Why Britain Used to be the Financial Capital of the World

Posted Oct 29, 2019 by Martin Armstrong

QUESTION: Why was Britain the financial capital of the world before the first world war? Are you saying it was not their gold reserves?

Thank you for the clarification

PCV

ANSWER: It was never the British gold reserves. It was the unique talent of the British who were traders in the city by nature. Perhaps it was a cultural aspect that made London the trading capital of the world compared to other cities, and the United States learned this trading instinct from the British.

Prior to World War I under the gold standard, global finance was really a hybrid public-private system. From the public side, 59 nations took part in the system. The private side was where the rules of engagement existed with credit risks and boundaries within private businesses and banks. Individuals could access the financial markets to facilitate trade both internationally and domestically. Yet, the central banks whose coordination and mutual assistance kept the gold standard operational were nominally private entities at this point in history.

London had emerged as the financial capital of the world before the war. London was of critical importance for its large financial institutions emerged as clearing banks for worldwide trade, which grew in importance and with that their gold reserves. London exercised great influence on global financial market conditions much as New York does today during the Post World War II era.

The public and private elements of the system fed each other and thereby supported each other in stable economic times. However, in times of war, suddenly the private v public linchpins would come into conflict. Today, we face a similar conflict because governments have perpetually borrowed in times of peace and never reduced their debts. Consequently, the similar conflicts which would destroy the financial system in times of war are present currently in times of peace.

In the event of a crisis, central banks would find themselves torn between two responsibilities. Defending their currency’s parity with the edifice of the international gold standard demanded rises in interest rates to maintain confidence in the currency and an adequate supply of money and credit to prevent a depression.

This was a policy objective that had its own internal contractionary effects. The problem of being the lender of last resort for their banking system to prevent bank failures by supplying emergency liquidity would require an expansion of credit and a lowering of interest rates. The system was without a clear balance and indeed, monetary history demonstrates that central banks of Europe were never able to achieve perfect harmony.

As Europe cascaded toward war in August 1914, these economic policies of the central banks came into direct conflict with one another. Under a gold standard, money could not simply be created and the cost of funding a war would, in reality, depleted the national resources. If a nation-state tried to remain within the gold standard system, its economy would contract and a collapse of the credit system would bring a halt to private commerce.

The other choice was to abandon the gold standard for at least the duration of the war, which would put at risk the costs of regaining parity into an unknown category sometimes into an uncertain future.

Britain and the United States were determined during World War I to uphold the exchange rate between the pound sterling and the dollar in the interest of easy borrowing under the confidence of the gold standard. Indeed, the United States continued to strike gold coins during World War I and it did not abandon the gold standard. France, Russia, Germany, and Austria-Hungary chose to abandon the gold standard which would have been impossible to maintain. Australia remained on the gold standard and it struck gold sovereigns in Sydney, Melbourne, and Perth.

London was the linchpin of the global financial system for it was the Financial Capital of the World prior to World War I. The real power behind the British pound was the international reach of the British Empire. London became the center of the financial markets which dominated the world economy. The city of London and the financial expertise of its traders and bankers were the real power that supported the British Empire, not its politicians nor its actual gold reserves.

There were five major merchant banks that dominated the world financial markets. They were the Rothschilds, Barings, Morgans, Kleinworts, and Schröders. Interestingly, at the peak of American power in 2007, there were also five investment banks – Goldman Sachs, Lehman Brothers, Bear Stearns, Morgan Stanley, and Merrill Lynch. Perhaps “5” was a lucky number.

London Port 1906

The top-five British firms in 1914 were involved in finance and underwriting ventures on a worldwide scale. There were also major banking institutions with large balance sheets such as Westminster (£104m), Lloyds (£107m), and Midland (£109m) which all had millions of depositors.

London was the financial capital of the world with the largest and most liquid markets globally. London funded world trade, discounting of bills of exchange with a daily volume prewar of over £7 million per day. London also maintained the secondary market which funded world trade which meant that 60% of all world trade went through London. They also provided for the extension of long- and short-term loans.

Then there were the insurance contracts that went through London which amounted to an astonishing two-thirds of global maritime deals were handled in Britain. Of course, London was also the capital of foreign exchange transactions. Even back then, 70% of the entire global telegraph cable network was operated by British companies. To this day, all the claims that if London left under Brexit, the banks would move to the EU is a joke. Neither Paris nor Frankfurt can offer the infrastructure needed for major international business.

Then there was the British shipping industry at that time which carried 55% of all the world’s seaborne trade. Then there was energy, which was predominantly coal-driven pre-World War I. There Britain controlled about 75% of the coking coal annually used by the world’s cargo vessels. This is what made London the financial capital of the world pre-World War I.

The system was based on the top investment banks, the main commercial banks providing the capital and money market functions as well as market-makers which brought together suppliers and buyers of credit. This network was connected with the regional savings banks and trusts, and then there was the next level of moneylenders, stockbrokers, discount bills of acceptance houses, and the insurance companies such as Lloyds of London. This structure is what made London dominant in the world of finance.

In Paris, the largest bank was Crédit Lyonnais (at $550m in 1913) which was, in fact, the largest financial institution in the world at that time. This was followed by Société Générale ($460m), and the Comptoir National d’Escompte de Paris ($365m). In Berlin, which was the third financial center in Europe in size, the primary institution was Deutsche Bank ($545m), with the lesser institutions being Disconto Gesellschaft ($281m), and Dresdner Bank ($350m).

Sovereign lending in Germany at this point in history was the small market of private investment houses such as Mendelssohn & Co. and Bleichröder. Germany was no match for Britain when it came to a financial structured system.

In the United States, the financial system was similar to that of Britain, but it was bigger in the customer base yet very regionalized. On Wall Street, the power rested in the hands of Bankers Trust, the National City Bank ($277m), and the Guaranty Trust Co. of New York ($230m). These were the banks that provided the bulk of industrial financing. They competed against the investment banks of J.P. Morgan & Co., Kidder Peabody & Co., Lee Higginson & Co., Kuhn, Loeb & Co., Speyer & Co., and J. & W. Seligman & Co. These banks would prove instrumental in the international financing of the Entente—and the relative lack of external debt finance for the Central Powers.

Therefore, Britain was NOT the Financial Capital of the World simply because it had gold reserves. It was the expertise of its traders and bankers in conjunction with the development of insurance which facilitated trade and shipping. But the fact that London was also the center for Forex trading, contracts were typically settled in London on world trade

Catalonia & the Inevitable Split of Spain

Posted Oct 24, 2019 by Martin Armstrong

QUESTION: Hi Marty,
I was expecting a blog about Catalonia after the trial. So, here I am. Things have escalated lately and we are seeing violence in the streets. People are getting angry with no solution nor proposal from Madrid on the table for years. Spain will never allow Catalonia to get independence, a referendum nor anything basically. They will do everything they can to avoid it. We did see that so many times already, working very closely with the law. It seems to me that independence has never been so close though. I am expecting PSOE together with PP to rule after 10N. They will make bad decisions again and I see that after that we might see the last part of the journey to finally get independence. I am not sure how this could/will be done. Spanish will jail everyone, beat everyone and call us nazis, violent, not using the law properly, supremacists etc. EU will not support it again. This time though I have the feeling we will make it. What does you/Socrates see here? How can independence be achieved in these circumstances? Spain has the law (theirs) and the power to stopped, but this has gone too far, we really need to do it. Our future and our children’s future are at high risk sticking within Spain.
Thanks for all your work.
M
ANSWER: It was the marriage of Ferdinand and Isabella in 1469 which united both crowns and set the stage for the creation of the Kingdom of Spain, at the dawn of the modern era. From a cyclical perspective, Spain will probably split by 2029. The separatist movement for Catalonia remains in play. It is only a question of time. The economic pressure will be to surge in 2021/2022 and that will most likely result in the final separation by 2029 with the potential to come a little early by 2025.

Bail-In v Bailout of Banks in USA

Posted Oct 24, 2019 by Martin Armstrong

QUESTION: Might you clarify this response you gave on one of your very recent blogs. You said bail-in may NOT be permitted on US soil. Did you mean that despite the laws written in the USA to allow it, you don’t think it is likely to happen to USA citizens banking in the USA?

OR were you only meaning in regards to overseas banks with locations within the USA would most likely not use bail-in.

OR because of all the EU money fleeing to USD/USA that the banks stable in the USA (for now) and thus no bail-in needed?

Do you think there would EVER be the case for a USA bank bail-in? Or is this just more conspiracy talk? For obvious reasons, this is of great concern to all of us as this USD repo madness, liquidity crisis and DB’s derivative contagion begins to spread throughout Europe into the next ECM turn in mid-January 2020.

Thank you in advance for your efforts and response to this question.

L

ANSWER: The bail-in laws were passed during the last crisis which was a popular response at that time because no bankers were ever punished for what they did in New York City. To the extent that FDIC exists, they would certainly honor that or it would be political suicide. However, the fine print is FDIC cover per person. Putting money at 5 different banks would seem to get around their limitations, but I would not count on that.

The gray area comes in two aspects.

1. First, there are at any given time money from one bank which can be at another (REPO) which is also why there is a liquidity crisis
2. Second, there are business accounts which exceed $100,000

The problem with a bail-in is that the ramifications would be far worse than the Great Depression. You would destroy businesses that would then be unable to make payroll and the unemployment would be massive – far greater than the 25% high of the Great Depression.

The BAIL-IN policy of Europe is a different animal altogether. This has nothing to do with bailing-out bankers. This stems from the refusal to consolidate debts. If banks failed in Southern Europe, then a bailout would mean money from the north could go to the south. This is the structural design. It is WHY Europe adopted the bail-in, quite different from the question of bankers’ conduct. Germany’s demand to join the Euro was that there would be no consolidation of debts. As I have said, the EU is like a family reunion with the cousin who is the drunk than people smile at, but would never lend him a dime. You can pretend it one happy family, but that is just the surface.

A bail-in would actually be devastating economically. It defeats the very idea of banking for if the burden is shifted to depositors to monitor banks when we have agencies who are supposed to do that, then why do we need governments or pay taxes?

Despite the laws, they were never thought threw and it is a huge difference between a regional bank and Goldman Sachs. The hatred was directed at the New York Banks – and rightly so. Because the federal court in New York City has protected the bankers, they have actually undermined the entire country by their stupid actions.

Paul Volcker raised interest rates insanely into 1981 to stop inflation, but he ignored the consequences.

Central Banks Pre & Post-1971

Posted Oct 22, 2019 by Martin Armstrong

QUESTION: You commented that the central banks had a difficult position when they were on the gold standard compared to post-1971. Could you explain that difference?

Thank you for the education. Its better than any classroom.

EJ

ANSWER: The United States created the Federal Reserve in 1913. Prior to World War I, central banks were long-established in Europe like the Bank of England in 1694. What you have to understand is that BEFORE World War I, the central banks of Europe were faced with two duties because there was the gold standard.

1.) The first was to defend their currency’s parity with gold and thereby the entire edifice of the international gold standard. This required raising interest rates and keeping the total volume of money and credit under control, often with contractionary effects.
2.) The second responsibility was to act as a lender of last resort for their banking system by supplying emergency liquidity. This necessitated an expansion of credit and a lowering of interest rates.

Post-1971, the central banks were no longer required to intervene to maintain the exchange rate relative to the gold standard, which is more or less similar to Hong Kong managing the peg to the dollar today.

Paul Volcker raised interest rates insanely into 1981 to stop inflation, but he ignored the consequences that would have on the value of the dollar on world markets. This was the stone that hit the standing pool of water which then at the 1985 Plaza Accord suggested that Europe create a single currency. One mistake is never corrected and never acknowledged. They constantly create a new scheme to solve the last one they created.

The French back in the 1960s had such a system where the central bank created the money and lent it to the government.

Who Earns the Money from Government Debt?

Posted Oct 21, 2019 by Martin Armstrong

QUESTION: Would you please explain exactly what government debt is and who receives the interest payment that governments make on borrowings? I thought that Governments borrowed from their respective central banks and paid the central bank interest on the debt. I never understood why a government would have to pay any interest. My brother tells me that all government debt is made up of bonds and the interest payment goes to the bondholder

Thank you

MMcDH

ANSWER: The interest paid on debt is to the bondholders, which includes foreign governments, Social Security, and private investors/institutions. The holdings of the debt change. Under Quantitative Easing, the bonds held by the central banks mean they receive the interest payments.

The French back in the 1960s had such a system where the central bank created the money and lent it to the government. That is a far better system because then the government does not compete with the private sector to borrow money thereby reducing economic growth.

Europe – How Bad Can This Get ?

Posted Oct 11, 2019 by Martin Armstrong

QUESTION: Hi Marty,

I’m based here in South of England, within the commuter belt into London. The ECM forecasts an economic downturn 18.01.2020, and Europe looks to be at the epicentre. My own research tells me the job cuts in the auto sector in Germany are quite severe.

How does all this play out after January? We have already witnessed companies collapsing, Thomas Cook, and many teetering on the very of edge of collapse. How bad is this going to be, and how does this compare to 2008?

Of course, the next 3 months of 2019 are going to be very volatile, what I’m trying to understand is how does all this look like to the average city worker within finance, law or professional services.

Within my own peer group most are clueless on what is going on and perhaps they should be thinking of income protection rather than going out and buying £60k Range Rovers. The apathy never ceases to amaze me.

I welcome your insight. Thanks for your great work which keeps us mere mortals informed.

Cheers IB

ANSWER: The answer is very bad. The structure of the Eurozone is an absolute disaster. It is promoted as a single country, but it lacks everything that stands behind a currency. Just look at the tariffs starting between the USA and the EU. It is IMPOSSIBLE to negotiate a trade deal with Europe because each country can veto any deal, proving this is not a single country, and thus there is no substance behind the single currency. This is why I say Brexit is the only way for Britain to survive. It cannot negotiate any trade deals with the USA, China, Canada, or whoever because any other state can veto it. They surrendered their sovereignty and it is undermining the European economy.

If the US had to seek the approval of all 50 states before it could do any national policy, nothing would ever get done. The French can block trade deals and the US will look at the EU as a single entity because that is the structure on the surface. So the US could impose tariffs on German cars because of something France refuses to yield on. It is a giant political mess.

The only way for Europe to survive is for the Eurozone to actually collapse. Then each country could negotiate for itself without a veto from another over something irrelevant to their economy.

If the Eurozone were to survive, each country must surrender all autonomy to Brussels on everything retaining only local culture and laws. Brussels is trying hard to make it the United States of Europe, but the first thing that must go is the refusal to consolidate the debts and end the bail-in policy. Anything shy of that is playing with fire.

While the ECM is turning in January 2020, that appears to be impacting more externally to Europe. Europe may see economic turmoil into 2021.

Cycle of Innovation

Posted Oct 9, 2019 by Martin Armstrong

QUESTION: Hi Martin,

I am curious about Industry/Technology, is there a cycle for industry, the industrial revolution, internet, etc., is it linear or cyclical.  Should we expect self-driving cars and continued advances or some kind of reversion to industry/technology past?   It seems that it may be linear, but maybe only up to a point and then the fall of Rome?

Was there maybe a grand civilization before Rome?  When we went through a museum in Rome with a guide, there was a breastplate that had different metals fused onto it.  The thing is that “technology” didn’t exist through the Roman time – the metal couldn’t be heated that hot to weld the two different metals (I don’t remember exactly the issue, just no one knew how the different metals were welded).  That would be cyclical but on a larger time scale?

I know your recommendation for getting into robotics in the future and can’t argue with that, just curious overall.  Your post of China moving on and the US going to horses and buggies got me thinking about this.

Thanks for any insight.  I really enjoy your work,

Harry

ANSWER: There has always been a cycle of innovation. That was one of Joseph Schumpeter’s main theories to explain the business cycle, which he called waves of innovation. For example, first there was the Canal Bubble that peaked during the Panic of 1825. There was the invention of the telegraph. The ancient Romans had invented the first version of the Pony Express and could get a letter from Britain to Rome in about 7 days.

This age of communication was followed by the invention of the steam engine, which then led to the railroad boom. That really peaked with the Panic of 1893, but the final rally in the railroads was 1907. Thereafter, the automobile took over and peaked in 1929.

On January 1, 1914, the world’s inaugural scheduled flight with a paying passenger hopped across the bay separating Tampa and St. Petersburg, Florida. Planes were used during World War I, but after the war there were thousands of unemployed pilots and a surplus of aircrafts along with an appreciation for the future significance of this new technology.

It was after World War I when civilian airliners began to emerge. The Fokker Trimotor built in Europe by the Dutch with a 8-12 passenger capacity was the most popular airliner in the 1920s. It had a range of about 600 miles. World War II was coming into play when the USA built Douglas DC-3 with a capacity of 28 passengers. It had a range of nearly 1500 miles. The DC-3 made its maiden commercial flight in 1936 between New York and Chicago and thus the airline stocks were the big innovation for the rally into 1937.

It was 1938 when televisions first began to be commercially available. It would be after World War II when this became the next real innovation boom. It was 1954 when color RCA TV systems were sold across America. By 1960, there were four debates between John F. Kennedy and Richard Nixon that were broadcast and changed the manner in which presidents would campaign. By 1969, Neil Armstrong walked on the moon for the first time as millions of American viewers watch live on network TV.

Of course, we have the internet, etc., but there is a clear cycle of innovation. There is a difference between when something is invented and when it becomes commercially viable. Based upon our database, the next one is in play which I believe is quantum computers. This will perhaps reach commercial viability by 2026. Artificial Intelligence may be the next immediate stock on the hotlist after 2020.

Europe could NEVER compete with the USA for they are EXTREMELY regulated. The #1 country in Europe to start a business is Great Britain.

Culture & Workforce Are Key to the Value of a Currency

Posted Oct 9, 2019 by Martin Armstrong

QUESTION: Hi Martin – was reading your latest post where you say “All currency is backed by the total productive capacity of its people.” – if this is the case, wouldn’t the number of productive workforces indicate a stronger currency? I take the case of India with a young workforce, and compare that with the US, with an aging baby boomer generation. Yet, it seems the INR is getting weaker against the USD. Am I missing the meaning of what you said here, appreciate your clarification on this thought?

JPM

ANSWER: It is not the sheer number of people. It also requires (1) education, (2) skills, and (3) a non-restricted economy with the least government interference. Otherwise, you can go to some countries where people are still herding animals and living in the bush.

The example of the non-restricted economy is simply communism. That is why it collapsed due to central planning and the denial of people to act in a free manner. They needed someone to sweep streets and you were next in line.

I had a friend whose family owned property in East Germany before the wall. They were able to get back their property and moved to open up a plant there for manufacture. I warned him it would be a bad move. He said I didn’t understand, they were German with a good work ethic. I said he did not understand they had no work ethic. His operation failed in less than 2 years. He then understood what I said. It took 4 East Germans to do the work of 1 West German. They did not know how to work.

The element (4) is the culture. In some cultures, there is a work ethic. In others, there just is not. In Japan, you jumped in a cab and you paid what was on the meter. If you tried to give him a tip, he would hand it back to you. It was more of an insult. Go to Hong Kong and the meter will say $8 and you hand him a $10 and he keeps the rest and tells you to get out. In Rome, the cab driver will start talking with you about America to distract you so he does not turn on the meter and then when you get to your destination he tells you how much which is typically twice what the meter would have been.

When you travel the world, as I do all the time, you see the huge difference in cultures which will account for vast differences in economics. In Italy, they are the third-largest economy in Europe. Yet on the street, you quickly see that it is far more entrepreneurial than France or Germany. So why do the numbers put Italy as #3? They also have the biggest black market because Italians simply ignore the government as best they can.

In the case of India, they do a lot of outsourcing there for programming. But language has another element to it that is typically never understood. Language is the key to the thinking process of culture. For example, in the USA I would say, “Here is my business card.” In Japan, that would be an insult. To them, why do you have to say it is “my” business card when that is obvious? You are elevating yourself above the person so it is more like saying, “This is my business card, you little schmuck!”You simply say, “Business card”.

Language is the window to how different cultures THINK. Asian culture BELIEVE in cycles — it is part of their religion. Western culture believes in a linear progression. Just look at global warming. They argue that the weather should be the same and it is not so we must be to blame.

It is more of a complex issue with these four distinct elements. Europe could NEVER compete with the USA for they are EXTREMELY regulated. The #1 country in Europe to start a business is Great Britain. Germany is #10 on the list. This is why Britain remains the financial capital of Europe. Despite all the nonsense that the banks will leave London and go to Paris or Frankfurt — good luck! They will not just have their entrepreneurial wings clipped. The infrastructure in Continental Europe compared to London could NEVER handle international telecommunications. It’s a real joke.

US versus Europe bailout

The Coming European Crisis

Posted Oct 6, 2019 by Martin Armstrong

QUESTION: Hi Martin,
first of all thank you for being alive and bring your knowledge to the world. I am also worried for when you will not be here, wondering if there is or will be anyone like you there?
I have a question as I am worried about my parents. They live in Europe, Spain, and they do not have much economic knowledge. They somehow trust in what the bank says, and for now they have their money on a fund which of course is giving almost nothing or even losing. What would you recommend to this kind of people if they just want to leave the money in a place without worrying too much, have better returns than a bank and have money available any time? Would you also recommend a private (non standard bank related) passive fund?
I am worried for the coming system crash as we are in difficult times and there is no “easy investment” by the looks of it. I hope to provide an educate answer to them and try to convince them to not to trust banks.
I guess this is the situation for a lot of people in the 70s, 80s in Europe. Last years most of them has lost a lot of money because of the bad advice from the banks whom they used (and somehow still but they are seing a bit the reality) to trust.
Thank you in advance.
JS

ANSWER: The real liquidity crisis hit in Europe. When the 2008-2009 crisis hit, the US bailed out the banks by taking the bad assets off their books. In Europe, they would not do that because it would mean money might flow from the north to the south to bail out banks the north had no respect for. Instead, they left the European banks with all the toxic losses and cut rates to negative, hoping the banks would make money on their own to cover their losses. That never happened. So Europe has been unable to recover all because of that policy which refused to consolidate the debts.

I do not like to recommend private funds that would impose a duty on me to constantly monitor them. I don’t have the time for that, and I do not charge for what I do so it would require ongoing resources and that would mandate a fee.

I also do not sell advertising on here because someone might think I am endorsing a particular investment just by allowing them to advertise. So I am careful about this sort of thing and understand that people respect me for my independence. I like to keep it that way. I even had a first-time attendee to one of our conferences remark I didn’t try to sell him anything. If I am trying to sell somebody something, then you do free seminars to get as many people to attend to listen to the sales pitch. Sorry, I am not selling investments.

All of that said, the best I can do is to say move the bulk of the money out of Europe to a major name money market fund investing in AAA short-term paper in the USA exclusively. This would be the best thing to do probably into 2021 before we would need to review the trend. Stay liquid. The politics in Europe will prevent any bailout. This will only lead to more discontent in Europe and put greater pressure on the separatist movements