International Finance and Investment: 1860 - 1914

There are several periods of financial globalization in this period of contemporary history. Bairoch finds a close link between the gold standard system and banking globalisation. On the other hand, when we talk about international finance, there are several aspects concerned and especially international trade, we can analyze two aspects, either the finance of international trade or the investment of international trade, which is rather long-term financing. We will promote capital transfers at the heart of the process of financial globalisation.

Finance and international investments

Foreign investment stocks relative to GDP, sample countries, 1860-2000.

From 1870 to 1914, capital exports reached unprecedented levels. From a long-term perspective, we see that foreign investment stocks reach 77% of world GDP and 20%. It was not until the 1980s that it surpassed the last peaks reached at the beginning of the 20th century. Then there is a period of financial recession, we have to wait until the 1980s to see an increase in the importance of global finance and wait until the 1990s to see the same importance of capital flows. We can also look at the prices of exported capital. We are seeing a narrowing of the gap between the different types of borrowing, showing that the international capital market is becoming increasingly integrated.

When we talk about financial globalisation, we are talking mainly about banks and debts issued by governments and companies and especially railways, we see that share issues were much rarer at the time.

Source: Daudin, Morys, O’Rourke, 2010, p. 10

We see the importance of investments for Great Britain because if we look at savings, we see that capital flows investing abroad were 14% between 1870 and 1914. At the beginning of the 20th century, almost half of British capital was exported through investment. As The Economist noted in 1911, "London is often more concerned with what is happening in Mexico than with the Midlands, more troubled by the Canadian railroad than a strike at the Galle mines. British investors invest all over the world and not only in Great Britain.

For France, too, capital flows from investments abroad account for a large share of savings. For Germany, the situation is a little different, but we are beginning to see the increasingly impressive importance of foreign investment; however, it is a country that is behind Great Britain and France.

United Nations, International Capital Movements during the Inter-war Period, New York, 1949.

Great Britain was the main investor, followed by France, which began in the 19th century as an importer of capital, and the British financed some of the first railways in France, but the situation changed thanks to a commercial surplus in France that shifted France's role. Germany also made a transition from debtor country to creditor country, but from 1813, Germany approached the importance of the French position in terms of foreign investment. If one realises the position of these three European countries, one understands why one speaks of Europe as the world's banker at the time.

We also see a transition from the United States. Until the beginning of the 20th century, the United States was by far the most important recipient of international investment. Foreign capital, and in particular British capital, finances much of the rail network in the United States as well as beef, mining and industrial operations. The growing wealth of this country thanks to its natural resources, its agricultural resources and its industrial success, leads to a transformation of the international role of the United States from a financial point of view starting to settle from a capital exporting point of view. It was during the First World War and especially after that we saw a US financial hegemony set in. Even in 1913 foreign investment in the United States remained more than double that of American investment abroad.

There are other debtors, such as Russia, for more or less the same reasons as the United States. The funds helped the Russians to build a major rail network and initiate financial ventures. There is a very important role for international finance in financing the Russian government and the Tsar's Court. Australia and New Zealand are major borrowers and most international funds are invested as securities to finance infrastructure such as railways, ports and utilities generally. We also see investments in mining companies in Australia and Canada. In Latin America, we can cite the mix of foreign investments in government securities and in companies. In Asia and Africa, we see investment in infrastructure, but especially to help foreign investment to develop sources of raw materials for European industries. There is a strong emphasis on investments either in government banks or in the securities of companies that invest in infrastructure.

After a certain point, it is difficult to say things that can be generalized because behind this overall distribution are various trends that represent different patterns of behaviour in exporting countries.

Source: Daudin, Morys, O’Rourke, 2010, p. 12

British investments are spread throughout the world. If there is one area that is not favoured by the British, it is Europe. The revolutions of 1848 deterred British investment in the two Americas. For France, there is a completely different geographical distribution. Investment in Europe is much greater than elsewhere. We see in the first half of the 19th century that the French invest in government securities from neighbouring countries. In the years 1879 and 1889, French investors built railways in Eastern Europe, but also started building the Suez Canal in Egypt. After the Franco-Russian alliance of 1894, French investors put enormous sums into the Tsar's government. For Russia, we see that for the entire period from 1870 to 1913, Russia accounted for a quarter of France's investments. We see that Germany specializes in Europe too, but not necessarily in the same countries, especially in the Ottoman Empire and Austria-Hungary, but we see a stronger interest in both Americas than in France. One guesses that empires play a role, but it is perhaps less important than one hears. On the other hand, there are important differences between European investors. The British Empire's share is 16% if you count only the colonies, but you can also add autonomous dominions to get to 40%, but you still have to remember that a very important dentinary is the United States which is an independent country. In contrast, France invested much less than Great Britain in its empire. For Germany, the importance of its empire as recipient of funds is even less important. Care must be taken with the empires-based argument to explain financial globalization.

Economic policy of the first globalisation of finance

There are several mechanisms involved. In the 1880s, there was a sovereign debt crisis in Latin America, but most people talked about bank loans. Before the First World War, there were very few international bank loans. We mainly see portfolio investments, direct investments in particular investments by companies or there is control of these investments by these companies.

The type of international remittance mechanism involves the central role of exchanges such as the London and Paris stock exchanges. When we talk about issues of these securities, we are talking about issues on stock exchanges in Europe. New York began to play a role before the First World War, but this remained negligible compared to the bankers of Europe. These issues are made on the basis of subscriptions for issues offered by investment banks. Investment banks are important players. In London, they talk about Merchant Banks like Rothschild and Baring. During this period, we see an increase in the role of these banks and their influence with the globalization of finance.

Source: Stanley Chapman, 1984, The Rise of Merchant Banking, p. 40

How can financial globalization be explained during this period? There is a continuum between the gold standard and financial globalization because some scholars find that financial globalization is made possible by the existence of an international monetary system based on the gold standard.

There are two other possibilities that are often proposed as an explanation for the foundations of this globalization. There is also the idea that the base is in the empire, it is the fact of having an empire that makes Britain capable of exporting capital. Finally, specialists are looking for microeconomic bases for financial globalisation and especially for the behaviour of European investors such as stock exchanges and large bankers. We see several proposals to explain the foundations of this financial globalization.

To sum up the three basic arguments, the gold standard works as a quality label. The gold standard functions as a quality label that allows a country to borrow more easily and at a lower interest rate on world capital markets. Such a quality label is particularly important for peripheral countries that would otherwise find it difficult to convince investors to lend them funds. The idea is that by choosing to go to the gold standard, peripheral countries submit to the flow-price mechanism giving legitimacy to lend funds with confidence in order to manage the economy in a disciplined manner. Russia in particular gave this justification to put itself on the gold standard in order to attract international funds.

Yet this argument is not totally convincing because once a country decides to put its currency on the basis of some kind of gold, there is a commitment, but the commitment is not as firm as that because a country always has the option to suspend convertibility into gold in times of crisis. This may give investors a certain function, but it goes up to a certain point. On the other hand, we talked about the United States is their hesitation against the gold standard. Everyone understood that there was public opinion volatility against the gold standard and that it would not be sure that the United States would remain on the gold standard. Despite this hesitation and uncertainty about the U.S. commitment to the gold standard, we see that the U.S. was the most important recipient for investment. Investors see that there are other arguments that count, not just the country's commitment to the gold standard.

Another argument is the idea that empire as royal seal that emphasizes imperialism as the basis of world finance before the First World War. Keynes had no doubt that the British Empire facilitated the export of capital by making it much cheaper for the British economy. Ferguson offered a very positive view of imperialism on world finance, because it created the possibility of financial globalization; for him there were very important benefits for the colony. There is certainly a controversial argument. Ferguson will explain how imperialism creates the basis for globalization by focusing on the political and economic structures of the colonies and dominions under British rule. The quality of the institutions found in the colonies is much better than if they were autonomous. Imperialism has played a role, but even in the British case, only 40% of foreign investment is spoken of when speaking of imperial investment. Most investments go to autonomous countries so imperialism goes to some extent to explain foreign investment trends, but this does not explain everything. Once you look at France and Germany, there is less explanation, because their empire counts less in terms of the distribution of their foreign investments. Finally, there are actors who play the role of guardian for investors creating the possibility of such an important financial globalization.

The most recent argument of Flandreau and Flores who put the role of Baring, Credit Lyonnais, Deutsch Bank who are big banks trying to control the allocation of world finance. They are able to act as custodians of international markets by requesting information from issuers. In this sense, they work for better or for worse like rating agencies these days. These bankers are not only pacifist actors who sometimes intervene to defend the interests of their clients.

We get the impression that by talking about these bankers, we are talking about a rational world finance with a rationality behind these investments and these custodians are opening the door to investments or opening the farm to a rational analysis of the possibility of investments. We cannot go too far because there are waves of investment and fads without a rational analysis of their prospects.

« The name and the glory and the position and everything is gone… Ned would have it all – glory and wealth. He might at least have guarded our good name. but it has all gone, offered up in his insatiate vanity and extravagance. »

— Tom Baring parle de Edward Baring [Lord Revelstoke] - [Ziegler, The Sixth Great Power, p. 252]

In the Baring crisis, there is the role of glory which is a non-rational element. We see that there are waves of investment that are not necessarily rational and returns that are sometimes very disappointing.