to influence the regulatory structure to protect themselves against the full impact of market outcomes, whether in the form of import competition, volatile commodity prices or uncertain employment conditions. The institutional arrangements they created have been described as the ‘Australian settlement’ because they balanced competing producer interests and arguably provided a stable framework for economic development until the 1970s, despite the inevitable costs.

The Growth of Manufacturing

An important part of the ‘Australian settlement’ was the imposition of a uniform federal tariff and its eventual elaboration into a system of ‘protection all round’. The original intended beneficiaries were manufacturers and their employees; indeed, when the first protectionist tariff was introduced in 1907, its operation was linked to the requirement that employers pay their workers ‘fair and reasonable wages’. Manufacturing’s actual contribution to economic growth before Federation has been controversial. The population influx of the 1850s widened opportunities for import-substitution but the best evidence suggests that manufacturing grew slowly as the industrial workforce increased (see table 1). Production was small-scale and confined largely to the processing of rural products and raw materials; assembly and repair-work; or the manufacture of goods for immediate consumption (e.g. soap and candle-making, brewing and distilling). Clothing and textile output was limited to a few lines. For all manufacturing, growth was restrained by the market’s small size and the limited opportunities for technical change it afforded.

After Federation, production was stimulated by several factors: rural expansion, the increasing use of agricultural machinery and refrigeration equipment, and the growing propensity of farm incomes to be spent locally. The removal of inter-colonial tariffs may also have helped. The statistical evidence indicates that between 1901 and the outbreak of the First World War manufacturing grew faster than the economy as a whole, while output per worker increased. But manufacturers also aspired mainly to supply the domestic market and expended increasing energy on retaining privileged access. Tariffs rose considerably between the two world wars. Some sectors became more capital intensive, particularly with the establishment of a local steel industry, the beginnings of automobile manufacture, and the greater use of electricity. But, except during the first half of the 1920s, there was little increase in labor productivity and the inter-war expansion of textile manufacturing reflected the heavy bias towards import substitution. Not until the Second World War and after did manufacturing growth accelerate and extend to those sectors most characteristic of an advance industrial economy (table 5). Amongst these were automobiles, chemicals, electrical and electronic equipment, and iron-and-steel. Growth was sustained during 1950s by similar factors to those operating in other countries during the ‘long boom’, including a growing stream of American direct investment, access to new and better technology, and stable conditions of full employment.

Table 5
Manufacturing and the Australian Economy, 1913-1949

1938-39 prices
Manufacturing share of GDP % Manufacturing annual rate of growth % GDP, annual rate of growth %
1913/14 21.9
1928/29 23.6 2.6 2.1
1948/49 29.8 3.4 2.2

Calculated from Haig (2001), Table A2. Rates of change are average annual changes since the previous year in the first column.

Manufacturing peaked in the mid-1960s at about 28 percent of national output (measured in 1968-69 prices) but natural resource industries remained the most important suppliers of exports. Since the 1920s, over-supply in world markets and the need to compensate farmers for manufacturing protection, had meant that virtually all rural industries, with the exception of wool, had been drawn into a complicated system of subsidies, price controls and market interventions at both federal and state levels. The post-war boom in the world economy increased demand for commodities, benefiting rural producers but also creating new opportunities for Australian miners. Most important of all, the first surge of breakneck growth in East Asia opened a vast new market for iron ore, coal and other mining products. Britain’s significance as a trading partner had declined markedly since the 1950s. By the end of the 1960s, Japan overtook it as Australia’s largest customer, while the United States was now the main provider of imports.

The mining bonanza contributed to the boom conditions experienced generally after 1950. The Federal Government played its part by using the full range of macroeconomic policies that were also increasingly familiar in similar western countries to secure stability and full employment. It encouraged high immigration, relaxing the entry criteria to allow in large numbers of southern Europeans, who added directly to the workforce, but also brought knowledge and experience. With state governments, the Commonwealth increased expenditure on education significantly, effectively entering the field for the first time after 1945. Access to secondary education was widened with the abandonment of fees in government schools and federal finance secured an enormous expansion of university places, especially after 1960. Some weaknesses remained. Enrolment rates after primary school were below those in many industrial countries and funding for technical education was poor. Despite this, the Australian population’s rising levels of education and skill continued to be important additional sources of growth. Finally, although government advisers expressed misgivings, industry policy remained determinedly interventionist. While state governments competed to attract manufacturing investment with tax and other incentives, by the 1960s protection had reached its highest level, with Australia playing virtually no part in the General Agreement on Tariffs and Trade (GATT), despite being an original signatory. The effects of rising tariffs since 1900 were evident in the considerable decline in Australia’s openness to trade (Table 6). Yet, as the post-war boom approached its end, the country still relied upon commodity exports and foreign investment to purchase the manufactures it was unable to produce itself. The impossibility of sustaining growth in this way was already becoming clear, even though the full implications would only be felt during the decades to come.

Table 6
Trade (Exports Plus Imports)
as a Share of GDP, Current Prices, %

1900/1 44.9
1928/29 36.9
1938/38 32.7
1964/65 33.3
1972/73 29.5

Calculated from Vamplew (1987), ANA 119-129.

Liberalization and Structural Change, 1973-2005

From the beginning of the 1970s, instability in the world economy and weakness at home ended Australia’s experience of the post-war boom. During the following decades, manufacturing’s share in output (table 7) and employment fell, while the long-term relative decline of commodity prices meant that natural resources could no longer be relied on to cover the cost of imports, let alone the long-standing deficits in payments for services, migrant remittances and interest on foreign debt. Until the early 1990s, Australia also suffered from persistent inflation and rising unemployment (which remained permanently higher, see chart 1). As a consequence, per capita incomes fluctuated during the 1970s, and the economy contracted in absolute terms during 1982-83 and 1990-91.

Even before the 1970s, new sources of growth and rising living standards had been needed, but the opportunities for economic change were restricted by the elaborate regulatory structure that had evolved since Federation. During that decade itself, policy and outlook were essentially defensive and backward looking, despite calls for reform and some willingness to alter the tariff. Governments sought to protect employment in established industries, while dependence on mineral exports actually increased as a result of the commodity booms at the decade’s beginning and end. By the 1980s, however, it was clear that the country’s existing institutions were failing and fundamental reform was required.

Table 7
The Australian Economy, 1974-2004

A. Percentage shares of value-added, constant prices

1974 1984 1994 2002
Agriculture 4.4 4.3 3.0 2.7
Manufacturing 18.1 15.2 13.3 11.8
Other industry, inc. mining 14.2 14.0 14.6 14.4
Services 63.4 66.4 69.1 71.1

B. Per capita GDP, annual average rate of growth %, constant prices

1973-84 1.2
1984-94 1.7
1994-2004 2.5

Calculated from World Bank, World Development Indicators (Sept. 2005).

Figure 1
Unemployment, 1971-2005, percent

Unemployment, 1971-2005, percent

Source: Reserve Bank of Australia (1988); Reserve Bank of Australia, G07Hist.xls. Survey data at August. The method of data collection changed in 1978.

The catalyst was the resumption of the relative fall of commodity prices since the Second World War which meant that the cost of purchasing manufactured goods inexorably rose for primary producers. The decline had been temporarily reversed by the oil shocks of the 1970s but, from the 1980/81 financial year until the decade’s end, the value of Australia’s merchandise imports exceeded that of merchandise exports in every year but two. The overall deficit on current account measured as a proportion of GDP also moved became permanently higher, averaging around 4.7 percent. During the 1930s, deflation had been followed by the further closing of the Australian economy. There was no longer much scope for this. Manufacturing had stagnated since the 1960s, suffering especially from the inflation of wage and other costs during the 1970s. It was particularly badly affected by the recession of 1982-83, when unemployment rose to almost ten percent, its highest level since the Great Depression. In 1983, a new federal Labor Government led by Bob Hawke sought to engineer a recovery through an ‘Accord’ with the trade union movement which aimed at creating employment by holding down real wages. But under Hawke and his Treasurer, Paul Keating — who warned colorfully that otherwise the country risked becoming a ‘banana republic’ — Labor also started to introduce broader reforms to increase the efficiency of Australian firms by improving their access to foreign finance and exposing them to greater competition. Costs would fall and exports of more profitable manufactures increase, reducing the economy’s dependence on commodities. During the 1980s and 1990s, the reforms deepened and widened, extending to state governments and continuing with the election of a conservative Liberal-National Party government under John Howard in 1996, as each act of deregulation invited further measures to consolidate them and increase their effectiveness. Key reforms included the floating of the Australian dollar and the deregulation of the financial system; the progressive removal of protection of most manufacturing and agriculture; the dismantling of the centralized system of wage-fixing; taxation reform; and the promotion of greater competition and better resource use through privatization and the restructuring of publicly-owned corporations, the elimination of government monopolies, and the deregulation of sectors like transport and telecommunications. In contrast with the 1930s, the prospects of further domestic reform were improved by an increasingly favorable international climate. Australia contributed by joining other nations in the Cairns Group to negotiate reductions of agricultural protection during the Uruguay round of GATT negotiations and by promoting regional liberalization through the Asia Pacific Economic Cooperation (APEC) forum.

Table 8
Exports and Openness, 1983-2004

Shares of total exports, % Shares of GDP: exports + imports, %
Goods Services
Rural Resource Manuf. Other
1983 30 34 9 3 24 26
1989 23 37 11 5 24 27
1999 20 34 17 4 24 37
2004 18 33 19 6 23 39

Calculated from: Reserve Bank of Australia, G10Hist.xls and H03Hist.xls; World Bank, World Development Indicators (Sept. 2005). Chain volume measures, except shares of GDP, 1983, which are at current prices.

The extent to which institutional reform had successfully brought about long-term structural change was still not clear at the end of the century. Recovery from the 1982-83 recession was based upon a strong revival of employment. By contrast, the uninterrupted growth experienced since 1992 arose from increases in the combined productivity of workers and capital. If this persisted, it was a historic change in the sources of growth from reliance on the accumulation of capital and the increase of the workforce to improvements in the efficiency of both. From the 1990s, the Australian economy also became more open (table 8). Manufactured goods increased their share of exports, while rural products continued to decline. Yet, although growth was more broadly-based, rapid and sustained (table 7), the country continued to experience large trade and current account deficits, which were augmented by the considerable increase of foreign debt after financial deregulation during the 1980s. Unemployment also failed to return to its pre-1974 level of around 2 percent, although much of the permanent rise occurred during the mid to late 1970s. In 2005, it remained 5 percent (Figure 1). Institutional reform clearly contributed to these changes in economic structure and performance but they were also influenced by other factors, including falling transport costs, the communications and information revolutions, the greater openness of the international economy, and the remarkable burst of economic growth during the century’s final decades in southeast and east Asia, above all China. Reform was also complemented by policies to provide the skills needed in a technologically-sophisticated, increasingly service-oriented economy. Retention rates in the last years of secondary education doubled during the 1980s, followed by a sharp increase of enrolments in technical colleges and universities. By 2002, total expenditure on education as a proportion of national income had caught up with the average of member countries of the OECD (Table 9). Shortages were nevertheless beginning to be experienced in the engineering and other skilled trades, raising questions about some priorities and the diminishing relative financial contribution of government to tertiary education.

Table 9
Tertiary Enrolments and Education Expenditure, 2002

Tertiary enrolments, gross percent Education expenditure as a proportion of GDP, percent
Australia 63.22 6.0
OECD 61.68 5.8
United States 70.67 7.2

Source: World Bank, World Development Indicators (Sept. 2005); OECD (2005). Gross enrolments are total enrolments, regardless of age, as a proportion of the population in the relevant official age group. OECD enrolments are for fifteen high-income members only.

Summing Up: The Australian Economy in a Wider Context

Virtually since the beginning of European occupation, the Australian economy had provided the original British colonizers, generations of migrants, and the descendants of both with a remarkably high standard of living. Towards the end of the nineteenth century, this was by all measures the highest in the world (see table 10). After 1900, national income per member of the population slipped behind that of several countries, but continued to compare favorably with most. In 2004, Australia was ranked behind only Norway and Sweden in the United Nation’s Human Development Index. Economic historians have differed over the sources of growth that made this possible. Butlin emphasized the significance of local factors like the unusually high rate of urbanization and the expansion of domestic manufacturing. In important respects, however, Australia was subject to the same forces as other European settler societies in New Zealand and Latin America, and its development bore striking similarities to theirs. From the 1820s, its economy grew as one frontier of an expanding western capitalism. With its close institutional ties to, and complementarities with, the most dynamic parts of the world economy, it drew capital and migrants from them, supplied them with commodities, and shared the benefits of their growth. Like other settler societies, it sought population growth as an end in itself and, from the turn of the nineteenth century, aspired to the creation of a national manufacturing base. Finally, when openness to the world economy appeared to threaten growth and living standards, governments intervened to regulate and protect with broader social objectives in mind. But there were also striking contrasts with other settler economies, notably those in Latin America like Argentina, with which it has been frequently compared. In particular, Australia responded to successive challenges to growth by finding new opportunities for wealth creation with a minimum of political disturbance, social conflict or economic instability, while sharing a rising national income as widely as possible.

Table 10
Per capita GDP in Australia, United States and Argentina
(1990 international dollars)

Australia United States Argentina
1870 3,641 2,457 1,311
1890 4,433 3,396 2,152
1950 7,493 9,561 4,987
1998 20,390 27,331 9,219

Sources: Australia: GDP, Haig (2001) as converted in Maddison (2003); all other data Maddison (1995) and (2001)

From the mid-twentieth century, Australia’s experience also resembled that of many advanced western countries. This included the post-war willingness to use macroeconomic policy to maintain growth and full employment; and, after the 1970s, the abandonment of much government intervention in private markets while at the same time retaining strong social services and seeking to improve education and training. Australia also experienced a similar relative decline of manufacturing, permanent rise of unemployment, and transition to a more service-based economy typical of high income countries. By the beginning of the new millennium, services accounted for over 70 percent of national income (table 7). Australia remained vulnerable as an exporter of commodities and importer of capital but its endowment of natural resources and the skills of its population were also creating opportunities. The country was again favorably positioned to take advantage of growth in the most dynamic parts of the world economy, particularly China. With the final abandonment of the White Australia policy during the 1970s, it had also started to integrate more closely with its region. This was further evidence of the capacity to change that allowed Australians to face the future with confidence.

References:

Anderson, Kym. “Australia in the International Economy.” In Reshaping Australia’s Economy: Growth with Equity and Sustainability, edited by John Nieuwenhuysen, Peter Lloyd and Margaret Mead, 33-49. Cambridge: Cambridge University Press, 2001.

Blainey, Geoffrey. The Rush that Never Ended: A History of Australian Mining, fourth edition. Melbourne: Melbourne University Press, 1993.

Borland, Jeff. “Unemployment.” In Reshaping Australia’s Economy: Growth and with Equity and Sustainable Development, edited by John Nieuwenhuysen, Peter Lloyd and Margaret Mead, 207-228. Cambridge: Cambridge University Press, 2001.

Butlin, N. G. Australian Domestic Product, Investment and Foreign Borrowing 1861-1938/39. Cambridge: Cambridge University Press, 1962.

Butlin, N.G. Economics and the Dreamtime, A Hypothetical History. Cambridge: Cambridge University Press, 1993.

Butlin, N.G. Forming a Colonial Economy: Australia, 1810-1850. Cambridge: Cambridge University Press, 1994.

Butlin, N.G. Investment in Australian Economic Development, 1861-1900. Cambridge: Cambridge University Press, 1964.

Butlin, N. G., A. Barnard and J. J. Pincus. Government and Capitalism: Public and Private Choice in Twentieth Century Australia. Sydney: George Allen and Unwin, 1982.

Butlin, S. J. Foundations of the Australian Monetary System, 1788-1851. Sydney: Sydney University Press, 1968.

Chapman, Bruce, and Glenn Withers. “Human Capital Accumulation: Education and Immigration.” In Reshaping Australia’s economy: growth with equity and sustainability, edited by John Nieuwenhuysen, Peter Lloyd and Margaret Mead, 242-267. Cambridge: Cambridge University Press, 2001.

Dowrick, Steve. “Productivity Boom: Miracle or Mirage?” In Reshaping Australia’s Economy: Growth with Equity and Sustainability, edited by John Nieuwenhuysen, Peter Lloyd and Margaret Mead, 19-32. Cambridge: Cambridge University Press, 2001.

Economist. “Has he got the ticker? A survey of Australia.” 7 May 2005.

Haig, B. D. “Australian Economic Growth and Structural Change in the 1950s: An International Comparison.” Australian Economic History Review 18, no. 1 (1978): 29-45.

Haig, B.D. “Manufacturing Output and Productivity 1910 to 1948/49.” Australian Economic History Review 15, no. 2 (1975): 136-61.

Haig, B.D. “New Estimates of Australian GDP: 1861-1948/49.” Australian Economic History Review 41, no. 1 (2001): 1-34.

Haig, B. D., and N. G. Cain. “Industrialization and Productivity: Australian Manufacturing in the 1920s and 1950s.” Explorations in Economic History 20, no. 2 (1983): 183-98.

Jackson, R. V. Australian Economic Development in the Nineteenth Century. Canberra: Australian National University Press, 1977.

Jackson, R.V. “The Colonial Economies: An Introduction.” Australian Economic History Review 38, no. 1 (1998): 1-15.

Kelly, Paul. The End of Certainty: The Story of the 1980s. Sydney: Allen and Unwin, 1992.

Macintyre, Stuart. A Concise History of Australia. Cambridge: Cambridge University Press, 1999.

McCarthy, J. W. “Australian Capital Cities in the Nineteenth Century.” In Urbanization in Australia; The Nineteenth Century, edited by J. W. McCarthy and C. B. Schedvin, 9-39. Sydney: Sydney University Press, 1974.

McLean, I.W. “Australian Economic Growth in Historical Perspective.” The Economic Record 80, no. 250 (2004): 330-45.

Maddison, Angus. Monitoring the World Economy 1820-1992. Paris: OECD, 1995.

Maddison, Angus. The World Economy: A Millennial Perspective. Paris: OECD, 2001.

Maddison, Angus. The World Economy: Historical Statistics. Paris: OECD, 2003.

Meredith, David, and Barrie Dyster. Australia in the Global Economy: Continuity and Change. Cambridge: Cambridge University Press, 1999.

Nicholas, Stephen, editor. Convict Workers: Reinterpreting Australia’s Past. Cambridge: Cambridge University Press, 1988.

OECD. Education at a Glance 2005 – Tables OECD, 2005 [cited 9 February 2006]. Available from http://www.oecd.org/document/11/0,2340,en_2825_495609_35321099_1_1_1_1,00.html.

Pope, David, and Glenn Withers. “The Role of Human Capital in Australia’s Long-Term Economic Growth.” Paper presented to 24th Conference of Economists, Adelaide, 1995.

Reserve Bank of Australia. “Australian Economic Statistics: 1949-50 to 1986-7: I Tables.” Occasional Paper No. 8A (1988).

Reserve Bank of Australia. Current Account – Balance of Payments – H1 [cited 29 November 2005]. Available from http://www.rba.gov.au/Statistics/Bulletin/H01bhist.xls.

Reserve Bank of Australia. Gross Domestic Product – G10 [cited 29 November 2005]. Available from http://www.rba.gov.au/Statistics/Bulletin/G10hist.xls.

Reserve Bank of Australia. Unemployment – Labour Force – G1 [cited 2 February 2006]. Available from http://www.rba.gov.au/Statistics/Bulletin/G07hist.xls.

Schedvin, C. B. Australia and the Great Depression: A Study of Economic Development and Policy in the 120s and 1930s. Sydney: Sydney University Press, 1970.

Schedvin, C.B. “Midas and the Merino: A Perspective on Australian Economic History.” Economic History Review 32, no. 4 (1979): 542-56.

Sinclair, W. A. The Process of Economic Development in Australia. Melbourne: Longman Cheshire, 1976.

United Nations Development Programme. Human Development Index [cited 29 November 2005]. Available from http://hdr.undp.org/statistics/data/indicators.cfm?x=1&y=1&z=1.

Vamplew, Wray, ed. Australians: Historical Statistics. Edited by Alan D. Gilbert and K. S. Inglis, Australians: A Historical Library. Sydney: Fairfax, Syme and Weldon Associates, 1987.

White, Colin. Mastering Risk: Environment, Markets and Politics in Australian Economic History. Melbourne: Oxford University Press, 1992.

World Bank. World Development Indicators ESDS International, University of Manchester, September 2005 [cited 29 November 2005]. Available from http://www.esds.ac.uk/International/Introduction.asp.

Citation: Attard, Bernard. “The Economic History of Australia from 1788: An Introduction”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL
http://eh.net/encyclopedia/the-economic-history-of-australia-from-1788-an-introduction/

Handbook of World Exchange Rates, 1590-1914

Author(s):Denzel, Markus A.
Reviewer(s):Officer, Lawrence H.

Published by EH.NET (December 2010)

Markus A. Denzel, Handbook of World Exchange Rates, 1590-1914. Surrey, UK: Ashgate, 2010. clii + 614 pp. $165 (hardcover), ISBN: 978-0-7546-0356-6.

Reviewed for EH.NET by Lawrence H. Officer, Department of Economics, University of Illinois at Chicago.

In 1962 a great historian of foreign exchange wrote: ?There is everything to be said for compiling continuous series of exchange rates for all the important exchanges in the principal Foreign Exchange markets, at least from the sixteenth century, but preferably also for the late Medieval Period. The material is there, in public records and business archives. But to make it accessible is a task that only some well-endowed research department could undertake? (Einzig, 1970, p. xii).

In fact, the task was largely done and the results made public in the last decade of the twentieth century via a set of 11 volumes under the rubric W?hrungen der Welt (Currencies of the World). Markus A. Denzel, Professor at University of Leipzig and the author of Handbook of World Exchange Rates, 1590-1914, was one of the editors of all but the first volume of this set. The eleven-volumes of W?hrungen der Welt are a fantastic resource for the monetary historian and exchange-rate specialist; but, for most potential users, it has the twin defects of a language barrier and the sheer mass of data presented. Therefore, eight years ago, Denzel began work on the Handbook, the objective of which is to present the content of W?hrungen der Welt into one manageable volume and in English, thus correcting the defects. As the author states: ?it was the central aim of this edition to act as an English anthology presenting the most important exchange rate series in the form of a handbook? (p. v).

But the author does more than simply condense the data series in the eleven German volumes into one English volume. Table 1 summarizes the various parts of the Handbook. Although over four-fifths of the book is devoted to exchange-rate series, there are over a hundred pages left over. A good part of the latter page group is devoted to two general histories, the first of which is a history of international ?cashless payments,? beginning with the bill of exchange in Europe (specifically Italy) in the Middle Ages and concentrating on that Continent, but also with reference to Arabian, Armenian, Chinese, and Indian experiences. This is as detailed a history of international exchange instruments as could be found anywhere — but here all in one place. Denzel continues the history beyond the bill of exchange to the telegraphic transfer and the check.

Table 1
Anatomy of the Handbook

use of handbook??? ?????? ??? ??? ??? ??? ????????????????????????????????? 12 pages
history of foreign exchange and currency systems??? ?????? ?? ? 89 pages
list of data sources??? ?????? ??? ??? ??? ??? ?????????????????????????????? 12 pages
bibliography??? ?????? ??? ??? ??? ??? ??? ???????????????????????????????????? 30 pages
exchange-rate series (text and tables)??? ???? ??? ??? ????????????? 614 pages
total substantive pages??? ???? ??? ??? ??? ??? ?????????????????????????? 757 pages

Also impressive is the related history of currency systems, again beginning in the Middle Ages (with the various regional divisions of the pound). Coins and moneys of account are the subject, and paper money is also considered. Denzel correctly observes that banknotes began in Sweden, but does not mention the much earlier Chinese experience with paper money. There is a discussion of the classic gold standard (1870-1914) with its different types, and Denzel points out that only four countries (Britain, France, Germany, United States) had a ?true? gold standard, meaning circulating gold coin and/or paper money and token coins convertible into gold.

The list of data sources and the bibliography are both remarkable. Data sources consist of four types: (1) unprinted sources, exchange-rate currents, and price currents, (2) newspapers, (3) merchant manuals, and (4) other printed sources. There is also an incredibly long list of merchant manuals underlying the Handbook in general, constituting 56 lines in small font (p. xx, note 37). The bibliography and footnote references demonstrate an extensive knowledge of the literature — both of data sources and of historical analysis. Denzel discusses early currency and exchange-rate handbooks in various languages and notes modern predecessor handbooks that began with McCusker (1978) and Spufford (1986). The bibliography is fantastic, suffering only from the inexplicable omission of Einzig (1970). The only serious criticism of the Handbook is the lack of an overall index.

While the exchange-rate series text and tables are based mainly on W?hrungen der Welt, the Handbook series are not simply replications of W?hrungen der Welt series. Some data are taken from two relevant volumes of Quellen und Forschungen zur Historischen Statistik von Deutschland (?Sources and Research on Historical Statistics of Germany?); errors in W?hrungen der Welt and Historischen Statistik von Deutschland are corrected; and there is new source material for several countries (Australia, Canada, Italy, the Ottoman Empire, Russia, Uruguay).

The exchange-rate tables are presented in an individual-country framework. For each country, there are lists and/or discussions of data sources, location of exchange markets, data sources, concordances with the W?hrungen der Welt or Historischen Statistik von Deutschland series, and other available data (not tabulated in the Handbook). Also, a history of the country?s currency units and international exchange instruments is presented, as well as a list of historical references. The exchange-rate series are arranged according to the domestic city of quotation, with separate series for each foreign city. The denomination is the domestic price of foreign currency, that is, the number of units of domestic currency per unit of foreign currency. However, the foreign-currency unit is generally not the basic unit (for example, one pound sterling) but rather a multiple of that unit (for example, 100 pounds sterling).

Generally, only series for the most important domestic market are provided; but there are exceptions. In particular, exchange rates for multiple domestic markets are presented for the period prior to currency standardization or integration of domestic markets. Again unlike W?hrungen der Welt, domestic exchange series are generally not shown; but as usual there are exceptions (for example, domestic exchange of Boston, New Orleans, and San Francisco on New York).

Different from the monthly series in W?hrungen der Welt with concomitant annual averages, the Handbook shows only annual averages. A criticism common to each work is that the annual average pertains only to one observation per month, with beginning-of-month the preferred day; whereas a true monthly average would incorporate all market days during the month. For each year, Denzel shows the number of months used to compute the annual figure. While each series begins with the earliest year for which data are available, the last year is 1914 and July the last month — so at most seven observations underlie the observation for that year. (Only one country, Poland, has an earlier final year — see Table 3 below.)

A unique usance (period of time for payment of bill of exchange) is selected for a given series — the dominant usance, with the shortest usance taken if dominance cannot be established — whereas W?hrungen der Welt has alternative series (varying with usance). For example, W?hrungen der Welt provides the New York on London rate in several alternative series: 60 day exchange rate, sight exchange rate, and cable-transfer exchange rate. The corresponding Handbook series is unique: the 60-day rate for 1783-1879, followed by the cable-transfer rate.

Denzel chooses market quotations over official rates and exchange rates (for bills of exchange) over ?money rates? (exchange of coin). So he is not concerned with parity rates as such (although he does pay attention to parity), and exchange rates are deliberately expressed as absolute levels rather than deviations from parity. He states that money rates are tabulated in cases when exchange rates are quoted in inflationary paper currency; but he does not correct the New York on London paper exchange rate during the greenback period and also for other periods of suspension of specie payments.

Table 2 shows the regional coverage of the Handbook?s exchange-rate series. The emphasis on Europe (including Britain) is apparent, with almost two-thirds of country specific pagination devoted to that region. The regional bias is primarily a result of history (especially the 1914 end-year).

Table 2
Regional Coverage of Exchange-Rate Series

Region??? ??? No. of? Countries??? Pages (Text and Tables)
??? ??? ??? ??? ??????????????????????????????? Number??? Percent of Total
Europe??? ????????? ??? 13??? ?????????? ??? ??? 398??? ??????????? 65
America??? ????????????? 8??? ???????????? ??? ??? 94??? ??????????? 15
Asia??? ??????????? ??? ?? 8??? ???????????? ??? ??? 86??? ??????????? 14
Oceania??? ????????????? 2??? ??????????????? ??? 18??? ????????????? 3
Africa??? ??????????? ??? ? 2??? ??????????????? ??? 18??? ????????????? 3
Total??? ????????? ?????? 33??? ?????????? ??? ??? 614??? ????????? 100

Table 3 lists the 33 domestic countries for which the Handbook provides data series. The ordering is according to number of country-specific pages devoted to the country. One again sees the European emphasis, with only two non-European countries in the top ten. It is interesting that just eight countries account for half (50.7 percent) of the total country pagination.

Table 3
Exchange-Rate Series: Country-Specific Text and Tables

Country??? ??? ??? ????????????? Range of Observations??? ??? No. Pages
Italy??? ????????? ??? ??? ??? ??????????????? 1590-1914??? ??? ?? ? ????? 88
Germany??? ????????? ??? ??? ????????????? 1657-1914??? ??? ?????????? 64
England/Great Britain??? ??? ?????????? 1590-1914??? ?????? ??? ??? 54
Netherlands??? ????????? ??? ??? ????????? 1593-1914??? ?????? ??? ??? 45
Thirteen Colonies/U.S. ?? ????????? ?? 1660-1914??? ?????? ??? ??? 32
France??? ????????? ??? ??? ??? ???????????? 1760-1914??? ?????? ??? ??? 28
Hapsburg Monarchy??? ????????? ??? ?? 1754-1914??? ?????? ??? ??? 24
China??? ????????? ??? ??? ??? ????????????? 1764-1914??? ?????? ??? ??? 22
Russian Empire??? ????????? ??? ??? ???? 1695-1914??? ?????? ??? ??? 20
Sweden??? ????????? ??? ??? ??? ?????????? 1700-1914??? ?????? ??? ??? 19
Argentina??? ????????? ??? ??? ??????????? 1824-1914??? ?????? ??? ??? 14
Switzerland??? ????????? ??? ??? ????????? 1842-1914??? ?????? ??? ??? 14
Brazil??? ????????? ??? ??? ??? ????????????? 1808-1914??? ?????? ??? ??? 12
Canada??? ????????? ??? ??? ??? ?????????? 1757-1914??? ?????? ??? ??? 12
Denmark??? ??? ??? ?????????????????????? 1696-1914??? ?????? ??? ??? 12
Mauritius??? ????????? ??? ??? ???????????? 1825-1914??? ?????? ??? ??? 12
British India??? ????????? ??? ??? ???????? 1819-1914??? ?????? ??? ??? 11
Ottoman Empire??? ????????? ??? ?????? 1760-1914??? ?????? ??? ??? 11
Australia??? ????????? ??? ??? ????????????? 1822-1914??? ?????? ??? ???? 9
Netherlands India??? ????????? ??? ???? 1818-1914??? ?????? ??? ???? 9
Japan??? ????????? ??? ??? ??? ????????????? 1861-1914??? ?????? ??? ???? 8
Persia??? ????????? ??? ??? ??? ????????????? 1809-1914??? ?????? ??? ???? 8
Straits Settlements??? ????????? ??? ??? 1834-1914??? ?????? ??? ???? 8
Cape Colony/South Africa???????? ??? 1811-1914??? ?????? ??? ???? 7
Egypt??? ????????? ??? ??? ??? ?????????????? 1869-1914????????? ??? ??? ? 7
Poland??? ????????? ??? ??? ??? ???????????? 1696-1812????????? ??? ??? ? 7
Jamaica??? ????????? ??? ??? ??? ?????????? 1675-1914????????? ??? ??? ? 6
Spain??? ????????? ??? ??? ??? ?????????????? 1820-1914????????? ??? ??? ? 6
Chile??? ????????? ??? ??? ??? ??????????????? 1827-1914????????? ??? ??? ? 5
Mexico??? ????????? ??? ??? ??? ???????????? 1886-1914? ?????? ??? ??? ? 5
New Zealand??? ????????? ??? ??? ???????? 1841-1914?? ?????? ??? ??? ? 5
Indochinese Union??? ????????? ??? ??? 1888-1914?? ?????? ??? ??? ? 3
Uruguay??? ????????? ??? ??? ????????????? 1871-1914?? ?????? ??? ??? ? 3

In sum, the Handbook is the result of a monumental undertaking with an overwhelmingly successful outcome. Scholars will be indebted to Denzel for years to come. The Handbook is admirable not only for its substance but also for the professionalism of its style and organization. Publication of the Handbook is an event which Paul Einzig would have applauded with gusto.

References:

Paul Einzig (1970), The History of Foreign Exchange, second edition. London: Macmillan.

John J. McCusker (1978), Money and Exchange in Europe and America, 1600-1775: A Handbook. Chapel Hill: University of North Carolina Press.

Peter Spufford (1986), Handbook of Medieval Exchange. London: Boydell and Brewer.

Lawrence H. Officer is Professor of Economics at University of Illinois at Chicago and Director of Research at MeasuringWorth.com. His most recent books are Everyday Economics: Honest Answers to Tough Questions and Two Centuries of Compensation for U.S. Production Workers in Manufacturing, both published by Palgrave Macmillan.

Copyright (c) 2010 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (December 2010). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
International and Domestic Trade and Relations
Geographic Area(s):General, International, or Comparative
Time Period(s):16th Century
17th Century
18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

The Ascent of Money: A Financial History of the World

Author(s):Ferguson, Niall
Reviewer(s):Horesh, Niv

Published by EH.NET (July 2009)

Niall Ferguson, The Ascent of Money: A Financial History of the World. New York: Penguin, 2008. v + 441 pp. $30 (hardcover), ISBN: 1594201929.

Reviewed for EH.NET by Niv Horesh, Faculty of Arts and Social Sciences, University of New South Wales.

Harvard?s Niall Ferguson is perhaps best known for his magisterial history of the House of Rothschild and, more recently, his exhortation against the risks of unbridled government borrowing and nebulous stimulus packages ostensibly designed to avert what is often termed the worst global economic crisis since the Great Depression. In the Ascent of Money he harnesses his narrative skills to offer lay readership a captivating account of global monetary history from time immemorial to the twenty-first century. The book?s release coincided with an eponymous television series that has already been broadcast in much of the English-speaking world. Both the series and the book are immensely entertaining and readily accessible, but the latter arguably makes for a more convenient platform from which academics can approach Ferguson?s many insights.

The Introduction (pp. 1-17) prepares readers for what Ferguson perceptively identifies as the core stories attending the evolution of money over the last four millennia. These are many and varied, as one would expect. He is concerned with, inter alia, the ?recurrent hostility? to financial intermediaries and religious minorities associated with them in early-modern European history; the triumph of the Dutch Republic over the Hapsburg Empire, the latter?s possession of silver mines in South America notwithstanding; the spread of paper money, fiat currency and invisible means of payment in the twentieth century; right through to the possible eclipse of American global primacy in the next two decades.

Titled ?Dreams of Avarice,? Chapter One sets course by recounting how the Incas were flabbergasted by the ?insatiable lust for gold and silver? that seemed to grip the Spanish conquistadors (p. 21). It then lays out with humor and verve the well-known story of Potos?, now a fairly sleepy town in the Bolivian Andes, which once provisioned Spain with untold amounts of silver. In the same breath, the chapter goes on to offer an overview of coinage since the seventh century BC. Notably, Ferguson sees the flow of silver from the Andes to Europe as a ?resource curse? which removed the incentives for more productive economic activity, while strengthening ?rent-seeking autocrats? in seventeenth-century Spain. Contrary to criticism of Eurocentrism often leveled at him, Ferguson carefully emphasizes here the contribution other peoples have made to modern finance: ?… economic life in the Eastern world ? in the Abassid caliphate or in Song China ? was far more advanced? at least until Fibonacci introduced Indian algebraic precepts in early thirteenth-century Italy (p. 32); these were later reified by the Medicis into double-entry bookkeeping in the Florentine republic (p. 43).

By the early seventeenth-century, European financial innovation had shifted from the Italian city-states to the Low Countries, though it was still driven by the exigencies of costly and recurrent warfare and ambitions of monopolizing trade with the East (p. 48-49). This spurt of European financial innovation had actually long ?preceded the industrial revolution,? a complex but much better-studied spate of events (p. 52). The financial and industrial revolutions then converged with the spread of joint-stock companies and proto-types of central banks in the latter half of the nineteenth century.

Subsequent chapters flesh out Ferguson?s analysis. Titled ?Of Human Bondage,? Chapter Two (pp. 65-118) explores, for example, the distinctness of the European economic trajectory, beginning with how the majority of Florentine citizenry partook of financing the Republic?s debt in the fourteenth century. In the seventeenth-century, the United Provinces of the Netherlands combined the borrowing techniques of an Italian city-state ?… with the scale of a nation-state.? The Dutch were able to finance their wars by pitching Amsterdam ?as the market for a whole range of new securities? (p. 75). The eighteenth and nineteenth centuries are characterized by Anglo-French friction, but here Ferguson sees a yawning gap between protestant Britain where public debt defaults became rarer and public debt itself increased many-fold and the powers of landed aristocracy diminished while a professional civil service became more influential ? and Catholic France where public offices were often sold to raise money, tax collection was farmed out and government bond issues lost credibility. Notably, the incremental spread of, and popular faith in, British government bonds allowed Whitehall to borrow overseas as well, much to the detriment of Napoleon?s armies. Ferguson similarly believes that (p. 97) the reluctance of European investors to buy into Confederate bonds during the American Civil War doomed the South?s endeavors. This historic lesson is invoked toward the end of the chapter when discussing, in passing, the Bush Administration?s large budget deficits.

Chapter Three (?Blowing Bubbles,? pp. 119-178) zooms in on arguably the most significant economic entity of our time: the joint-stock company. Ferguson aptly dubs it ?perhaps the single greatest Dutch invention of all.? Here, he elides earlier ? though fairly short-lived ? occurrences of comparable entities both in Europe and in pre-modern Asia. But there can be little doubt that the establishment of the Dutch VOC (1602) marked a veritable turning point, not least because it underlay the growth of the world?s first bourse. Indeed, the establishment of royally-chartered companies principally aimed at trade with Asia seems to have underpinned the rise of stock exchanges and public debt in Europe?s Northeast as a whole. The rise of public debt and publicly-listed equity was beset by frequent speculative bubbles, from which emerged a more sophisticated British credit economy.

Chapter Four (?The Return of Risk,? pp. 176-229) takes up a swag of issues from the impact of Hurricane Katrina on the U.S. psyche, through how the Great Fire of London (1666) created demand for insurance policies, to Japan?s welfare system and Milton Friedman?s mentorship of Latin American finance ministers. By comparison, Chapter Five (?Safe as Houses,? pp. 230-82) is more singularly framed around what Ferguson perceptively calls ?the passion for property? in the home-owning democracies of Anglo-Saxondom. He aptly reminds us (p. 233, 241) that as recently as the 1930s, little more than two-fifths of U.S. households owned their home compared with over 65% today, and traces back this staggering social transformation to the New Deal and the Civil Rights Movement. The expansion of home ownership was facilitated in the late 1930s by then-novel institutions like Fannie Mae, which are at the heart of the recent sub-prime meltdown. In that sense, but not in that sense only, Ferguson does a wonderful job of explaining well beyond clich?s the linkages between the Great Depression to today?s global finance crisis. He then points the finger (p. 269) at rating agencies such as Moody?s and Standard & Poor?s for obfuscating the precariousness of collateralized sub-prime mortgages, which financial ?alchemists? turned into tradable debt obligations.

In essence, the last chapter (?From Empire to Chimerica,? pp. 283-340) is dedicated to China?s resurgence in the twenty-first century, and subtly considers whether this might ultimately result in a catastrophic Sino-American military confrontation. From a China specialist?s perspective, it is perhaps a pity that a scholar of Ferguson?s wisdom and insight stops short of opining whether we are witnessing at present the rise of a new form of capitalism with Chinese characteristics (e.g. capitalism without democracy) or simply gradual Chinese adaptation to Western market norms. Academic pedants might also quip that Ferguson draws heavily on Kenneth Pomeranz?s path-breaking book, The Great Divergence, when writing that living standards in Europe and China were on par as late as the eighteenth-century (p. 285). This might have called for a more detailed discussion, given that earlier parts of the book allude to the Italian city-states (fourteenth century) as the progenitors of Europe?s financial revolution. Similarly, Ferguson?s assertion that the ?… ease with which the [Chinese] Empire could finance its deficits by printing money discouraged the emergence of European-style capital markets? (p. 286) might sound a little facile to specialists, not least because note issuance was all but abandoned by late-Imperial dynasties.

However, these are minor criticisms that do not detract in any way from the wonderful feat of storytelling which Ferguson has again pulled off. This book makes for a bold and original attempt to provide a comprehensive history of what, some say, makes the world go around. It is likely to turn into a best-selling classic, and a must-read item in countless undergraduate courses.

Niv Horesh is Lecturer in Chinese Studies at the School of Languages and Linguistics, University of New South Wales, Sydney, Australia. His first book, Shanghai’s Bund and Beyond (Yale University Press, 2009), is the first comparative study in English of foreign banks and banknote issuance in pre-war China. His second book (forthcoming in 2010), is a comprehensive socio-economic account of Shanghai?s rise to prominence (1842-2010).

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):General or Comparative

Capitals of Capital: A History of International Financial Centres, 1780-2005

Author(s):Cassis, Youssef
Reviewer(s):Schenk, Catherine R.

Published by EH.NET (October 2007)

Youssef Cassis, Capitals of Capital: A History of International Financial Centres, 1780-2005. Cambridge: Cambridge University Press, 2007. xiv + 385 pp. $40 (cloth), ISBN: 978-0-521-84535-9.

Reviewed for EH.NET by Catherine R. Schenk, Department of Economic and Social History, University of Glasgow.

Given the recent international transmission of the U.S. sub-prime loan crisis, it is a particularly appropriate moment to consider the long-term development of financial markets and the growth of international capital. Pictet & Cie, itself a venerable private bank, commissioned Youssef Cassis, Professor of Economic and Social History at the University of Geneva, to write a history of international financial centers (IFCs) to mark its bicentennial, and they have certainly generated a fine monument to commemorate their anniversary. This is a truly scholarly work of synthesis drawing on an impressively comprehensive bibliography and with a helpful glossary included.

Beginning with the rise of private banks in the eighteenth century and concluding with the financial conglomerates and hedge funds of the early twenty-first century, Cassis has produced a comprehensive overview of the developments of the main centers of capital: London and New York, Amsterdam, Paris, Brussels, Zurich, Frankfurt and Tokyo. His account shows how these centers were buffeted by political crisis and military conflict but proved resilient through innovation and specialization. The structure is strictly chronological, although themes of rivalry and competition, regulation and innovation emerge. Changes in the financial architecture are traced throughout as private banks gave way to joint stock banks, and stock markets matured and became international. The concentration of capital at the end of the nineteenth century, described in the first part of the book, is echoed near the end of the book by the mergers and acquisition wave of the 1980s and 1990s, which saw a return to the scale and breadth of global financial activity that had occurred a century earlier. Nevertheless, Cassis is skeptical of the comparison of the ‘new’ globalization of the 1980s with the first era of globalization given the technological and scale differences between the two periods, and he seeks merely to position the integration and growth of financial markets that has occurred in the last 25 years in its historical context.

The most detailed descriptions are devoted to the three chapters that draw out the decline of Amsterdam and the rivalry between London and Paris from the early nineteenth century to 1914. The years of crisis from the beginning of the First World War to the end of the Second World War are treated together in a single chapter. Along with the description of the changing fortunes of European centers, this period sees the rise of New York as a major player with very different characteristics than its European rivals. One chapter covers the recovery of markets from the war and the subsequent financial innovation (in the form of the Eurodollar market) that transformed the nature of business done by IFCs in the 1970s. The final substantive chapter takes the story from 1980 to 2005. In common with all histories that seek to cover such a broad time period there is a sense that later decades get rather short-changed, but that is the nature of this kind of project.

The final chapter draws conclusions from the long historical perspective on why IFCs emerge and prosper. There is a range of features that seem to promote the establishment of IFCs, including political security and a strong currency, but Cassis admits that his account of the historical record shows that no combination is either necessary or sufficient. He moves between centers that were important mainly because of large domestic markets that make for large banks and transaction volumes (New York and Tokyo) and those that operated more as financial services entrepots (Zurich and post-1950 London) but concludes that his research has shown that being a world economic leader is (usually) an important underlying cause of the rise of IFCs. Will all large economies eventually generate an IFC, and if so what does this suggest about Shanghai, for example? Other long-term factors include wars (which dent but do not necessarily end IFCs) and openness to migrant skilled workers. He concludes that state intervention “rarely determines the destinies of IFCs in a lasting or fundamental way” and controversially argues that regulation is more a consequence of how an IFC develops than a cause. He concludes that most regulatory interventions did not profoundly change the outcome of the hierarchy of IFCs. Supporters of Shanghai as an IFC of the future will take comfort from this argument that size of the domestic economy rather than regulation or strength of the national currency are the most important long-term drivers of IFCs.

Cassis has not quite escaped the challenges of identifying, classifying and ranking IFCs, although one of the themes of the book is shifting rivalries. He dodges the tricky question of how to rank IFCs by using various measures at various times; including size of national banks, employment, and value of foreign issues. Each of these measures reflects different attributes of international financial activity but none allows a comprehensive comparative approach given the different ranges of activity in each center. Moreover, these measures become less useful with globalization once a product may involve activity in several centers, and as innovation changes the labor requirements and some operations are outsourced. Nevertheless, the breadth, scope and detail of the study must recommend it to scholars and students seeking an overview of the development of international financial and banking markets over the past two hundred years.

Catherine Schenk is Professor of International Economic History at the University of Glasgow. She is the author of Hong Kong as an International Financial Centre; Emergence and Development (Routledge, 2001). Her most recent project examines the exchange rate regime choices of a range of developing economies in the early 1970s.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII

Debtor Diplomacy: Finance and American Foreign Relations in the Civil War Era, 1837-1873

Author(s):Sexton, Jay
Reviewer(s):Weidenmier, Marc D.

Published by EH.NET (March 2007)

Jay Sexton, Debtor Diplomacy: Finance and American Foreign Relations in the Civil War Era, 1837-1873. Oxford: Oxford University Press, 2005. ix +287 pp. $74 (hardcover), ISBN: 0-19-928103-3.

Reviewed for EH.NET by Marc D. Weidenmier, Department of Economics, Claremont McKenna College.

In Debtor Diplomacy, Jay Sexton of Oxford University examines the role of financiers in American international relations in the mid-nineteenth century. The author’s main thesis is that American international relations were inextricably tied to American and European financiers during the mid-nineteenth century and Civil War period. As a result, American foreign relations during this period cannot be understood without a deep understanding of the actions and motivations of the trans-Atlantic financiers.

The monograph is divided into six chapters. Sexton introduces his basic argument in Chapter 1. This is followed by a discussion of the House of Baring and their important role in American politics and finance in the years leading up to outbreak of the American Civil War. Sexton documents the dramatic rise in American foreign indebtedness to Europe during the antebellum period. He argues that the United States depended on foreign capital to such an extent that it often influenced American political decisions.

Chapters 3 and 4 form the meat and potatoes portion of the monograph. In Chapter 3, Sexton examines Union financial polices and international relations with Europe during the Civil War. The author discusses in great detail how American diplomats worked to achieve two goals during the Civil War: (1) float a large U.S. bond issue on the London market, and (2) block efforts by the Southern Confederacy to achieve recognition from European powers and prevent the South from borrowing funds in Europe to buys guns and military supplies. Although the United States failed to float a loan on the London exchange, the Union sold millions of bonds on the Dutch and German exchanges. In addition, Robert Walker and other American officials in London were quite successful in thwarting Confederate political and financial efforts to achieve recognition from European powers and preventing the South from floating a large loan in international capital markets.

Chapter 4 focuses on Confederate international relations and financial policies in Europe. The author details the difficulties the Confederacy had in selling bonds in Europe and securing recognition from foreign powers. Sexton’s analysis demonstrates that he spent a great deal of time reading and analyzing primary source documents from the period. For example, he provides a detailed discussion and analysis of the British government’s decision to remain neutral during the American Civil War based on a number of letters and documents written at the time. Sexton also argues that the Confederacy would have been much better off during the war if the rebel nation has shipped cotton to Europe in the first two years of the war in exchange for military goods rather than rely on a self-imposed cotton embargo (“King Cotton”) as a carrot to bring European powers into the conflict. Sexton concludes the discussion of Confederate policy by arguing that the South should have centralized its overseas operations and given the central government greater control in buying and shipping supplies from England (as opposed to letting the private sector handle blockade running).

Chapter 5 discusses America’s post-Civil War relations with England. Sexton focuses on the U.S. government’s dispute with England for allowing the Confederacy to build the commerce raider Alabama on British soil. The Alabama wreaked havoc on the U.S. merchant marine fleet and sank nearly seventy Union vessels during the Civil War. England and the United States settled the dispute in 1871 and a court awarded America $15.5 million. Sexton convincingly argues that the Alabama dispute was intimately tied to the United States’ ability to borrow from Europe and refinance its existing debts in the post-bellum period. The author’s well-supported argument shows how politics and economics can reinforce one another in international capital markets. Chapter 6 concludes the monograph with a discussion of the importance of financiers in American international relations during the mid-nineteenth century.

Although the monograph is interesting and well researched, the book has a couple of shortcomings. In several places, Sexton makes the argument that the Union blockade was very important in preventing the Confederacy from obtaining vital military supplies from England. The author overstates the importance of the Union blockade. As shown by Lebergott (1981), Confederate ships were generally successful in running the Union blockade until late 1864 and early 1865 given that steam powered blockade runners generally faced Union clipper ships powered by the wind. The small supply of Confederate merchant vessels (as noted by the author) and the poor financial standing of the Southern government was by far the most important reason for the small number of military supplies ? relative to what the Confederate government desired ? that crossed the Atlantic during the war.

Sexton also argues that the cotton bonds issued by the Southern Confederacy in London to raise funds to fight the war were not an economic success. Instead, the author argues that the South should have issued cotton certificates in Europe with the assistance of William Lindsay, a prominent Englishmen who was also a member of Parliament. While we will never know the outcome of this alternative financing strategy, the argument that the Erlanger Loan was not a success is simply inconsistent with the historical record. Given the Southern Confederacy’s unwillingness to levy and collect taxes, it is simply amazing that the Confederate government was able to issue any bonds in Europe (Lebergott, 1983).

As pointed out by Weidenmier (2005), the cotton bonds were largely issued to settle overdue debts with British gun contractors who had cut off trade credit to the rebel nation. British manufacturers supplied nearly two-thirds of Confederate guns during the war including the standard battle arm of Johnny Reb, the Enfield Rifle. The importance of British guns to the Confederate cause explains why the South continued to make interest payments on the cotton bonds in gold as late as March 1865, despite the onset of domestic hyperinflation and weeks before the surrender of the Confederate capital to Grant’s army. To service the cotton bonds in March 1865, the Confederate government dispatched a ship carrying gold coin to run the Union blockade to England at a time when the probability of running the blockade was less than 20 percent (Lebergott, 1983). Indeed, it seems very unlikely that a government would go to such lengths to service a debt obligation (while defaulting on every other debt obligation) unless it had substantial economic value to the war effort (no guns equals no war). Financial markets understood the importance of the cotton bonds to the rebel cause given that the debt issue traded for 50 pounds sterling (50 percent of par value) in January 1865 ? three months before the fall of Richmond ? while all other Confederate assets were trading for about five percent of their par value at this stage of the war.

Notwithstanding these shortcomings, Sexton has written an interesting historical account of U.S. foreign relations with Europe in the mid-nineteenth century with a focus on the American Civil War. The author has successfully demonstrated the importance of financiers in American international relations with Europe in the Civil War period. This book is likely to be of interest to diplomatic historians and economic historians with an interest in the interplay between politics, economics, and financiers during the American Civil War.

References:

Lebergott, Stanley (1983). “Why the South Lost: Commercial Purpose in the Confederacy, 1861-1865.” Journal of American History, 70:58-74.

Lebergott, Stanley (1981). “Through the Blockade: The Profitability and Extent of Cotton Smuggling, 1861-1865.” Journal of Economic History, 41: 867-88.

Weidenmier, Marc D. (2005). “Gunboats, Reputation, and Sovereign Repayment: Lessons from the Southern Confederacy.” Journal of International Economics, 66: 407-422 (also published as NBER Working Paper #10960).

Marc D. Weidenmier is an Associate Professor of Economics at Claremont McKenna College and the NBER. His recent publications include, “Can Interest-Bearing Money Circulate? A Small Denomination Arkansas Experiment, 1861-1863,” Journal of Money, Credit, and Banking, (co-authored with Richard Burdekin, forthcoming), and “Volatility in an Era of Reduced Uncertainty: Lessons from Pax Britannica.” Journal of Financial Economics, 79: 693-707 (co-authored with William Brown and Richard Burdekin, also published as NBER Working Paper #11319).

Subject(s):Military and War
Geographic Area(s):North America
Time Period(s):19th Century

The Rise of the Amsterdam Market and Information Exchange: Merchants, Commercial Expansion and Change in the Spatial Economy of the Low Countries, c. 1550-1630

Author(s):Lesger, Clé L
Reviewer(s):Neal, Larry

Published by EH.NET (January 2007)

Cl? Lesger, The Rise of the Amsterdam Market and Information Exchange: Merchants, Commercial Expansion and Change in the Spatial Economy of the Low Countries, c. 1550-1630. Burlington, VT: Ashgate, 2006. xii + 326 pp. $100 (cloth), ISBN: 0-7546-5220-3.

Reviewed for EH.NET by Larry Neal, Department of Economics, London School of Economics.

Cl? Lesger, Senior Lecturer in Economic and Social History at the University of Amsterdam, provides quantitative evidence guided by economic theory to show that what really mattered at the end of the sixteenth century for Amsterdam’s rise to economic preeminence in Europe in the seventeenth and eighteenth centuries was its institutions, not its geography. The impetus for its rise was not inherent in its institutions, however, but came from the external shock of the failure of the revolt against Spanish rule in the southern Netherlands combined with the failure of the Spanish to reestablish control over the northern Low Countries. Geography played a role in determining those military outcomes, but not, Lesger argues, in determining the resulting changes in the patterns of trade.

This argument, familiar to readers of Jonathan Israel’s voluminous writings on the Dutch Republic, nevertheless runs counter to a tendency among historians to see very long-lived movements in historical developments that persist despite occasional shocks. Lesger notes that this has led historians, led by Fernand Braudel and others including some contemporary Dutch historians, to trace Amsterdam’s rise to preeminence to its geography and especially the attempts of its citizens to alter and control that geography. Not so, argues Lesger. The older historical literature was correct when it attributed Amsterdam’s rise to closing Antwerp’s access to the Scheldt. This destroyed Antwerp’s role as the major gateway for transportation networks throughout the Low Countries and forced its merchant community to disperse.

Amsterdam’s elite welcomed the new merchants because they saw no conflict between the trades of the Antwerp merchants who dealt in luxury goods, sugar, spices, and naval stores from distant lands and the trades of the Amsterdam merchants who dealt more with transshipping these goods on to its regional hinterland, northern Germany and the Baltic. Very quickly during the 1590s, the new merchants and their information networks combined with the older merchants and their continued trade networks to make Amsterdam the next global entrep?t, replacing Antwerp through the eighteenth century.

The entire region of the Low Countries comprising modern Belgium, the Netherlands, and Luxembourg was a well-integrated economic unit by the middle of the sixteenth century. Using the concept of a network of transportation gateways, Lesger shows that each city had a geographically determined hinterland and its niche for trade in specific commodities with the outer world. Prior to the revolt of the Netherlands against Philip II, Antwerp was the primary gateway through which the other cities in the Low Countries participated in the long-distance trades, the so-called “rich trades” in textiles, spices, porcelain, and luxury goods in general. Amsterdam was a major regional gateway, but focused on South Holland as its hinterland while re-exporting a wide variety of products to the Baltic and northern Germany, with emphasis on low value, bulky commodities. Overall, it accounted for only 6% of total exports, compared to Antwerp’s 75%.

After the Revolt disrupted trade patterns, especially for Antwerp, Lesger argues that there was little change in the gateway role of Amsterdam. Figures on both exports and imports for 1580 and 1584 show that Amsterdam was still oriented in its trade toward northern and eastern Europe. Starting in the 1590s, however, Amsterdam’s trade began a vertiginous rise that continued up to 1630. Lesger argues that rise had to be the consequences of the Revolt. To explain this sudden and dramatic break with geographically determined trade patterns, Lesger examines the role of the wealthy merchants displaced from Antwerp who increasingly fled to Amsterdam. Examining the records of the Wisselbank by various groups of depositors, he shows that the new merchants led the explosion of trade activity from Amsterdam, especially to Russia through the port of Archangel. Both the new merchants and various groups of North Hollanders led the way to the Indies, both East and West.

Part II turns to explore the institutional determinants in Amsterdam that enabled the influx of foreign merchants to occur so quickly with such dramatic results, and then to be sustained for the next century and a half. The answer, he argues, came from the ability of the incumbent Amsterdam elite to extract rents from the increased trading activity by maintaining political control while levying low indirect taxes on a rapidly increasing base of trade that did not conflict with Amsterdam’s traditional trade flows as a regional hub, and indeed helped to expand those trade flows as well.

The rising importance of Amsterdam’s traditional transit trade with the lower Rhine leads Lesger to see most of it increased trade with the wider world as really transit trade as well. In fact, he argues, Amsterdam displayed in the early seventeenth century all the features that modern trade analysts associate with transit trade. For a trade center to maintain its role in transit trade it must provide cost advantages to suppliers and customers in the services it provides in the form of finance, information, and price discovery, as well as in the physical facilities it maintains for transshipment. Ultimately then, the secret of Amsterdam’s success as the preeminent entrep?t for Europe’s long-distance trade lay not in its port and warehousing facilities for transshipments, but rather in its information processing facilities.

Overall, Lesger’s valuable quantitative study amplifies the importance of the service sector, which played a very modern role in establishing and then maintaining Amsterdam’s preeminence. Finally, this reviewer was very pleased to see the emphasis on external and irreversible shocks for explaining Amsterdam’s rise. A similar story, of course, helps explain its eventual demise in the nineteenth century and its replacement by London.

Larry Neal is Professor Emeritus at the University of Illinois, a Research Associate with the NBER and Visiting Professor at the London School of Economics.

Subject(s):Transport and Distribution, Energy, and Other Services
Geographic Area(s):Europe
Time Period(s):17th Century

Exchange Rates and Economic Policy in the Twentieth Century

Author(s):Catterall, Ross E.
Aldcroft, Derek H.
Reviewer(s):Battilossi, Stefano

Published by EH.NET (December 2005)

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Ross E. Catterall and Derek H. Aldcroft, editors, Exchange Rates and Economic Policy in the Twentieth Century. Aldershot, UK: Ashgate, 2004. xiii + 326 pp. ?57.50/$110 (hardback), ISBN: 1-84014-262-2.

Reviewed for EH.NET by Stefano Battilossi, Department of Economic History and Institutions, Universidad Carlos III Madrid.

Benefits and shortcomings of alternative exchange rate regimes have been hotly debated by economists and policy-makers throughout the second half of the twentieth century. Can the history of exchange rates during this period provide original insights that positively interact with theory and policy? The editors of this volume, Ross E. Catterall (Anglia University) and Derek Aldcroft (University of Leicester), assigned themselves a challenging task, namely to assess the impact of exchange rate regimes on national economies and the world economy, as well as to draw out the relevance of history for policymakers. However, both the organization and the content of the volume hardly match such ambitions. The book is mainly based on papers originally presented at the XII International Economic History Congress in 1998, subsequently revised and reworked. New chapters were also added to cover the transition to the European single currency. In fact, the last quarter of the twentieth century gets the lion’s share of the attention and accounts for more than two thirds of the total pages. In spite of the stated objective of providing “a background canvas” and a coherent framework for the collected essays (p. 4), the introduction by Catterall is rather an impressionistic journey through the modern history of exchange rate regimes and fails to direct the reader towards common threads and focal points. All in all the volume gives the impression of a medley of contributions occasionally brought together, rather than strategically arranged around a set of well-identified key issues.

That is unfortunate, since a wealth of theoretical and empirical analysis has been produced on the subject in the last decades. In the early 1970s the Bretton Woods anti-floating fundamentalism gave way to a more benign view, according to which floating rates were not inherently destabilizing but actually fostered monetary independence and enhanced governments’ flexible responses to exogenous shocks. Hard-pressed by overlapping oil and wage shocks, policymakers enthusiastically embraced the new credo, which was eventually institutionalized in the Jamaica agreement of 1976. Yet the sharp and quite unexpected increase in the volatility of both nominal and real exchange rates was an unwelcome surprise even for pro-floaters. Whereas European policy-makers quickly switched back to pegged exchange rates, academic researchers were puzzled by the apparent lack of a direct relationship between exchange rate fluctuations and macroeconomic fundamentals. This finding, clearly at odds with established models, paved the way to a new wave of empirical research along the lines of the expectations-driven asset approach proposed by Rudy Dornbusch and Jeffery Frenkel among others. By the early 1980s, Richard Meese and Kenneth Rogoff challenged the conventional academic wisdom by demonstrating that random walk forecasts outperformed economic models of exchange rates in the short-run [1]. Likewise, other empirical studies found the effects of exchange rate fluctuations on real macroeconomic quantities, such as trade volumes, to be small or insignificant. Nevertheless, from a policy perspective, in the 1980s pegged regimes continued to enjoy very good press due to their success in providing a nominal anchor in experiments of disinflation and macroeconomic stabilization in Southern Europe and Latin America.

With the collapse of the European Rate Mechanism in 1992-93, and even more in the aftermaths of the “twin” crises that savaged Latin America and East Asia in the 1990s, pegs’ popularity suddenly declined. Meanwhile, the relationship between exchange rate regimes and financial crises emerged as a subject of even greater dispute. The big issue was whether such crises had been determined by economic and financial fundamentals, or by financial markets’ behavior. Whereas international institutions such as the IMF were generally inclined to point to underlying macroeconomic divergence rather than to market pressures, the idea of self-fulfilling crisis cast into ‘second-generation’ models of currency crises became increasingly popular among policy-makers just too keen on blaming markets and speculators. In any case, a new consensus emerged around the notion that pegged exchange rate regimes were too rigid and thus prone to break-down as a consequence of sudden reversals of expectations (whether based in fundamentals or not). Thus, at the turn of the new century, a global switch to more flexible intermediate regimes could be observed.

In spite of the almost unanimous acceptance of such policy lesson, however, researchers are still struggling to assess the practical relevance of exchange rates: the “exchange rate disconnect puzzle” remains as elusive as ever [2]. Interestingly, a systematic revision of the recent history of exchange rates has been carried out by Carmen Reinhart and Kenneth Rogoff in order to reclassify postwar exchange rate regimes on a “de facto” rather than “de jure” basis (in fact, many official fixed regimes proved to be backdoor floats), and then to test their impact on growth and macroeconomic performance [3]. Their results suggest that in developing countries with partial insulation from global capital markets, pegged regimes enhanced inflation control with no apparent sacrifice of growth, which seem to run against the freshly emerged consensus that pegs are not viable for developing countries. Perhaps this announces a new swing of the policy pendulum back in favor of pegs?

Many of the above mentioned recent developments in empirical analysis are unfortunately neglected in the volume. Some of the essays are, however, keen on elaborating on the interaction between theories and policy implications, with a special interest in monetary policies and exchange rates in Western Europe in the 1980s and 90s. Michael Oliver’s contribution (pp. 103-29) offers a useful survey of the theoretical underpinnings — from Mundell-Fleming to the monetary approach to the balance of payments — of disinflationary policies based on monetary and exchange rate targets, and provides a critical assessment of their effectiveness based on the experience of the U.S., the UK and the EMS. In turn, Ross Catterall (pp. 228-53) focuses on the failure of theoretical models to account for the post-1973 volatility of exchange rates. He blames the increased volume of speculative (i.e. not related to real international transactions and portfolio investments) flows for this volatility puzzle, and contends that nowadays currency speculators “determine the degree to which countries can compete in export markets” (p. 238). For instance, the “mysterious” rise of the euro against the U.S. dollar and the British pound since 2003 brings him to conclude that “the European economies, despite the existence of the single currency, are indeed at the mercy of the exchange rate roller-coaster” (p. 244), which in his view also spells disaster for the future sustainability of the single currency experiment. More or less in the same vein, George Zis (pp. 254-95) discusses the ebb and flow of the theoretical case for flexible exchange rates. By examining the original contributions of Milton Friedman and H.G. Johnson, the “abysmal failure of the flow foreign exchange market model” (p. 279) and the subsequent emergence of a monetary theory of exchange rate determination, Zis contends that the case for flexible exchange rates as a means of achieving monetary independence was (and still is) ill-founded as it is based on undemonstrated assumptions — such as the efficiency of foreign exchange markets — and fails to incorporate basic elements of open economy macroeconomics (such as the impact of currency substitution on the demand for money) into its original “insular” approach. Finally, Angelos Kiotos (pp. 296-320) provides a survey of the current literature on the potential benefits of the adoption of the Euro (aka ‘euroization’) by Balkan countries as a de jure or de facto base of their monetary regimes.

Apart from survey chapters, the volume makes little contributions to original empirical analysis. Although explicitly devoted to assessing the impact of exchange rate regimes on economic performances in the 1930s, Derek Aldcroft’s chapter (pp. 17-70) offers in fact a textbook-style review of the extensive literature on the monetary history of the 1920s and 30s. Special emphasis is given to the well-known fact that countries that devalued their currencies and subsequently resorted to managed floating performed better in terms of economic recovery than gold bloc countries with overvalued currencies and heavy deflationary pressures. Incidentally, this essay is an almost perfect replica of a couple of chapters already published by Aldcroft in a previous book on Exchange Rate Regimes in the Twentieth Century with Michael Oliver (Elgar, 1998). More original, on the contrary, is Scott Sumner’s essay, which uses both quantitative techniques and qualitative evidence in order to assess the impact of the Fed’s monetary policy on stock market behavior and expectations of devaluation and inflation in the 1930s (pp. 71-102).

Three other papers have a clear empirical focus. Allen Webster (pp. 130-71) addresses the issue whether trade barriers created by exchange rates “have historically been sufficiently important to provide a key justification for European monetary union” (p. 139). By gauging the microeconomic costs of exchange rates in terms of risk premia and transaction costs, Webster in fact estimates the potential benefits for Britain from joining the EMU. Based on simulations of effective rates of protection and anti-export bias resulting from exchange rate barriers for the UK in the period 1989-90, he concludes that such barriers had a negligible effect on value added, although “a markedly stronger effect on average upon the returns to capital” (p. 148). The findings strike a clear Euro-skeptic note, suggesting that the removal of such distortions would have no significant impact on economic efficiency. With Kieron Toner (pp. 172-201) we move unexpectedly to the Southern hemisphere with a detailed analytical narrative of liberal reforms implemented in Australia in the 1980s. Toner argues that, by putting the cart of exchange rate and financial market liberalization before the horse of macroeconomic stabilization and structural reforms, Australian governments hindered industrial development and contributed to increasing the country’s financial fragility — which he takes as evidence of the ‘irretrievable flawness’ of the ‘classical strategy’ for reform (p. 197). Finally, we travel back again to Europe with Costas Karfakis, who offers an interesting analysis of the role of monetary and exchange rate policies (‘hard-drachma’) in the process of macroeconomic stabilization and adjustment in Greece in the 1990s (pp. 202-27). This is the only essay in which explicit modeling and quantitative techniques are employed in order empirically to address important issues raised in the exchange rate literature, such as sterilization policies, the credibility of exchange rate-based disinflation and the impact of a nominal exchange rate anchor on inflation inertia.

In spite of the unquestionable merits of some of its individual parts, altogether the thematic dispersion, lack of analytical focus and relative scarcity of empirical content make the volume a rather disappointing read.

References:

1. R. Meese and K.S. Rogoff, “Empirical Exchange Rate Models of the Seventies: Do They Fit Out of Sample?’ Journal of International Economics 14 (1983), pp. 3-24.

2. R.P. Flood and K.R. Rose, “Understanding Exchange Rate Volatility without the Contrivance of Macroeconomics,” Economic Journal 109 (1999), pp. 660-72; M. Obstfeld and K. Rogoff, “The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?” in B. Bernanke and K. Rogoff, eds., NEBR Macroeconomics Annual 2000 (Cambridge: MIT Press, 2000, pp. 339-90).

3. C. M. Reinhart and K. S. Rogoff, “The Modern History of Exchange Rate Arrangements: A Reinterpretation,” Quarterly Journal of Economics 119 (2004), pp. 1-48.

Stefano Battilossi is visiting professor at Universidad Carlos III Madrid. He is currently carrying out research projects on the determinants of multinational banking during the first globalization and on financial repression in Western Europe in the second half of the twentieth century.

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Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: WWII and post-WWII