Dutch Finance
in brief
oday we take it for granted that government and finance are joined at the hip. But it was not always so. Back in the feudal era the monarchs funded themselves from their royal estates and they fought wars with the feudal hosts of their top vassals, their noble tenants-in-chief.
Commerce and trading run on credit. Merchants typically borrow to anticipate the sale of their merchandise; it just makes sense. But merchants also need protection, for their valuable cargoes are an eternal temptation to Vikings and pirates upon the high seas. Thus the need for navies. It just makes sense for merchants to finance the local political Big Man in return for protection from pirates.
And it makes sense for the local political Big Man to cultivate the local merchants and borrow from them.
Of course, it can all go wrong, and Britain's King Edward III ruined a few Italian bankers with his Hundred Years War in France.
But when Henry VIII of the six wives decided to nationalize the English armed forces and disarm the nobles, things got more serious, and Henry's wars resulted in multiple financial crises and debasings of the currency.
It was the Dutch that solved the problem with the invention of central banking in their war of liberation against Spain from 1566-1608. The Exchange Bank of Amsterdam provided a market in government debt that, you might say, joined government and commerce into a joint enterprise.
The Dutch brought their finance to England when they invaded in 1688 and set up the Bank of England in 1692. The Brits promptly started a Second Hundred Years War against France, and ran their national debt up to 250 percent of GDP before teaching the French a lesson near the village of Waterloo in 1815.
Alexander Hamilton brought Dutch Finance to the newly born United States of America and founded the US national debt by buying the debt issued by the various states during the Revolutionary War at par and setting up the Bank of the United States. Hamilton's financial system made it possible for President Jefferson to finance the Louisiana Purchase mostly with debt.
Since the early 19th century two additional lessons have been learned. The first, advocated by Walter Bagehot in 1873 in Lombard Street is that the central bank must act as the "lender of last resort" for the financial system backed, if necessary, by the full faith and credit of the national government. But this lesson have proved hard for US central bankers to learn, as the Federal Reserve System failed to act as "lender of last resort" in the Wall Street Crash of 1929 and the Lehman Brothers failure of 2008.
The second lesson is not to permit a collapse of government credit into hyper-inflation. Because Hitler.