How Payments of Trade Went from a Strategy to Convey Textile Proceeds House to the “Basis of Trendy Business Banking” – Purpose.com

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The History of Textiles Is the History of Human Ingenuity – Reason.com

This is my last guest post of the week, and I want to thank Eugene Volokh again for inviting me to share some selections from The Fabric of Civilization. These “social technologies” posts are all taken from Chapter 5, “Traders”.

Thomas Salmon had a problem. As a tax collector in Somerset, Salmon had amassed the thousands of pounds of gold and silver it took to get to London. But England of 1657 had no checking accounts, wire transfers, or armored cars. Physical travel with so many species has been difficult and dangerous. What should salmon do?

He took the coins to local drapers known as drapers. In return, they gave him notes called bills of exchange. These bills worked like checks, but instead of going to a bank, they asked a London businessman named Richard Burt to give Salmon cash. Burt bought woolen cloth from scattered producers and sold it to London dealers, receiving a commission on the sale.

When he sold their wares, Burt kept the drapers’ credits on his books, and they withdrew their accounts with bills of exchange. A Somerset draper could buy household items from a local dealer and pay for it with a bill of exchange. The trader would cash the bill on a trip to London or, more likely, use it to pay his own suppliers who did business there. Accepting coins from the helmsman was another way for drapers to redeem their loans. Salmon would take the bills to London, exchange them for species with Burt, and deposit the money with the treasury. An institution created to serve the textile industry had become vital to the finances of the British Crown.

Bills of exchange, which came from Italian textile traders in the 13th century, were described as “the most important financial innovation of the High Middle Ages”. They started out as a way for retailers to transfer the proceeds from the fairs in Champagne back to their home office. Written in a kind of shorthand, these slips of paper were essentially form letters asking an agent, usually a bank, in another city to pay someone a certain amount. When a merchant issued a bill of exchange, his local bank sent a notice to their overseas branch asking them to honor the bill on presentation. Bills of exchange were not official, state-sanctioned documents drafted in advance, but rather social technologies developed through trial and error. Its utility depended on connections and trust.

As retailers set up office networks in several locations, switching became more and more flexible. At the beginning of the 14th century, one could be redeemed in most large cities in Western Europe. Whether you wanted to buy wool or pay for armies, coins no longer had to be dragged across land and sea. “Bills of exchange,” writes the historian Francesca Trivellato, “were the invisible currency of the” international money republic “of early modern Europe.”

Although bills began as a way to easily transport money and convert foreign money, other uses quickly developed. For starters, they fixed the currency bottleneck by allowing many more transactions with the same amount of types.

To see why, consider two hypothetical English businessmen. The first (“John”) exports raw wool and sells it to a Florentine trader (“Giovanni”) for a bill to be paid in London. The second (“Peter”) imports silk fabric and buys it (from “Piero”) with a bill of exchange to be paid in Florence. In the books of the banks, the two notes can be offset against each other, with only the difference actually changing hands as currency. A small supply of coins can allow a lot more exchanges. “Such a system could be incredibly efficient,” writes economist Meir Kohn. “For example, a bank in Genoa received 160,000 lire in payments from abroad in the form of bills of exchange between 1456 and 1459, and only 7.5% of this amount was settled in cash, the remaining 92.5% was settled in bank.”

Illustration by Joanna Andreasson for The Fabric of Civilization. The cash flows begin with John’s sale of wool (bottom left) and Piero’s sale of silk (top right).

Bills of exchange also provided credits. In its simplest form, they gave users a float. An invoice was not made payable immediately, but after a certain time or use from the date of issue. The usage was slightly longer than the usual travel time between the two cities, which ensured that the cancellation to meet the bill could reach the payer. The pillow added an additional grace period to the short term loan.

Over time, traders found ways to convert bills of exchange into open credit. In a common but often condemned practice known as a dry bill of exchange, the first bill of exchange was not paid for in cash (or as an account settlement), but with a new bill that simply reversed the original one. This paper swap created an interest-free loan that is twice the length of usage. Lenders could extend the terms by adding multiple back and forth exchanges.

With a slight deviation, a dry exchange could evade bans on interest rate premiums. The trick was to change the exchange rate on the return invoice. For example, if a merchant in Bordeaux exchanged 100 livres for an original invoice that was payable for 140 guilders in Amsterdam, the return invoice could repay the 140 guilders for 105 livres in Bordeaux.

Over time, bills of exchange became negotiable. You can transfer an originally issued invoice simply by signing the reverse. The signature conveyed to you the legal obligation to pay the underlying debt if the bill could not be honored. Once bills of exchange were negotiable, they became more liquid. If you need cash, you can sell your bills at a discount to face value, just like bonds change hands today. Or you can issue a new bill and sell it to a money broker at a discount to cash it later. In theory at least, there was no limit to the number of times an invoice could be routed from one owner to the next.

“The product of this evolutionary process – the discounting of negotiable bills – was a financial invention of enormous economic importance,” writes Kohn. “Indeed, it would become the bedrock of modern commercial banking in the 17th and 18th centuries.”

The ability to negotiate has made invoices more and more useful in everyday trade outside of specialized money markets. Although no one had to accept them as currency – bills of exchange were not legal tender – they were almost as good as cash if people trusted the signers.

Despite the risk of default, bills of exchange persisted and only disappeared from daily trading when they were replaced by central bank currencies. As recently as 1826, a banker in Manchester was attesting to its continued popularity and informed a parliamentary inquiry that he had seen 10 pound bills with a hundred or more signatures in circulation. “I’ve seen pieces of paper attached to a bill as long as one sheet of paper could go,” he said, “and when that was filled another was attached to it.”

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