Category Archives: USA

A New Take on Sovereign Debt and Gunboat Diplomacy

Going multilateral? Financial Markets’ Access and the League of Nations Loans, 1923-8


Juan Flores (The Paul Bairoch Institute of Economic History, University of Geneva) and
Yann Decorzant (Centre Régional d’Etudes des Populations Alpines)

Abstract: Why are international financial institutions important? This article reassesses the role of the loans issued with the support of the League of Nations. These long-term loans constituted the financial basis of the League’s strategy to restore the productive basis of countries in central and eastern Europe in the aftermath of the First World War. In this article, it is argued that the League’s loans accomplished the task for which they were conceived because they allowed countries in financial distress to access capital markets. The League adopted an innovative system of funds management and monitoring that ensured the compliance of borrowing countries with its programmes. Empirical evidence is provided to show that financial markets had a positive view of the League’s role as an external, multilateral agent, solving the credibility problem of borrowing countries and allowing them to engage in economic and institutional reforms. This success was achieved despite the League’s own lack of lending resources. It is also demonstrated that this multilateral solution performed better than the bilateral arrangements adopted by other governments in eastern Europe because of its lower borrowing and transaction costs.

Source: The Economic History Review (2016), 69:2, pp. 653–678

Review by Vincent Bignon (Banque de France, France)

Flores and Decorzant’s paper deals with the achievements of the League of Nations in helping some central and Eastern European sovereign states to secure market access during in the Interwar years. Its success is assessed by measuring the financial performance of the loans of those countries and is compared with the performance of the loans issued by a control group made of countries of the same region that did not received the League’s support. The comparison of the yield at issue and fees paid to issuing banks allows the authors to conclude that the League of Nations did a very good job in helping those countries, hence the suggestion in the title to go multilateral.

The authors argue that the loans sponsored by the League of Nation – League’s loan thereafter – solved a commitment issue for borrowing governments, which consisted in the non-credibility when trying to signal their willingness to repay. The authors mention that the League brought financial expertise related to the planning of the loan issuance and in the negotiations of the clauses of contracts, suggesting that those countries lacked the human capital in their Treasuries and central banks. They also describe that the League support went with a monitoring of the stabilization program by a special League envoy.


Empirical results show that League loans led to a reduction of countries’ risk premium, thus allowing relaxing the borrowing constraint, and sometimes reduced quantity rationing for countries that were unable to issue directly through prestigious private bankers. Yet the interests rates of League loans were much higher than those of comparable US bond of the same rating, suggesting that the League did not create a free lunch.

Besides those important points, the paper is important by dealing with a major post war macro financial management issue: the organization of sovereign loans issuance to failed states since their technical administrative apparatus were too impoverished by the war to be able to provide basic peacetime functions such as a stable exchange rate, a fiscal policy with able tax collection. Comparison is made of the League’s loans with those of the IMF, but the situation also echoes the unilateral post WW 2 US Marshall plan. The paper does not study whether the League succeeded in channeling some other private funds to those countries on top of the proceeds of the League loans and does not study how the funds were used to stabilize the situation.


The paper belongs to the recent economic history tradition that aims at deciphering the explanations for sovereign debt repayment away from the gunboat diplomacy explanation, to which Juan Flores had previously contributed together with Marc Flandreau. It is also inspired by the issue of institutional fixes used to signal and enforce credible commitment, suggesting that multilateral foreign fixes solved this problem. This detailed study of financial conditions of League loans adds stimulating knowledge to our knowledge of post WW1 stabilization plans, adding on Sargent (1984) and Santaella (1993). It’s also a very nice complement to the couple of papers on multilateral lending to sovereign states by Tunker and Esteves (2016a, 2016b) that deal with 19th century style multilateralism, when the main European powers guaranteed loans to help a few states secured market access, but without any founding of an international organization.

But the main contribution of the paper, somewhat clouded by the comparison with the IMF, is to lead to a questioning of the functions fulfilled by the League of Nations in the Interwar political system. This bigger issue surfaced at two critical moments. First in the choice of the control group that focus on the sole Central and Eastern European countries, but does not include Germany and France despite that they both received external funding to stabilize their financial situation at the exact moment of the League’s loans. This brings a second issue, one of self-selection of countries into the League’s loans program. Indeed, Germany and France chose to not participate to the League’s scheme despite the fact that they both needed a similar type of funding to stabilize their macro situation. The fact that they did not apply for financial assistance means either that they have the qualified staff and the state apparatus to signal their commitment to repay, or that the League’s loan came with too harsh a monitoring and external constraint on financial policy. It is as if the conditions attached with League’ loans self-selected the good-enough failed states (new states created out of the demise of the Austro-Hungarian Empire) but discouraged more powerful states to apply to the League’ assistance.


Now if one reminds that the promise of the League of Nations was the preservation of peace, the success of the League loans issuance was meager compared to the failure in preserving Europe from a second major war. This of course echoes the previous research of Juan Flores with Marc Flandreau on the role of financial market microstructure in keeping the world in peace during the 19th century. By comparison, the League of Nations failed. Yet a successful League, which would have emulated Rothschild’s 19th century role in peace-keeping would have designed a scheme in which all states in need -France and Germany included – would have borrowed through it.

This leads to wonder the function assigned by their political brokers to the program of financial assistance of the League. As the IMF, the League was only able to design a scheme attractive to the sole countries that had no allies ready or strong-enough to help them secure market access. Also why did the UK and the US chose to channel funds through the League rather than directly? Clearly they needed the League as a delegated agent. Does that means that the League was another form of money doctors or that it acts as a coalition of powerful countries made of those too weak to lend and those rich but without enforcement power? This interpretation is consistent with the authors’ view “the League (…) provided arbitration functions in case of disputes.”

In sum the paper opens new connections with the political science literature on important historical issues dealing with the design of international organization able to provide public goods such as peace and not just helping the (strategic) failed states.


Esteves, R. and Tuner, C. (2016a) “Feeling the blues. Moral hazard and debt dilution in eurobonds before 1914”, Journal of International Money and Finance 65, pp. 46-68.

Esteves, R. and Tuner, C. (2016b) “Eurobonds past and present: A comparative review on debt mutualization in Europe”, Review of Law & Economics (forthcoming).

Flandreau, M. and Flores, J. (2012) “The peaceful conspiracy: Bond markets and international relations during the Pax Britannica”, International Organization, 66, pp. 211-41.

Santaella, J. A (1993) ‘Stabilization programs and external enforcement: experience from the 1920s’, Staff Papers—International Monetary Fund (J. IMF Econ Rev), 40, pp. 584–621

Sargent, T. J., (1983) ‘The ends of four big inflations’, in R. E. Hall, ed., Inflation: Causes and Effects (Chicago, Ill.: University of Chicago Press, pp. 41–97

Keynes and Actual Investment Decisions in Practice

Keynes and Wall Street

By David Chambers (Judge Business School, Cambridge University) and Ali Kabiri (University of Buckingham)

Abstract: This article examines in detail how John Maynard Keynes approached investing in the U.S. stock market on behalf of his Cambridge College after the 1929 Wall Street Crash. We exploit the considerable archival material documenting his portfolio holdings, his correspondence with investment advisors, and his two visits to the United States in the 1930s. While he displayed an enthusiasm for investing in common stocks, he was equally attracted to preferred stocks. His U.S. stock picks reflected his detailed analysis of company fundamentals and a pronounced value approach. Already in this period, therefore, it is possible to see the origins of some of the investment techniques adopted by professional investors in the latter half of the twentieth century.

Source: Business History Review (2016), 90(2,Summer), pp. 301-328 (Free access from October 4 to 18, 2016).

Reviewed by Janette Rutterford (Open University)

This short article looks at Keynes’ purchases of US securities in the period from after the Wall Street Crash until World War II. The investments the authors discuss are not Keynes’ personal investments but are those relating to the discretionary fund (the ‘Fund’) which formed part of the King’s College, Cambridge endowment fund and which was managed by Keynes. The authors rely for their analysis on previously unused archival material: the annual portfolio holdings of the endowment fund; the annual report on discretionary fund performance provided by Keynes to the endowment fund trustees; correspondence between Keynes and investment experts; and details of two visits by Keynes to the US in 1931 and 1934.


The authors look at various aspects of the investments in US securities made by Keynes. They first note the high proportion of equities in the endowment fund as a whole. They then focus in detail on the US holdings which averaged 33% by value of the Fund during the 1930s. They find that Keynes invested heavily in preferred stock, which he believed had suffered relatively more than ordinary shares in the Wall Street Crash and, in particular, where the preference dividends were in arrears. He concentrated on particular sectors – investment trusts, utilities and gold mining – which were all trading at discounts to underlying value, either to do with the amount of leverage or with the price of gold. He also made some limited attempts at timing the market with purchases and sales, though the available archival data for this is limited. The remainder of the paper explores the type of investment advice Keynes sought from brokers, and from those finance specialists and politicians he met on his US visits. The authors conclude that he used outside advice to supplement his own views and that, for the Fund, as far as investment in US securities was concerned, he acted as a long-term investor, making targeted, value investments rather than ‘following the herd’.

This paper adds a small element to an area of research which is as yet in its infancy: the analysis of actual investment decision making in practice, and the evolution of investment strategies over time. In terms of strategies, Keynes used both value investing and, to a lesser extent, market timing for the Fund. Keynes was influenced by Lawrence Smith’s 1925 book which recommended equity investment over bond investment on the basis of total returns (dividends plus retained earnings) rather than just dividend yield, the then common equity valuation method. Keynes appears not to have known Benjamin Graham but came to the same conclusion – namely that, post Wall Street Crash, value investing would lead to outperformance. He experimented with market timing in his own personal portfolio but only to a limited extent in the Fund. He was thus an active investor tilting his portfolio away from the market, by ignoring both US and UK railway and banks securities. Another fascinating aspect which is only touched on in this paper is the quality of investment advice at the time. How does it stack up compared to current broker research?


The paper highlights the fact that issues which are still not settled today were already a concern before WWII. Should you buy the market or try to outperform? What is the appropriate benchmark portfolio against which to judge an active strategy? How should performance be reported to the client (in this case the trustees) and how often? How can one decide how much outperformance comes from the asset allocation choice of shares over bonds, from the choice of a particular sector, at a particular time, whilst making allowance for forced cash outflows or sales such as occurred during WWII? More research on how these issues were addressed in the past will better inform the current debate.

Lessons from ‘Too Big to Fail’ in the 1980s

Can a bank run be stopped? Government guarantees and the run on Continental Illinois

Mark A Carlson (Bank for International Settlements) and Jonathan Rose (Board of Governors of the Federal Reserve)

Abstract: This paper analyzes the run on Continental Illinois in 1984. We find that the run slowed but did not stop following an extraordinary government intervention, which included the guarantee of all liabilities of the bank and a commitment to provide ongoing liquidity support. Continental’s outflows were driven by a broad set of US and foreign financial institutions. These were large, sophisticated creditors with holdings far in excess of the insurance limit. During the initial run, creditors with relatively liquid balance sheets nevertheless withdrew more than other creditors, likely reflecting low tolerance to hold illiquid assets. In addition, smaller and more distant creditors were more likely to withdraw. In the second and more drawn out phase of the run, institutions with relative large exposures to Continental were more likely to withdraw, reflecting a general unwillingness to have an outsized exposure to a troubled institution even in the absence of credit risk. Finally, we show that the concentration of holdings of Continental’s liabilities was a key dynamic in the run and was importantly linked to Continental’s systemic importance.


Distributed on NEP-HIS 2016-4-16

Review by Anthony Gandy (ifs University College)

I have to thank Bernardo Batiz-Lazo for spotting this paper and circulating it through NEP-HIS, my interest in this is less research focused than teaching focused. Having the honour of teaching bankers about banking, sometimes I am asked questions which I find difficult to answer. One such question has been ‘why are inter-bank flows seen as less volatile, than consumer deposits?’ In this very accessible paper, Carlson and Rose answers this question by analysing the reality of a bank run, looking at the raw data from the treasury department of a bank which did indeed suffer a bank run: Continental Illinois – which became the biggest banking failure in US history when it flopped in 1984.


For the business historian, the paper may lack a little character as it rather skimps over the cause of Continental’s demise, though this has been covered by many others, including the Federal Deposit Insurance Corporation (1997). The paper briefly explains the problems Continental faced in building a large portfolio of assets in both the oil and gas sector and developing nations in Latin America. A key factor in the failure of Continental in 1984, was the 1982 failure of the small bank Penn Square Bank of Oklahoma. Cushing, Oklahoma is the, quite literally, hub (and one time bottleneck) of the US oil and gas sector. The the massive storage facility in that location became the settlement point for the pricing of West Texas Intermediate (WTI), also known as Texas light sweet, oil. Penn Square focused on the oil sector and sold assets to Continental, according the FDIC (1997) to the tune of $1bn. Confidence in Continental was further eroded by the default of Mexico in 1982 thus undermining the perceived quality of its emerging market assets.

Depositors queuing outside the insolvent Penn Square Bank (1982)

Depositors queuing outside the insolvent Penn Square Bank (1982)

In 1984 the failure of Penn would translate into the failure of the 7th largest bank in the US, Continental Illinois. This was a great illustration of contagion, but contagion which was contained by the central authorities and, earlier, a panel of supporting banks. Many popular articles on Continental do an excellent job of explaining why its assets deteriorated and then vaguely discuss the concept of contagion. The real value of the paper by Carlson and Rose comes from their analysis of the liability side of the balance sheet (sections 3 to 6 in the paper). Carlson and Rose take great care in detailing the make up of those liabilities and the behaviour of different groups of liability holders. For instance, initially during the crisis 16 banks announced a advancing $4.5bn in short term credit. But as the crisis went forward the regulators (Federal Deposit Insurance Corporation, the Federal Reserve and the Office of the Comptroller of the Currency) were required to step in to provide a wide ranging guarantee. This was essential as the bank had few small depositors who, in turn, could rely on the then $100,000 depositor guarantee scheme.


It would be very easy to pause and take in the implications of table 1 in the paper. It shows that on the 31st March 1984, Continental had a most remarkable liability structure. With $10.0bn of domestic deposits, it funded most of its books through $18.5bn of foreign deposits, together with smaller amounts of other wholesale funding. However, the research conducted by Carlson and Rose showed that the intolerance of international lenders, did become a factor but it was only one of a number of effects. In section 6 of the paper they look at the impact of funding concentration. The largest ten depositors funded Continental to the tune of $3.4bn and the largest 25 to $6bn dollars, or 16% of deposits. Half of these were foreign banks and the rest split between domestic banks, money market funds and foreign governments.

Initially, `run off’, from the largest creditors was an important challenge. But this was related to liquidity preference. Those institutions which needed to retain a highly liquid position were quick to move their deposits out of Continental. One could only speculate that these withdrawals would probably have been made by money market funds. Only later, in a more protracted run off, which took place even after interventions, does the size of the exposure and distance play a disproportionate role. What is clear is the unwillingness of distant banks to retain exposure to a failing institution. After the initial banking sector intervention and then the US central authority intervention, foreign deposits rapidly decline.

It’s a detailed study, one which can be used to illustrate to students both issues of liquidity preference and the rationale for the structures of the new prudential liquidity ratios, especially the Net Stable Funding Ratio. It can also be used to illustrate the problems of concentration risk – but I would enliven the discussion with the addition of the more colourful experience of Penn Square Bank- a banks famed for drinking beer out of cowboy boots!


Federal Deposit Insurance Corporation, 1997. Chapter 7 `Continental Illinois and `Too Big to Fail’ In: History of the Eighties, Lessons for the Future, Volume 1. Available on line at:

More general reads on Continental and Penn Square:

Huber, R. L. (1992). How Continental Bank outsourced its” crown jewels. Harvard Business Review, 71(1), 121-129.

Aharony, J., & Swary, I. (1996). Additional evidence on the information-based contagion effects of bank failures. Journal of Banking & Finance, 20(1), 57-69.

Society? Economics? Politics? Personality? What causes inequality?

What Drives Inequality?

by Jon D. Wisman (American)

Abstract Over the past 40 years, inequality has exploded in the U.S. and significantly increased in virtually all nations. Why? The current debate typically identifies the causes as economic, due to some combination of technological change, globalization, inadequate education, demographics, and most recently, Piketty’s claim that it is the rate of return on capital exceeding the growth rate. But to the extent true, these are proximate causes. They all take place within a political framework in which they could in principle be neutralized. Indeed, this mistake is itself political. It masks the true cause of inequality and presents it as if natural, due to the forces of progress, just as in pre-modern times it was the will of gods. By examining three broad distributional changes in modern times, this article demonstrates the dynamics by which inequality is a political phenomenon through and through. It places special emphasis on the role played by ideology – politics’ most powerful instrument – in making inequality appear as necessary.


Distributed by NEP-HIS on 2015-10-04

Reviewed by Mark J Crowley

This paper was circulated by NEP-HIS on 2015-05-05.  It explores a topical issue in political discourse at present, in which the debate has largely been categorised into two major camps.  First, the Conservative argument, stretching back to Margaret Thatcher in Britain (and simultaneously championed by Ronald Reagan and Charles Murray in the USA) was that inequality was good and accepted by the populace as a way of categorising and organising the nation.  Their argument, it so followed, ensured that those who were at the lower part of society would be inspired to work harder as a means to lessen their inequality.  The second argument that has now experienced resurgence in the UK following the election of the left wing veteran Jeremy Corbyn to the leadership of the opposition Labour Party is that inequality is an evil in society that punishes the poor for their poverty.  The counter argument is that the richer, which have the broadest shoulders, should bear the heaviest burden in times of hardship, and that austerity should not hit the poorest of society in the hardest way.  Thus a political solution should be sought to ensure a fairer distribution of wealth in favour of the poorest in society.  Similar arguments have been made in the US by proponents of increased state welfare.  It is in this context that the debates highlighted in this paper should be seen.

Thatcher and Reagan were the major architects of a change in economic policy away from state welfare.

Thatcher and Reagan were the major architects of a change in economic policy away from state welfare.

This meticulously researched article demonstrates that inequality as a phenomenon has long roots.  Citing that inequality has virtually been omnipresent in the world since the dawn of civilisation, Wisman couches the argument concerning inequality within the wider organisation and economic hierarchy of society.  Building on the argument of Simon Kuznets that inequality, at the beginning of economic development shows vast differences between rich and poor but subsequently stabilises, he looks at other factors beyond economics that contribute to the growing inequality in society.  The heavy focus on political literature examining the impact of politics on rising inequality is especially interesting, and takes this paper beyond the traditional Marxist arguments that have often been proposed about the failures and flaws of capitalism.  Other arguments, such as the impact of the industrial revolution, are explored in detail and are shown to be significant factors in defining inequality.  This runs as a counter-exploration to the work of Nick Crafts who has explored the extent to which the industrial revolution, especially in Britain, was ‘successful’.

Despite the arguments and debates about why inequality exists, there still appears to be no conclusive answer about its cause.

Despite the arguments and debates about why inequality exists, there still appears to be no conclusive answer about its cause.

Ideology is also a factor that is explored in detail.  The explanations for inequality have often been provided with ideological labels, with some offering proposals for eradicating inequality, while others propose that individuals, and not society, should change in order to reverse the trend.  The latter was forcefully proposed by Margaret Thatcher and Milton Friedman, whereas the former was commonly the battle-cry of post-war socialist-leaning parties (most notably the largely out-of power Labour Party of Britain in the post-war period, with the exception of 1945-51 and brief periods in the 1970s).

The religious argument about helping people who are less fortunate than yourself has now become more tenuous in favour of using religion as a form of legitimizing inequality.

The religious argument about helping people who are less fortunate than yourself has now become more tenuous in favour of using religion as a form of legitimizing inequality.

The exploration of religion as a factor is also particularly interesting here.  Wisman argues that providing state institutions with religious foundations thus legitimises their status, and hereby ensures that inequality has a stronger place in society.  This point, while contentious, has been alluded to in previous literature, but has not been explored in great depth.  The section in this paper on religion is also small, although such is its significance, I am sure the author would seek to expand on this in a later draft.


This paper is wide-ranging, and shows a large number of factors that have contributed to inequality in the western world, especially the USA.  It highlights the fact that the arguments concerning inequality are more complex than has possibly been previously assumed.  Arguing that politics and economics are intertwined, it effectively argues that a synthesis of these two disciplines are required in order to address the issue of inequality and reduce the gap between rich and poor in society.

I found this article absolutely fascinating.  I can offer very little in terms of suggestions for improvement.  However, one aspect did come to mind, and that was the impact of inequality on individual/collective advancement?  Perhaps this would take the research off into a tangent too far away from the author’s original focus, but the issue that sprung to mind for me was the impact of the inequality mentioned by the author on aspects such as educational attainment and future employment opportunities?  For example, in the UK, the major debate for decades has been the apparent disparity between the numbers of state school and privately-educated students attending the nation’s elite universities, namely Oxbridge.  Arguments have often centred on the assumption that private, fee-paying schools are perceived to be better in terms of educational quality, and thus admissions officers disproportionately favour these students when applying to university.  While official figures show that Oxbridge is made up of a higher proportion of state school student than their privately-educated counterparts, this ignores the fact that over 90% of British students are still educated in the state system.  Furthermore, so the argument goes, those with an elite education then attain the highest-paying jobs and occupy the highest positions in society, thus generating the argument that positions in the judiciary and politics are not representative of the composition of society.  These are complex arguments.  This paper alludes to many of these points concerning the origins of inequality.  Perhaps a future direction of this research would be to apply the models highlighted and apply them to certain examples in society to test their validity?


Dorey, Peter, British Conservatism: the Politics and Philosophy of Inequality (London, I. B. Tauris, 2011)

Thane, Pat (ed.) The Origins of British Social Policy (London: Croom Helm ; Totowa, N.J.: Rowman & Littlefield, 1978).

Thane, Pat, The Foundations of the Welfare State, (Harlow: Longman, 1982).

Technology and Financial Inclusion in North America

Did Railroads Make Antebellum U.S. Banks More Sound?

By Jeremy Atack (Vanderbilt), Matthew Steven Jaremski (Colgate), and Peter Rousseau (Vanderbilt).

Abstract: We investigate the relationships of bank failures and balance sheet conditions with measures of proximity to different forms of transportation in the United States over the period from 1830-1860. A series of hazard models and bank-level regressions indicate a systematic relationship between proximity to railroads (but not to other means of transportation) and “good” banking outcomes. Although railroads improved economic conditions along their routes, we offer evidence of another channel. Specifically, railroads facilitated better information flows about banks that led to modifications in bank asset composition consistent with reductions in the incidence of moral hazard.


Review by Bernardo Bátiz-Lazo

Executive briefing

This paper was distributed by NEP-HIS on 2014-04-18. Atack, Jaremski and Rousseau (henceforward AJR) deal with the otherwise thorny issue of causation in the relationship between financial intermediation and economic growth. They focus on bank issued notes rather deposits; and argue for and provide empirical evidence of bi-directional causation based on empirical estimates that combine geography (ie GIS) and financial data. The nature of their reported causation emerges from their approach to railroads as a transport technology that shapes markets while also shaped by its users.


In this paper AJR study the effect of improved means of communication on market integration and particularly whether banks in previously remote areas of pre-Civil War USA had an incentive to over extend their liabilities. AJR’s paper is an important contribution: first, because they focus on bank issued notes and bills rather than deposits to understand how banks financed themselves. Second, because of the dearth of systematic empirical testing whether the improvements in the means of communication affected the operation of banks.


In 19th century north America and in the absence of a central bank, notes from local banks were substitutes among themselves and between them and payment in species. Those in the most remote communities (ie with little or no oversight) had an opportunity to misbehave “in ways that compromised the positions of their liability holders” (behaviour which AJR label “quasi-wildcatting”). Railroads, canals and boats connected communities and enabled better trading opportunities. But ease of communication also meant greater potential for oversight.


ACJ test bank failure rates (banks that didn’t redeem notes at full value), closed banks (ceased operation but redeem at full value), new banks and balance sheet management for 1,818 banks in existence in the US in 5 year increments between 1830 and 1862. Measures of distance between forms of communication (i.e. railroads, canals, steam navegable river, navegable lake and maritime trade) and bank location emerged from overlapping contemporary maps with GIS data. Financial data was collected from annual editions of the “Merchants and Bankers’ Almanac”. They distinguish between states that passed “free banking laws” (from 1837 to the early 1850s) and those that did not. They also considered changes in failure rates and balance sheet variance (applying the so called CAMEL model – to the best of data availability) for locations that had issuing banks before new transport infrastructure and those where banks appear only after new means of communication were deployed:

Improvements in finance over the period also provided a means of payment that promoted increasingly impersonal trade. To the extent that the railroads drew new banks closer to the centers of economic activity and allowed existing banks to participate in the growth opportunities afforded by efficient connections.(p. 2)


Railroads were the only transport technology that returned statistically significant effects. It suggested that the advent of railroads did indeed pushed bankers to reduce the risk in their portfolios. But regardless of transport variables, “[l]arger banks with more reserves, loans, and deposits and fewer bank notes were less likely to fail.” (p.20). It is thus likely that railroads impact banks’ operation as they brought about greater economic diversity, urbanisation and other measures of economic development which translated in larger volume of deposits but also greater scrutiny and oversight. In this sense railroads (as exogenous variable) made banks less likely to fail.

But ACJ note that means of transportation were not necessarily exogenous to banks. Reasons for the endogeneity of transport infrastructure included bankers promoting and investing in railroads to bring them to their communities. Also railways could find advantages to expand into vigorously active locations (where new banks could establish to capture a growing volume of deposits and serve a growing demand for loans).

Other empirical results include banks decreased the amount of excess reserves, notes in circulation and bond holdings while also increased the volume of loans after the arrival of a railroad. In short, considering railroads an endogenous variable also results in transport technologies lowering bank failure rates by encouraging banks to operate more safely.


The work of AJR is part of a growing and increasingly fruitful trend which combines GPS data with other more “traditional” sources. But for me the paper could also inform contemporary debates on payments. Specifically their focus is on banks of issue, in itself a novelty in the history of payment systems. For AJR technological change improves means of payment when it reduces transaction costs by increasing trust on the issuer. But as noted above, there are a number of alternative technologies which have, in principle, equal opportunity to succeed. In this regard AJR state:

Here, we describe a mechanism by which railroads not only affected finance on the extensive margin, but also led to efficiency changes that enhanced the intensity of financial intermediation. And, of course, it is the interaction of the intensity of intermediation along with its quantity that seems most important for long-run growth (Rousseau and Wachtel 1998, 2011). This relationship proves to be one that does not generalize to all types of transportation; rather, railroads seem to have been the only transportation methods that affected banks in this way.(p4)

In other words, financial inclusion and improvements in the payment system interact and enhance economic growth when the former take place through specific forms of technological change. It is the interaction with users that which helps railroads to dominate and effectively change the payments system. Moreover, this process involves changes in the portfolio (and overall level of risk) of individual banks.

The idea that users shape technology is not new to those well versed in the social studies of technology. However, AJR’s argument is novel not only for the study of the economic history of Antibellum America but also when considering that in today’s complex payments ecosystem there are a number or alternatives for digital payments, many of which are based on mobile phones. Yet it would seem that there is greater competition between mobile phone apps than between mobile and other payment solutions (cash and coins, Visa/Mastercard issued credit cards, PayPal, Bitcoin and digital currencies, etc.). AJR results would then suggest that, ceteris paribus, the technology with greater chance to succeed is that which has great bi-directional causality (i.e. significant exogenous and endogenous features). So people’s love for smart phones would suggest mobile payments might have greater chance to change the payment ecosystem than digital currencies (such as Bitcoin), but is early days to decide which of the different mobile apps has greater chance to actually do so.

Wall Street (1867)

Wall Street (1867)

Another aspect in which AJR’s has a contemporary slant refers to security and trust. These are key issues in today’s digital payments debate, yet the possibility of fraud is absence from AJR’s narrative. For this I mean not “wildcatting” but ascertaining whether notes of a trust worthy bank could have been forged. I am not clear how to capture this phenomenon empirically. It is also unlikely that the volume of forged notes of any one trusted issuer was significant. But the point is, as Patrice Baubeau (IDHES-Nanterre) has noted, that in the 19th century the technological effort for fraud was rather simple: a small furnace or a printing press. Yet today that effort is n-times more complex.

AJR also make the point that changes in the payments ecosystem are linked to bank stability and the fragility of the financial system. This is an argument that often escapes those discussing the digital payments debate.

Overall it is a short but well put together paper. It does what it says on the can, and thus highly recommended reading.

Does Bank Competition Lead to Higher Growth?

Bank Deregulation, Competition and Economic Growth: The US Free Banking Experience

By Philipp Ager (University of Southern Denmark) and Fabrizio Spargoli (Erasmus University Rotterdam)


We exploit the introduction of free banking laws in US states during the 1837-1863 period to examine the impact of removing barriers to bank entry on bank competition and economic
growth. As governments were not concerned about systemic stability in this period, we are
able to isolate the effects of bank competition from those of state implicit guarantees. We find
that the introduction of free banking laws stimulated the creation of new banks and led to
more bank failures. Our empirical evidence indicates that states adopting free banking laws
experienced an increase in output per capita compared to the states that retained state bank
chartering policies. We argue that the fiercer bank competition following the introduction of
free banking laws might have spurred economic growth by (1) increasing the money stock
and the availability of credit; (2) leading to efficiency gains in the banking market. Our
findings suggest that the more frequent bank failures occurring in a competitive banking
market do not harm long-run economic growth in a system without public safety nets.


Circulated by NEP-HIS on: 2013-12-29

Review by Natacha Postel-Vinay

In this paper, Philipp Ager (University of Southern Denmark) and Fabrizio Spargoli (Erasmus University Rotterdam) ask two very topical questions. Does increased bank competition lead to higher economic growth? And, if so, how? Following the recent crisis, many have wondered whether the alternative to “too-big-to-fail” — having many smaller banks competing with each other — would necessarily be a better one. Clouding the debate has been the difficulty of finding appropriate historical settings in which to test the hypothesis that more competition leads to greater growth. In their paper, Ager and Spargoli focus on what they consider the best instance of intense bank competition without any implicit government bail-out guarantee: the American free banking era.

Between 1837 and 1863 new laws were passed in a number of states allowing just about anyone to set up a bank, with very few requirements to fulfill. Until then, banks wanting to open needed a charter from their state, for which they had to meet relatively stringent criteria. As the authors show using a new quantitative analytical framework, the new laws greatly increased the creation of new banks in the states which passed them. As competition increased, however, a higher proportion of banks ended up failing. Could it still be the case that the introduction of free banking laws led to greater growth in those states?

A satire on Andrew Jackson's campaign to destroy the Bank of the United States and its support among state banks, 1836. It was partly to fill this gap that states allowed free banking.

A satire on Andrew Jackson’s campaign to destroy the Bank of the United States and its support among state banks, 1836. It was partly to fill this gap that some states allowed free banking.

The paper’s most important finding is that increasing competition among banks did lead to higher economic growth. Jaremski and Rousseau’s 2012 paper (previously reviewed in NEP-HIS here) found that a new “free” bank, as opposed to a charter bank, did not have a positive effect on the local economy. While this is an important finding in itself, it is also important to look at the effect of the introduction of free banking laws on aggregate bank behaviour, if only because the new entry of free banks may alter the willingness of charter banks to enter the market and their behaviour once in the market. Charter banks’ behaviour may in turn alter free banks’ behaviour, and so on. Interestingly, Ager and Spargoli’s study finds that in the aggregate, the acceleration in bank entry and resulting greater competition among all types of banks had a positive effect on economic growth.

To arrive at this conclusion, the authors are careful to include a number of controls. First, there is the possibility that growth opportunities led some states to adopt free banking laws, in which case the authors would face a reverse-causality problem. Hence they conduct a county-level analysis in which they include time-invariant county characteristics and state-specific linear output trends (although perhaps it would be nice to see these output trends going further back in time than 1830). Second, they also control for other laws that states might have introduced at the same time as the free banking ones, which could potentially bias the results. Finally, they control for unobserved heterogeneity between states by examining contiguous counties lying on the border of states that introduced free banking. Their results are robust to these different specifications.

Private Bank Note, Drover’s Bank, Salt Lake City, Utah, $3, 1856

Private Bank Note, Drover’s Bank, Salt Lake City, Utah, $3, 1856

Ager and Spargoli are of course also interested in where this growth came from. They find a positive relationship between the introduction of free banking laws and lending, and conclude that one of the main channels through which this increase in growth occurred was the increase in the availability of credit that greater competition fostered. This story is consistent with the finance-growth nexus literature, which argues that greater (and safer) access to credit is conducive to economic development.

Although this seems perfectly reasonable, it would perhaps have been interesting to see when most of the failures occurred. If, for instance, they mainly occurred towards the end of the period under study, say around the 1857 panic, then it is possible that the negative effects of such failures on subsequent growth would not have been picked up by this study, since it ends in 1860. This leaves open the possibility that the positive relationship between free banking and increased access to credit was not a beneficial one for the economy in the long run. Loan growth (and asset growth more generally) is not always a good thing, as the recent crisis has tended to show.

Private Bank Note, Mechanics Bank, Tennessee, $10, 1854

Private Bank Note, Mechanics Bank, Tennessee, $10, 1854

Overall however, Ager and Spargoli’s paper asks a very important question and offers a solid analysis. A natural next step would be to include output data on the periods preceding and following the free banking era, although the occurrence of the Civil War is an obvious obstacle to this study.



Jaremski, M., and P. L. Rousseau (2012): “Banks, Free Banks, and U.S. Economic Growth,” Economic Inquiry, 51(2), 1603–21.

“A fluid, ever-evolving, and organic process of improvement, misstep and improvement”: The Long Road to Monetary Union in the USA

Politics on the Road to the U. S. Monetary Union

Peter L. Rousseau (, Vanderbilt University


Abstract: Is political unity a necessary condition for a successful monetary union? The early United States seems a leading example of this principle. But the view is misleadingly simple. I review the historical record and uncover signs that the United States did not achieve a stable monetary union, at least if measured by a uniform currency and adequate safeguards against systemic risk, until well after the Civil War and probably not until the founding of the Federal Reserve. Political change and shifting policy positions end up as key factors in shaping the monetary union that did ultimately emerge.

Review by Manuel Bautista Gonzalez

Peter L. Rousseau

Peter L. Rousseau

In this piece published in NEP-HIS 2013-04-13, Peter Rousseau argues for the need to complicate the widely-held, simplistic view that political union is a necessary condition for a successful monetary union. By studying the intersection of politics, money and finance in the United States from the American Revolution to the Great Depression, Rousseau posits that there is no automatic mechanism to ensure the concurrence of political and monetary union.

Although Rousseau begins his paper with a rather narrow definition of monetary union as a “system with a uniform currency and adequate safeguards against systemic risk” (Rousseau 2013: 1), he expands it throughout the paper to take into account other characteristics and consequences of processes of monetary unification.

The most obvious element of monetary union is the adoption of a single unit of account and uniform currency throughout a territory. To function, monetary union requires credible authorities with effective powers to control the supply of money while properly backing liabilities to minimize uncertainty. To reduce transactions costs, monetary union also demands institutional arrangements between the government and the banking system as a private supplier of means of payment. With monetary union, short-term and long-term capital markets become part of a payments system, whereby due to network effects, the reduction of borrowing costs in regular conditions can meet rapidly-spreading liquidity squeezes in times of financial distress. To recapitulate, monetary union has a dual, difficult nature, for it requires the virtuous alignment of public and private interests; henceforth, politics will mold for better or for worse the actual operation of any monetary union.

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