Medieval money tricks

Financial engineering has not had a good press of late. A whole alphabet soup of complex financial practices have been blamed for the recent financial crisis. One such process, called securitisation, saw banks bundling up thousands of loans – many of which had been made to borrowers who would have trouble meeting the repayments – into large, hugely complex products and selling them on to investors.

Even now, some of the world’s largest banks are being investigated for manipulating LIBOR, a key financial standard determining the interest rates charged to millions of borrowers.
This complicated relationship between financial innovation and wider economic, political and social considerations is not new, however, and can be traced back to the Middle Ages and even beyond.

Typical ingenuity

Finance and morality

Case study 1: Discounting

When Matthew Paris, the 13th-century English chronicler, reported the death-bed words of Robert Grosseteste, the reforming bishop of Lincoln (died 1253), he included some financial advice. It should be noted that this source tells us more about Paris’s opinions than those of the bishop:

For example, I take up a one-year loan of a hundred marks [£66 13s 4d] for a hundred pounds. I am obliged to make and seal a bond, in which I acknowledge receipt of a loan of a hundred pounds, payable in one year. But if you should wish to repay the money that you received to the pope’s usurer within a month, or sooner, he will not receive anything other than the full hundred pounds, which terms are heavier than those of the Jews.

In this hypothetical example, the interest rate works out at 50 per cent per annum if the 100 marks were received at the start and £100 repaid at the end of one year. Were the £100 to be repaid within the year, however, then the effective annualised rate would be much higher. If it was repaid after one month, as above, the annualised interest rate would be 600 per cent. Conversely, if the debtor could delay payment beyond the year, then the annualised rate of interest would fall – if it was repaid after two years, without incurring any further charges, then the effective rate of interest would be reduced to 22.5 per cent per annum. By contrast, the Jews were not subject to the usury prohibition and could openly charge interest. The king regulated and protected this market, capping the rate at 2d in the pound (of 240d) per week for the length of the loan – corresponding to an annualised non-compounded interest rate of 43.3 per cent.

Case study 2: Gifts

From 1272 until c1342 the kings of England employed a succession of Italian merchant societies as ‘bankers to the crown’. The granting of periodic gifts to the Italians was the preferred means of paying interest. For example, in the three years 1328–31, Edward III borrowed around £42,000 from the Bardi of Florence and promised them gifts totalling £11,000. Later, after the relationship between Edward and the Bardi had broken down in the 1340s, an Exchequer official calculated that the Bardi had been promised over £84,000 since 1309 as gifts. He argued that these were ‘usury’ and that the king should not be bound to pay them.

This document records a gift made by Edward III’s father, Edward II, to his then bankers, the Frescobaldi of Florence:

Charged to Ingelard de Warley, keeper of the wardrobe on 10 July 1310 – £1,000 paid to Amerigo di Frescobaldi and his fellows, merchants of the society of the Frescobaldi of Florence, of the king’s gift, for certain damages that they sustained in the third year [1309–10] by reason of a certain loan of 10,000m [£6,666 13s 4d] made to the king by them as it appears by a wardrobe bill that they have returned. [Paid] in five tallies made to various recipients as appears in the great roll of the receipt for the same day. By order of the treasurer.

This case is particularly valuable because we have detailed information about the amounts and dates of advances and repayments. It is therefore possible to reconstruct the interest rate represented by this gift, which works out to be 23.67 per cent annually. From this and other similar examples,it seems that the English kings could normally borrow at between 15 per cent and 25 per cent per annum but, during times of financial pressure, they might have to pay interest rates of 40 per cent to 60 per cent and even higher.

Case study 3: Exchange rate manipulation

The use of bills of exchange to extend credit rather than to actually transfer money was called ‘dry exchange’ and can best be demonstrated in practice as follows (also summed up above): In Venice on 26 September 1442, Francesco Venier & Bros sold a bill of exchange for 150 ducats to Cosimo di Medici and Co, payable in London after three months at the rate of 44½ pence sterling per ducat. Medici sent the bill of exchange to his representatives in London, where they should have received £27 16s 3d (6,675d). When they presented the bill for payment on 31 December, however, Venier’s representatives refused to pay (probably by prior agreement with Medici) and the bill was ‘rechanged’ or sent back to Venice to be settled in another three months.

But this second exchange transaction took place at the rate prevailing in London, which two FX brokers testified was 41¼ pence sterling. As a result of this spread or difference of 3¼ pence between the rates in Venice and London, Venier repaid Medici not the original 150 ducats, but just under 162 ducats. In short, Venier had borrowed 150 ducats for six months and paid 12 ducats in interest, an annualised interest rate of 15.7 per cent.

This built-in spread was not, of course, the only factor influencing exchange rate movements. The pattern of international trade resulted in seasonal flows of money from one country to another while less predictable events, such as war or political unrest, could also have a significant impact. A merchant’s profits therefore depended on his ability to predict market movements and to time his trades, just like today.