the glorious revolution's effect on english private finance: a microhistory, 1680-1705

Economic History Association

The Glorious Revolution's Effect on English Private Finance: A Microhistory, 1680-1705Author(s): Stephen QuinnSource: The Journal of Economic History, Vol. 61, No. 3 (Sep., 2001), pp. 593-615Published by: Cambridge University Press on behalf of the Economic History AssociationStable URL: http://www.jstor.org/stable/2698129 .

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THE JOURNAL OF ECONOMIC HISTORY

VOLUME 61 SEPTEMBER 2001 NUMBER 3

_________________ ~~.... S.....

The Glorious Revolution's Effect on English Private Finance: A Microhistory,

1680-1705 STEPHEN QUINN

The lending portfolio of a London banker is analyzed to better understand the relationship between public and private finance during England's Financial Revolution. The Glorious Revolution's political settlement appears to have reduced the risk premium on sovereign debt; but it seems to have raised, not lowered, rates on private debt. Two. explanations for these higher private rates are suggested. During the war years 1 690- 1697, the government's improved capacity to borrow seems to have "crowded out" private borrowing. After peace was restored and the government's borrowing re- trenched, the new political regime seems to have stimulated demand for loanable funds.

In 1688 the Catholic king James II fled England, to be replaced by the Protestant Dutchman William of Orange. William's claim to the English

throne came by way of his marriage to James II's first daughter, Mary. In retrospect the Dutch invasion was termed a "revolution" because it led to a political settlement that fundamentally changed the relationship between Crown and Parliament; it was called "glorious" by its Whiggish victors because it occasioned so little bloodshed, and because the settlement prevented civil strife for generations to come.1 Within months of his investiture, however, William Ill brought England into Holland's ongoing war against France. By the time peace was restored in 1697, the size of the English public debt had grown from less than ?1 million before 1688 to ?19 million, or over one- third of national income.2 While the crowding out of private debt would be the expected result of such large-scale military finance, Douglass North and Barry

The Journal of Economic History, Vol. 61, No. 3 (Sept. 2001). C) The Economic History Association. All rights reserved. ISSN 0022-0507.

Stephen Quinn, Department of Economics, Box 298510, Texas Christian University, Fort Worth, TX 76129. E-mail: s.quinnetcu.edu.

The author wishes to thank Larry Neal, Ann Carlos, Jean-Laurent Rosenthal, John Smail, Naomi Lamoreaux, Avner Greif, Lee Craig, Robert Garnett, and seminars at UCLA, Stanford, the Triangle Economic History Seminar inNorth Carolina, University of Colorado, and Royal Holloway College. The data collection for this article was made possible by the support of the Social Sciences Research Council and Texas Christian University. Special thanks to Philip Winterbottom and the Royal Bank of Scotland.

Israel, "Dutch Role," p. 124; and Morrill, "Sensible Revolution," p. 74. 2Jones, "War and Economy," p. 70.

593



594 Quinn

Weingast have argued that this was more than offset by a contrary dynamic: namely, that sovereign credibility greatly increased the overall supply of loanable funds, so that public and private finance could expand in tandem.3

While the growth of public finance in England could thus have worked either to the benefit or to the detriment of private debt, or both, this study will attempt to determine which effect was dominant. In the process, the testable implications of three distinct hypotheses will be clarified.4 If the primary effect of the institutional changes of the 1 690s was to make lenders substitute sovereign for private debt, then we would expect to see a negative supply shock in the private-sector market for loanable funds, leading to the familiar substitution effect of "crowding out." The rates on private debt would rise even as those on public debt fell. Alternatively, if the primary impact of a well-managed public debt was to increase the overall supply of funds to private borrowers, then the two rates should have fallen in tandem. This would be a positive supply shock, which we might well characterize as a "Golden Age of Saving." And thirdly, if the primary effect of fiscal stabili- zation was to bolster the private-sector demand for loanable funds, then both rates would rise. This would be a positive demand shock, reflecting a "Golden Age of Investing."

To test these different stories, I have collected rates of return on loans held by a London goldsmith-banker named Sir Francis Child.5 Child was the son of a clothier who rose from junior partner in 1671 to become one of the wealthiest men in England by the time of his death in 1713.6 With the Glori- ous Revolution he became politically well connected, thanks especially to his friendship and banking relationship with the new Lord Chamberlain. In 1 689 he was knighted and appointed jeweler to King William, and elected Lord Mayor of London in 1699.7 The data presented here were generated from Child's lending over the years 1680-1705. These observations provide the first time series of London-based private loan rates for the late seventeenth century.

Child's evidence tells us that government borrowing acted as a substitute for private debt during the war years, effectively crowding it out. Following the restoration of peace in 1697, average rates of return on private loans remained higher than they had been before 1688; this was especially pro- nounced with longer-term loans. Hence I reject the hypothesis that an in-

3North and Weingast, "Constitutions," pp. 804, 824-28; Neal, Rise, pp. 11-12; Roseveare, Finan- cial Revolution, pp. 47-51; Carruthers, City, p. 115-36; Carlos, Key, and Dupree, "Learning," p. 319; and Dickson's seminal Financial Revolution.

4 Dickson surveyed contemporary writings on the relationship between government and private rates and found them "neither rigorous nor free from confusion" (ibid., p. 479).

'Royal Bank of Scotland Archives, Child's Ledgers, vols. 6, 7, 10, and 11. 6 Hilton Price, Marygold, pp. 24-26; Grassby, Business Community, p. 357; and Healy, Coutts,

p. 108. 7 Samuel, "Sir Francis Child's Jewellery Business," p. 49; and Hilton Price, Marygold, p. 80.



Glorious Revolution 595

creased supply of loanable funds was the dominant result of the Glorious Revolution. The change in term structure supports the idea that the revolu- tionary settlement had stimulated demand for private borrowing. Such a demand shock suggests a different growth mechanism than has been the focus of recent articles. Another finding is that in the 1690s Child and his customers began to own government debt, East India Company bonds, and other corporate assets. Child held them in his own name; his customers used them as collateral. This evidence of advances in financial technique confirms that private-sector behavior was being altered by the revolution in public finance.

THE STAKES

The relationship between government credibility and private investment has been at the crux of a debate concerning the nature of England's pre- industrial development. North and Weingast portray the Glorious Revolution as a change in institutional structure that promoted fiscal responsibility.8 The key change was William placing himself within the rule of law and agreeing to fiscal oversight by Parliament. Henceforth the Crown's ordinary funding required annual Parliamentary reauthorization, along with some parliamentary assessment of needs and assignment of expenditures.9 The extraordinary funds needed to finance warfare required additional legislative action. As the balance of fiscal power shifted to the legislature, Parliament delivered to William unprecedented levels of funding for the Nine Years' War (1688- 1697).10 The irony is that William's constitutional fetters actually won him greater military power than his absolutist forebears had enjoyed.

War finance also required extensive borrowing. Here kings had to pay a risk premium commensurate with previous misbehavior. In Britain during the first half of the seventeenth century, forced loans and outright confisca- tion had been problems. Such outrages ended after the English Civil War and the beheading of Charles I at Parliament's behest in 1649.11 By the second half of the century the primary fear was default, as occurred in 1672 when Charles II ordered the "Stop of the Exchequer" and ruined a whole cohort of financiers.12 Because of this risk, lenders to the king demanded interest rates of 8 to 12 percent, at a time when private rates had a usury ceiling of 6 percent."3

'North and Weingast, "Constitutions." Their view of the Glorious Revolution forms part of the larger enterprise of explaining the role of institutions in economic history. For example, see Milgrom, North, and Weingast, "Role of Institutions"; and Greif "Reputation" and "Contract Enforceability.'

9 Roseveare, Financial Revolution, pp. 30-32. 10 Jones, War and Economy, pp. 95-106. " Ashton, Crown. 12 Horsefield, "'Stop of the Exchequer'." 13 Homer, History, p. 13 1.



596 Quinn

With the constitutional changes of the Glorious Revolution, government debt was transformed from the royal debt to the national debt, backed by both Crown and Parliament. The new constitutional arrangement caused a drop in government rates by reducing the likelihood of default. Within 50 years, government interest rates fell to 3 percent.14 P. G. M. Dickson has referred to this as the "Confidence Argument.""5 Parliament was viewed as less prone to default than the king because it included commercial interests that would be harmed by it. 16 Moreover, as a corporate body, Parliament had a longer time horizon than any individual king, which made reputation a more effective enforcement mechanism. Parliament's new role reduced the threat from regime change; indeed, each subsequent change of monarch became an opportunity for parliament to expand its power.17 The likelihood of the king attempting to renege on the entire constitutional arrangement was now considered low because the memories of forced abdication-not to mention regicide-had made credible Parliament's implicit threat to remove the king. "

Trust in Parliament permitted further developments that increased the attractions of government debt.19 Parliament offered new types of long- and short-term debt, and its ability to borrow from an expanded circle of people deepened the market and increased liquidity. A joint-stock bank had been discussed for decades, but it only became a reality-the Bank of England in this new environment.20 Because most of the Bank's assets were government debt, its stock became a new, transferable type of quasi-government debt. The East India Company, the Million Bank, and the South Sea Com- pany also absorbed large quantities of government debt.21 Less risk, new products, and greater liquidity formed a bundle of advances stemming from Parliament's new power.

Empirical demonstration that constitutional changes quickly reduced the interest rate on sovereign debt is problematic. War finance in the 1690s increased the government's demand for funds, which muddles measurement of the purely institutional impact. However, over the span of decades, government rates did fall. In 1694 the Bank of England was paid by the govern-

'4Ibid., p. 156. ' Dickson, Financial Revolution, pp. 475, 481-85. 16 Grassby, Business Community, pp. 223-25. 17 Roseveare, Financial Revolution; and Morrill, "Sensible Revolution." 18 Israel ("Dutch Role," p. 160) has argued that Parliament established the power over William only

after 1691, when the king switched focus from controlling Britain to the fight with Louis XIV in Flanders. However, William's bold grab of power aligned Whigs and Tories towards reducing monar- chical authority (ibid., p. 161).

19 This trend in credibility was bolstered by the introduction of sinking funds, improved tax collection, and the emergence of the Bank of England as the hub of government debt finance. See Dickson, Financial Revolution, p. 482; and Brewer, Sinews, pp. 88-134.

20 Clapham, Bank of England, pp. 13-23; and Horsefield, British Monetary Experiments, pp. 125-37. 21 Scott, Constitution and Finance, pp. 205, 275, 288-89.




ment at 8 percent. When the Bank's capital was expanded in 1707, the rate fell to 6 percent.22 In 1716 the rate fell further to 5 percent, and in 1742 to 3 percent. Downward trends in government rates are apparent in other forms of government debt as well.23

While it is clear that government rates declined over the early decades of the eighteenth century, evidence of the critical crossover effect on private- sector rates has been elusive. North and Weingast's optimistic story relies on the idea that improvements in govermnent credibility promoted private capital markets and encouraged economic growth.24 But, as they acknowl- edge, "the data from the first half of the eighteenth century, in contrast to those from the second half, are sketchy, and for the period prior to the Glori- ous Revolution, almost nonexistent."25 In the only major previous study of the early eighteenth century, Gregory Clark has calculated nearly 2,000 observations of rates of return on real property from 1540 to 1770.26 Finding no sudden decline in those rates, Clark concludes that the institutional changes of the Glorious Revolution did not reach the sphere of private investment.27 He argues that the constitutional settlement of 1688 had little impact because real property rights had been secured far earlier.28

Clark's real property, however, is not a good test of the proposition. Land's ability to generate rents to service debts was little affected by whether the king or Parliament defaulted on government debt. Also, trans- fers of real property were handled on a personal basis by lawyers and scriv- eners with well-established procedures and legal recourse.29 In contrast, one's ability to hold the king accountable for default was a sore question. Another problem was that the assets underlying Clark's sample were far removed from the London money market: about 80 percent of the properties were rural, the remainder divided among London, Bristol, Exeter, Norwich,

22 In the interim, however, the Bank had also gained monopolies over joint-stock banking and corporate note issue. These valuable concessions by Parliament would also have worked to reduce these interest rates.

23 Dickson, Financial Revolution, p. 471; and Pressnell, "Rate of Interest," pp. 179-80. Extending the story of declining government r-ates into the mid-eighteenth century is problematic also because the supply of new government debt fell during the 1720s and 1730s.

24 This connection was made as early as Pressnell, "Rate of Interest," p. 181. 25 North and Weingast, "Constitutions," p. 826. 26 Clark, "Political Foundations." The rates of return were reported by the Charity Commission. The

Commission ascertained whether charities in England and Wales were behaving in conformity with donors' wills.

27 Ibid., pp. 564, 577-80. In fact, Clark finds only the South Sea Bubble of 1720 to have had a large and statistically significant effect. The strong negative relationship between property rates and the wild events of 1720 suggests that the contracts under consideration were acting like fixed-return bonds. In the face of increasing asset prices in the bubble year, the rate of return fell by one percentage point.

28 ".England in the period prior to the Industrial Revolution cannot be cited as an example of the importance of political stability to economic development, contrary to institutionalists such as North, who seeks institutional explanations of growth and development"(ibid., p. 587).

29 Melton, Sir Robert Clayton.



598 Quinn

and York. In the seventeenth century, however, the finance of government debt was concentrated in London. The two did not become close substitutes until the mid-eighteenth century.30 Given these dissimilarities, the lack of response in the property rental market to the changes in government fmance neither proves nor refutes the North-Weingast confidence hypothesis.

HYPOTHESES AND IMIPLICATIONS

The battleground of this debate is the financial sector. The literature has agreed that the transmission of a positive political shock should inform private investment decisions through the medium of credit markets. The literature has also agreed on how the shock should be measured. North and Weingast hypothesize that private-sector interest rates should have fallen after the Glorious Revolution; Clark adopts the same standard to reject this hypothesis. What has not been addressed is the appropriateness of the hypothesis. Should private rates have dropped if the premium on government debt fell? The answer depends on whether government debt acted as a substitute or complement to private debt.3" Debts based on government revenue, personal property, or real property comprise different markets. The relationships among these markets must be considered when telling stories based on measurable outcomes such as interest rates.

If private debt and government debt are substitutes, then private rates should rise if government debt suddenly becomes more attractive. To see this in its simplest form, consider two markets: one for government debt, where the public supplies funds and the Treasury demands them; and one for private debt, where the public is both supplier and demander. To clarify the argument, assume that the only difference between the two markets is the government's higher chance of default. The risk premium on government debt creates a gap between the equilibrium rates in the two markets. This premium was positive during the seventeenth century.32 Figure 1 illustrates this situation. If the government's risk premium suddenly disappears, gov- emnment rates will fall and private rates will rise until the two rates are equal and all arbitrage opportunities vanish. This outcome is labeled the "convergence rate." If helpful, one can imagine the supply curve in the private market shifting back as investors transfer funds. Those investors become suppli- ers in the government market, shifting that supply curve out.33 This suggests

30 "Rent charges, for example, were steadily superseded by government perpetuities after 1727, since the latter were as secure as rent changes and much more liquid" (Clark, "Political Foundations," p. 575).

31 Ricardo thought that there was no relationship between govermment and private rates (Principles, p. 199).

32 Grassby, Business Community, pp. 241-42. 33 If the equivalent definition of a substitute in demand terms is preferred, as per textbook definitions

such as Varian's Intermediate Microeconomics (p. 111), the supply of loanable fumds may be transformed into the demand for investment assets. One must then also invert the rate of return to create the




Government Debt Market Private Debt Market Rate of Return Rate of Return

/S

....... X Convergence

D

Quantity Quantity

FIGURE 1 RATE CONVERGENCE WITH SUBSTITUTION

Source: See the text.

that the first effect of increased confidence in the government will be to raise private-sector rates and to reduce govenmment rates. The relative size of these adjusttnents will depend on the relative elasticities: the market with the less elastic combination of demand and supply will see more rate adjustment than the market more sensitive to changes in rates. Also, recall that the premise behind the converging rates of return in the two markets is that the products are perfect substitutes except for a risk premium. If the degree of substitution were less than perfect, we would see a larger drop in government rates and a smaller rise in private rates.

A central element of North and Weingast's optimistic story, however, is the claim that private lending was stimulated by the reduction of government default risk. Limited government meant less overall risk, which attracted new funds into the credit markets and, in turn, pushed all rates down.34 Instead of acting as a substitute, government debt complemented private debt. As Larry Neal suggests, government debt may well have become "an intermediate asset that reduced the cost of waiting for traders during the turnaround time necessary to make continued profits from either long-distance trade or long-term investments in the domestic economy."35 Such enhanced liquidity would have promoted saving and reduced private rates.

price of the asset. The story remains the same because the drop in risk can be viewed as a jump in the rate of return or as a drop in the asset price, since the two are inversely related.

3 Dickson notes that the supply of new funds was essential for the "Confidence Argument" to work (Financial Revolution, p. 480).

35 Neal, "Monetary and Financial Architecture," p. 21.



600 Quinn

Gains would also accrue to persons holding only private debt. Govern- ment defaults tended to spread through the banking system, threatening deposits and access to credit, so a more secure government debt had the effect of reducing systemic risk. With less chance of a panic, the public became more inclined to save and lenders more willing to adjust their port- folios towards private debt instead of precautionary cash. Less systemic risk may also have encouraged financial entrepreneurship. For example, as Ann Carlos, Jennifer Key, and Jill Dupree show, the trading of Royal Africa Company and Hudson's Bay Company stocks enjoyed remarkable upswings in the 1690s.36 Carlos, Key, and Dupree stress that the market for stocks existed before 1688 and did not arise "Phoenix-like from the ashes of the old regime,"37 and yet the pace of activity did accelerate after the constitutional changes. North and Weingast suggest similar developments in the market for bills of exchange; the growth of insurance is another example.38 In addition, a shared monarchy implied intemational complementarities: London was open to Amsterdam, and the Dutch were the major foreign investors for decades following the Glorious Revolution.39 And, as Bruce Carruthers argues, the constitutional changes prompted an increased willingness, among the politically minded, to supply fundds.40

Collectively, these stories give rise to the hypothesis that constitutional change increased the supply of loanable funds and reduced interest rates. But how quickly should we expect this chain of events to have occurred, given that each ofthe processes involved-deepening the financial markets, chan- neling foreign investment, and adjusting norms of behavior-required time? This study's coverage ends in 1705, when a new cycle of war spending began to dominate English fmance. If signs of complementarity had not emerged by 1705, then measuring their effects on interest rates would have been complicated by renewed war spending, which did not abate until the Peace of Utrecht in 1713.

We have two alternative hypotheses to explain why private rates might not fall, or might even increase. One argues that government debt acted as a substitute, crowding out private debt; another claims that the revolution in public finance directly stimulated investment demand. The latter envisions political and financial changes causing a shift in the demand for private borrowing, so that private rates rose independently of changes in government rates. The reasoning is similar to a real business cycle model in which expectations of higher future growth cause an immediate increase in the demand for funds, on the expectation that a future abundance of money will

36 Carlos, Key, and Dupree, "Learning," pp. 327, 336. 37 Ibid., p. 319. 38 North and Weingast, "Constitutions," pp. 826-27; and Roseveare, Financial Revolution, p. 69. 39 Dickson, Financial Revolution, pp. 304-37. 40 Carruthers, City, p. 117.




make loans easier to repay.4" This increase in demand causes private rates to rise and the quantity of borrowing to increase.

Other authors have found indications of a pick-up in investment demand around the turn of the eighteenth century. Julian Hoppit finds that bankrupt- cies were more numerous in the five years after 1700 than during the 1690s.42 This trend could support a demand-shock story, because business failures were positively correlated with the level of business activity.43 Such a story is also implied by Carlos, Key, and Dupree's evidence on the growth of stock trading." A boom in the international sector was not apparent, however. For example, new ship construction slowed greatly after 1697, and exports and reexports slowed after 1689.45 Such evidence must, of course, be disentangled from war-related constraints on trade before any conclusions can drawn. In sum, the challenge for a new demand-side story is to show how the increased security of government fmance could stimulate entrepre- neurial activity in ways other than decreased capital costs.

One potential measure of increased expectations of future growth is changes in the term structure. The spread between rates of different durations has been found to have predictive power regarding future growth.46 An increase in the spread (defined as long-term rates minus short-term rates) indicates expectations of future growth, which in the case of the Glorious Revolution would support the demand-side story. In terms of Child's portfolio, this shock would have stayed at the long end of the term structure since Child's loans to individuals, like those of most bankers, were nonmarket- able. In contrast, govermnent debt was marketable, so arbitrage would have evened the shock of crowding-out over the term structure of government debt, and then over the term structure of private debt. The ability of changes in the term structure to indicate a demand shift instead of crowding out, however, depends on evidence of effective arbitrage behavior. Late- seventeenth-century government debt was usually one year or more in duration. Absent the ability to sell government debt, increased government borrowing would affect private borrowing of similar length and result in an increase in the spread between long- and short-term private loans.

To step back from annual variation, the rates of return presented below are measured as averages spanning eight to ten years. Period 1 (1 680-1 689) represents the era before the revolution in public finance. Period 2 (1690-1697) comprises the war years during which government debt grew

41 Plosser and Rouwenhorst, "Intemational Term Structures." 42 Hoppit, Risk, pp. 182-83. Bankruptcy levels were much higher still from 1706 to 1710. " Ibid., pp. 176-81. 4 Carlos, Key, and Dupree, "Leaming." "4 Davis, Rise, pp. 22-23. 4 Estrella and Hardouvelis, "Term Structure"; and Dotsey, "Predictive Content."



602 Quinn

rapidly. Period 3 includes the postwar years 1698-1705.47 Inflation was not a concern in interpreting the long-term rates, as the general price level fluc- tuated around a constant mean from 1630 to 1760.48 Given the inadequacies of existing price series over short periods, all rates in this study are reported in nominal terms.

The observed reduction in the premium on government debt over these three periods allows us to gauge several relationships between the public and private financial markets. As the attractiveness of government debt grew, government rates should have fallen and the quantity of lending in the government market should have increased. The timing of this basic result is masked, of course, by the large increase in the government's demand for funds during the war years 1690-1697. Evidence of a decline in government rates relative to private rates would therefore have been delayed until after the end of hostilities. This second period also saw a price spike and a liquidity crunch, so these nominal values included a cash and a short-term inflation premium. The key test is therefore to compare the pre- and postwar periods. If private rates fell in the postwar period, then the hypothesis of a positive supply shock is affirmed. But if private rates rose, then the alternative hypotheses (a negative supply shock, or a positive demand shock) pre- vail. Table 1 summarizes these possibilities. An increase in private debt and spread would support the demand-shock story. A decrease in private debt would support the substitution story and, to the degree that arbitrage worked in the market for government debt, reduce the expected impact of "crowding out" on the spread for private debt.

TESTS AND DISCUSSION

To ascertain what did happen to rates during the 1690s, I have encoded Sir Francis Child's lending records for the years 1680 to 1705.49 Child was a goldsmith-banker located on Fleet Street in London's West End, offering services ranging from retail jewelry to demand accounts and lending.50 He extended credit to more than 800 customers;51 about 60 percent of those transactions were recorded in his "Pawn Account."52 (The remaining 40

47 The War of Spanish Succession did break out in late 1703, but had a limited financial effect in its early years.

48Phelps Brown and Hopkins, "Seven Centuries," p. 188. 49Child, Ledgers. 50A bank by the name Child's and Co. is still at the location, but it is now owned by the Royal Bank

of Scotland. 51 The sample had 847 different borrowers; however, names were often incomplete or had different

spellings, so the number should be taken with some latitude. Because Child was a West End banker, many of his borrowers were aristocrats such as Lord Cholmondeley and Lady Russell. Others were merchants, and still others were members of the City's monied interests, such as Henry Ferne and William Shepherd. Child's largest debtor, after the government, was the East India Company.

52 This figure was derived from Child's "Casting Up" accounts (Quinn, "Tallies," p. 48).




TABLE 1 PREDICTED IMPACT OF THE "GLORIOUS REVOLUTION" ON PRIVATE-SECTOR

FINANCIAL VARIABLES, BY HYPOTHESIS

Positive Supply Shock Positive Demand Shock ("Golden Age Negative Supply Shock ("Golden Age

Variable of Saving") ("Crowding Out") of Investing") Interest Rates Decrease Increase Increase Spread No change* No change* Increase Quantity of Lending Increase Decrease Increase * Assuming effective arbitrage of government debt. Note: This table assumes a reduction in the risk of government debt. Source: See the text.

percent were overdrafts on deposit accounts scattered about numerous ledgers, which have not been reconstructed.) The Pawn Account began in 1680 when Child took over as senior partner, and ran on into the twentieth century following the long life of Child's Bank. Child recorded assets and liabilities separately but did not use double-entry accounting.53 The transacting party was usually named, so most loans and repayments can be matched. I was able to reconstruct 2,439 loans. Most of the records for the year 1690 were missing, so I was unable to reconstruct most of the loans that originated or were concluded in that year. Child's records provide far more observations for this period then have been published to date. Also, since he lent to both the government and private individuals, his records provide observations in both markets."4

Child did not record the contracted interest rates on individual loans, but we are able to calculate the actual rate of return on each loan. Table 2 reports the size, length, and average rate of return for all loans for each of the three periods. The size and timing of installments could vary widely for a loan repaid in parts, so loan length has been calculated as the average length of each installment period, weighted by the value of the installment. Based on these three broad periods, loan rates appear to have been higher after 1690 than before. These raw figures work against the hypothesis that an

" Child's practice conforms to what Richard Grassby has called the "household stage" of accounting, which sought to establish a record rather than to facilitate fiscal analysis (Business Community, pp. 188-89).

5 Child's government debt mostly took the form of "tallies," or anticipations on future tax revenue. The nature of these anticipations did not change while Child held them, so their rates reflected the general pricing of government debt rather than particular effects such as new instruments or forms of transfer (Chandaman, English Public Revenue, pp. 281-3 02). Child did hold a few of the new government debt instruments, including lottery tickets and Exchequer bills, but not enough to support broad conclusions. Moreover, his focus on old instruments may reflect a banker's comparative advantage in holding less liquid assets. After 1698 the East India Company itself became a large holder of government debt, so shares in the company and the company's bonds became a mix of the two markets (Roseveare, Financial Revolution, p. 44; the same situation applied to Bank of England stock and debt). Child's account, however, shows no record of him holding stock, although some of his customers used stock as collateral.



604 Quinn

TABLE 2

SUMMARY

CHARACTERISTICS

OF

FRANCIS

CHILD'S

LOANS,

BY

TYPE

AND

PERIOD

Loans to

Individuals

Interest-Bearing

Type of

Collateral

Directly

Held

Government

and

Corporate

Debt

All

Personal

Government

and

None

Non-Interest-

Government

East

India

Lottery

Bank of

Loans

Total

Pawna

Pledgesb

Corporate

Debt'

Specified

Bearing

Debtd

Company

Bonds

Tickets

England

Notes

Period 1:

1680-1689

Mean

Rate of

Return (m )

4.55

6.10

7.42

5.73

4.71

5.60

0.00

7.04

4.70

Observations

800

587

162

15

2

408

204

7

2

0

0

Mean

Principal

?686

?631

?306

?644

?602

?759

?742

?3,357

?1,895

Mean

Length in

Days

424

416

532

330

90

375

461

73

127

Percentage of

Loans

73.4

20.3

1.9

0.3

51.0

25.5

0.9

0.3

Percentage of

Principal

67.4

9.0

1.8

0.2

56.4

27.6

4.3

0.7

Period 2:

1690-1697

Mean

Rate of

Return

(%)

7.53

7.32

6.62

8.38

9.83

7.63

0.00

13.24

27.70

6.14

Observations

752

358

160

34

12

152

164

226

0

1

3

Mean

Principal

?747

?514

?329

?475

?1,218

?662

?400

?1,325

?59

?5,382

Mean

Length in

Days

344

518

610

432

195

467

243

141

307

332

Percentage of

Loans

47.6

21.3

4.5

1.6

20.2

21.8

30.1

0.1

0.4

Percentage of

Principal

32.8

9.4

2.9

2.6

17.9

11.7

53.3

0.0

2.9

Period 3:

1698-1705

Mean

Rate of

Retumrn

()

6.44

6.93

5.93

5.98

6.33

8.70

0.00

6.70

8.31

16.25

6.38

Observations

887

529

126

72

166

165

86

206

50

15

1

Mean

Principal

?1,096

?1,006

?804

?561

?1,472

?887

?520

?1,344

?2,019

?896

?1,309

Mean

Length in

Days

246

305

332

466

208

312

138

160

149

297

283

Percentage of

Loans

59.6

14.2

8.1

18.7

18.6

9.7

23.2

5.6

1.7

0.1

Percentage of

Principal

54.8

10.4

4.2

25.1

15.1

4.6

28.5

10.4

1.4

0.1

a

Plate,

jewels,

and

other

personal

property. b

Personal

bonds,

notes,

bills of

exchange,

and

mortgages. c

Anticipations on

government

revenue

(tallies),

Exchequer

bills,

East

India

Company

bonds,

lottery

tickets,

and

Bank of

England

stock. d

Anticipations on

government

revenue

(tallies),

and

Exchequer

bills.

Source:

Ledgers of Sir

Francis

Child,

Volumes 6, 7,

10,

and 11.

See

also

the

text.




increase in the supply of private lending reduced rates. However, simple totals do not control for a number of factors that could explain changes in rates of return. For example, the length of loans decreased over time, while the size of loans increased. The loan descriptions in the ledgers also reveal that some loans were purchases of debt of corporate entities such as the government, the East India Company, or the Bank of England. Many private loans carried collateral such as pawned silver, personal bonds, or government lottery tickets. And many borrowers had repeated dealings with Child, which also could have affected the rate of return.

To describe some of these loan characteristics, Table 2 classifies the loans by type of debtor. The primary distinction is between loans made to individuals and loans made by means of acquiring government and corporate debt. Taken together, returns on interest-bearing loans to individuals were 6.9 percent in Period 3, versus 6.1 percent in Period 1. These personal loans are further broken down into four types of backing: pawns of personal property (silver plate, gold, jewels, and so on), personal financial instruments (bonds, notes, bills, and so on), corporate financial instruments (government debt, East India Company bonds, and so on), and no stated collateral. This reveals that Child expanded the use of financial assets as collateral in Periods 2 and 3. After the war, loans secured by government and corporate debt rose from near zero to almost one-fifth of Child's total lending. Moreover these loans were large, with an average principal of ?1,472 in Period 3. In contrast, the use of unsecured loans was more than halved after the 1680s. This transformation demonstrates that, alongside the famous changes in public finance, a revolution in private finance had occurred.

In the 1690s Child began to hold government debt and corporate securities directly. These instruments had been available in earlier decades, but the dramatic changes in public finance were expanding the range of individuals who actually held them. Government debt became an enormously important investment option for Child. During the war, one-half of his lent principal went into government debt. After the war this portion remained a quarter of all lent principal. That a banker might become a significant player in the market for public debt without being a member of a major revenue syndicate was a break with prewar practice. Child's holding of government debt as a stand-alone investnent was part of the deepening of the market for public debt. Child was also beginning to invest directly in corporate debt: in the postwar period, East India Company bonds emerged to comprise one-tenth of his lent principal. Malt lottery tickets and 6- percent Bank of England specie notes were further examples of the spread of new assets.55 All this supports the argument that bankers, merchants, and other monied people were discovering new uses for financial instruments.56

" The malt lottery tickets were created in April 1697 to be repaid out of a sixpence-per-bushel excise on malt (Dickson, Financial Revolution, p. 49).

56 Carlos, Key, and Dupree, "Learning"; and Neal, "Monetary and Financial Architecture."



606 Quinn

The war years of Period 2 witnessed a large risk premium, of around 6 percentage points, on government debt. The gap was largest during the monetary crisis of 1696-1697. In those years, the English monetary stock was recoined, producing a devastating liquidity crunch and leading to a suspension of payments by the Bank of England in 1 696.57 These rates are in keeping with those estimated in other studies.58 In the years after the war, however, the gap between private and public rates disappeared. In- deed, private debt may have begun to carry a risk premium relative to government debt.

To explore further the nature of loans, regression analysis may be used to estimate the impact of the many variables in play (Table 3). The length and principal of the loans are the key continuous variables. Both are measured in log form, so that the importance of an additional pound or an additional day decreases as loans increase in size or duration. To gain more flexibility in estimating the term structure, a squared loan-length variable is also used.59 Since a squared term grows exponentially, this specification affects the estimated rate on longer loans. All these variables are multiplied by binary (dummy) variables for each period to allow the estimation of distinct term structures. Most of the remaining variables are qualitative, and serve to control for collateral and the nature of the borrower.

An additional consideration is that about 19 percent of Child's loans reported no interest at all. The records of another goldsmith-banker, James Hoare, reveal a similarly large number of non-interest-bearing loans.60 Al- though the ledgers do not explain the nature of these loans, the differences between them and other loans are telling. Table 4 shows that Child's non- interest-bearing loans averaged smaller values and shorter durations. Twenty-eight percent of his non-interest-bearing loans had a length of 30 days or less, compared to just 12 percent of interest-bearing loans. These short lengths suggest discounting-that is, the deduction of interest from principal on the loan's inception.61 Because the initial principal was over- reported, no interest appeared when the loan was repaid. For example, the discounting of bills of exchange, an instrument used for international payments, was common in this period. Such a loan would typically take this form to conceal usurious interest rates of over 6 percent.

57 Clapham,BankofEngland, pp.36-37;Horsefield,BritishMonetaryExperiments,p. 133; and Li, Great Recoinage, pp. 135-40.

58 Roseveare, Financial Revolution, p. 35. 59 The length is not logged before or after being squared because doing so created substantial multi-

collinearity. 60Hoare's Bank Archives, Ledger 1, 1677-1685, Hoare's Bank. 61 It appears unlikely the loans were no-interest arrangements like modem credit cards, because Child

received no fee for providing means of payment, and because the credits were not created at the site of consumer expenditure.




TABLE 3 DEFIMT[ONS OF RELEVANT VARIABLES

TIME

Period 1 1 for years 1680-1689 (inclusive); otherwise 0. Period 2 1 for years 1690-1697 (inclusive); otherwise 0. Period 3 1 for years 1698-1705 (inclusive); otherwise 0.

TERM AND PRINCIPAL

Length Log duration of the loan (in days), using the average of each installments weighted by value.

Principal Log of the loan's principal (in pounds).

OTHER LOAN CHARACTERISTICS

Government 1 for direct investment in government debt; otherwise 0. Posted 1 if the loan was closed by having the principal posted to another

account; otherwise 0. Disposed 1 if the loan was closed by having the pawned collateral liquidated;

otherwise 0. Malt tickets 1 if a direct investment in malt lottery tickets; otherwise 0. Bank of England notes 1 if a direct investment in Bank of England specie notes; otherwise 0. Pawn 1 if a personal loan including a stated collateral of silver, gold, jewels,

foreign coin, watches, etc.; otherwise 0. Personalpledges 1 if a personal loan including a stated collateral of private fmancial

security: bond, note, bill, mortgage, etc.; otherwise 0. Corporate security 1 if a personal loan including a stated collateral of corporate financial

security: government debt, East India stock or bond, malt ticket, etc.; otherwise 0.

Any discounts 1 if an interest-bearing loans to an individual who received at least one zero-interest loan; otherwise 0.

Loans The number of loans made to the borrower. Corporate and government borrowers are excluded.

Previous loans The number of loans to the borrower up to that date. For example, the second loan to an individual would be equal to 1. The East India Company and the government are excluded, because they are captured by their own qualitative variables.

Repayments Number of repayments in completing the loan.

Source: Same as Table 2.

Other non-interest-bearing loans were of long duration. Some of these were likely nonperforming loans that Child had written off without com- ment. Table 4 captures the dichotomous nature ofthese non-interest-bearing loans, in that it reports higher Gini coefficients on length and size than for interest-bearing ones.

Regressions were estimated on two versions of the data set (Table 5).62

Regression 1 excludes observations with a zero rate of return; in Re-

62 A number of variables could be set to zero without significantly altering the results. A Wald test fails to reject the null (F-statistic = 0.483596, Probability = 0.925385) that the restricted model is statistically different from Colunm 1 when the coefficients Length in Period 3, Length squared in Period 1, Length squared in Period 2, Principal in Period 3, Government Length squared in Period 2, Bank ofEngland notes, Pawn, Previous loans, Loans, Any discounts, Repayments in Period 2, and Repayments in Period 3 are set equal to zero. Indeed, most control variables relating to type of collateral had no significance, whereas term and principal were very important.



608 Quinn

TABLE 4 SUMMARY STATISTICS ON :NTEREST-BEARING AND NON-INTEREST-BEARING

LOANS

Non-Interest-Bearing Interest-Bearing

Observations 454 1,985 Mean length in days 321 338 Median length in days 74.5 157 Mean principal ?575 ?918 Median principal ?100 ?400

Gini coefficient on days to repayment 0.76 0.63 Gini coefficient on principal 0.79 0.66

Source: Same as Table 2.

gression 2 it is assumed that "non-interest-bearing" loans in fact carried a rate of 7 percent, just above the usury limit. The two regressions agree in terms of scale and direction of change, so together they estimate a reason- able range. fficients andp-values-the probability that the coefficient cannot be distinguished from zero-are reported. The coefficients on the log variables provide estimates of elasticities. For instance, this means that a 1 0 percent increase in the principal during Period 1 would lower the rate of return by 0.635 percent.

The regressions confirm that private rates did rise after the war. To capture these results in a straightforward way, Table 6 contrasts two sce- narios: a one-month loan for ?1 00 versus a one-year loan for ?1,000. Re- payment occurs in one installment. All other qualities except for time period are set to zero. A one-month loan in Period 3 (after the war) shows little or no increase in rate of return relative to an identical loan from Pe- riod 1. Rates on these short-term loans do, however, show a jump upwards during the war years of Period 2, as would be expected. In contrast, the rates on a ?1,000 loan lasting one year rise by about 1.5 percentage points during and after the war.

The regressions also confirm that government rates fell after the war. Table 7 reports the difference between government and private rates. In Period 3, the risk premium on government debt disappears, and even becomes a small discount. This convergence seems to occur more quickly than previously supposed, suggesting that confidence in the new constitutional regime solidified soon after 1697.64

Since these results lead us to rule out a positive supply shock, the spread between long- and short-term loans can be used to sort the remaining alter- natives. Indeed, the difference between the prewar and postwar periods

63 The regression results using the non-interest-bearing observations valued at zero produced implau- sibly low rates and have not been reported.

" Dickson, Financial Revolution, p. 473; and Pressnell, "Rate of Interest," p. 179.




TABLE 5 DETERMINANTS OF INTEREST RATES ON CHILD'S LOAN PORTFOLIO

(dependent variable = log rate of return)

(1) (2) All Loans, with Non-

Interest-Bearing Interest-Bearing Loans Loans Only Set to 7 Percent: (N= 1,985) (N= 2,439)

Variable Coefficient p-value Coefficient p-value

Constant -2.651513 0.00 -2.653738 0.00 Period 1 0.540913 0.00 0.337698 0.01 Period 2 0.686625 0.00 0.377703 0.01 Length in Period Ia -0.115591 0.00 -0.08238 0.00 Length in Period 2 b -0.127497 0.00 -0.082438 0.00 Length in Period 3 c -0.022154 0.17 -0.022757 0.10 Length squared in Period I d -1.74E-09 0.91 1.35E-08 0.07 Length squared in Period 2 e 1.19E-08 0.39 -1.67E-10 0.99 Length squared in Period 3 f -5.58E-08 0.05 -5.2E-08 0.04 Principal in Period I H -0.063508 0.00 -0.046268 0.00 Principal in Period 2 h -0.042247 0.01 -0.032024 0.01 Principal in Period 3' -0.006646 0.62 -0.008044 0.49 Government in Period 2 0.594233 0.00 0.539981 0.00 Government in Period 3 k -0.077277 0.51 0.139904 0.19 Government length squared in Period 2' 2.47E-07 0.59 8.15E-08 0.84 Government length squared in Period 3 5.22E-07 0.00 5.15E-07 0.00 Posted -0.623248 0.00 0.021395 0.79 Disposed -0.82523 0.00 -0.439815 0.00 Malt tickets 0.729997 0.00 0.644677 0.00 Bank ofEngland notes 0.206783 0.41 0.206397 0.38 Pawn -0.004893 0.87 -0.00657 0.79 Personalpledges 0.060243 0.23 0.06853 0.10 Corporate security -0.006936 0.88 0.001753 0.97 Any discounts 0.017786 0.53 0.089167 0.00 Loans -0.000455 0.11 -0.000397 0.11 Previous loans 0.00053 0.16 0.00049 0.16 Repayments in Period 1 n 0.050597 0.01 0.01766 0.28 Repayments in Period 2 ? 0.001973 0.94 -0.004572 0.83 Repayments in Period 3 P 0.002219 0.90 0.000803 0.96 Adjusted R2 0.221544 0.17649 Prob (F-statistic) 0 0

'Length - Period 1; 'Principal * Period 3; b Length * Period 2; i Government - Period 2; C Length * Period 3; k Government * Period 3; d Length 2 Period 1; 'Government - Length 2 - Period 2;

Length 2 * Period 2; m Government * Length 2 * Period 3; f Length 2 * Period 3; n Repayments * Period 1; g Principal - Period 1; 'Repayments Period 2; h Principal - Period 2; P Repayments * Period 3. Source: See the text.



610 Quinn

TABLE 6

ESTIMATED PRIVATE RATES OF RETURN, BY TERM, PRINCIPAL, PERIOD, AND REGRESSION SPECIFICATION

(percentages, annualized)

Per Regression (1) Per Regression (2)

30-day, ?100 principal Period 1 (1680-89) 6.4 6.1 Period 2 (1690-97) 7.5 6.7 Period 3 (1698-1705) 6.4 6.3

One-year, ?1,000 principal Period 1 (1680-89) 4.2 4.5 Period 2 (1690-97) 4.9 5.0 Period 3 (1698-1705) 5.9 5.8

Notes: Private rates are derived from the regression equations estimated in Table 5. Source: Table 5.

stems from a change in the term structure. Compared to the 1 680s, the war brought an upward shift in the term structure. To illustrate, Figure 2 shows the estimated term structure of rates of return for a ?1,000 loan in each of the three periods. The spread did not change between Periods 1 and 2, but rates rose across the board, suggesting the sort of crowding out that might be expected during a transition from peace to war. The even distribution of the shift suggests effective arbitrage between government debt of different durations-in its absence, pressure would have focused on long-term rates-and the details of Child's lending evince just this sort of behavior. Child often purchased government debt on the second- ary market and held it for only a portion of its life: on average, for five months (see Table 2).

In contrast, between Periods 2 and 3, the spread decreased substantially. Figure 2 shows that the rate of return on loans of two months or less fell after the war, while the rate on longer loans increased further. The spread on government debt converged even more. These results suggest that the demand-shock story came into its own once war finance had slackened and the viability of the new constitutional regime was established. John Wells

TABLE 7 ESTIMATED PREMIUM ON GOVERNMENT DEBT, BY PERIOD AND REGRESSION

SPECIFICATION (Government rate less private rate, annualized percentages)

Per Regression (1) Per Regression (2)

Period 2 (1690-1697) 4.0 3.6 Period3 (1698-1705) -0.4 -0.8

Notes: Rates derived from the regression equations estimated in Table 5, assuming a one-year, ?1,000 loan. Source: Table 5.




8%

7%

6% erd3198-1705)

r 5%

4% Period 1 (16801689)

3%

0 1 2 3 4

Duration (years)

FIGURE 2 ESTIMATED TERM STRUCTURES OF CH]LD'S INDIVIDUAL LOANS

Notes: Based on data derived from the regression results in Table 5, assuming a ?1,000 loan. Source: See the text.

and Douglas Wills also find that the end of the Nine Years' War was a major boost to investor confidence.65

A complication for the demand-shock story, however, is that the length of Child's private loans fell after the war (see Table 2). The average length of loans backed by government or corporate assets did increase slightly after the war, but these were of shorter average duration than other loans to begin with. The median values show the same trend. An exception was loans backed by personal pledges which saw an increased mean length. But their median fell from 173 days in Period 1 to 79 in Period 3, indicating that the majority of these loans were shortening also. For Child, higher long-term rates were not matched by more long-term private lending.

One final measure remains to be considered. Figure 3 plots the total value of Child's loans by year, broken down into government debt, private debt with interest, and private debt without interest. The arrival of government debt after the Revolution was a striking change, as was the slump in private lending during the war years. Missing ledger folios account for the paucity of lending in 1690; and 1696 saw little lending due to the recoinage crisis. With the return to peace after 1697, private lending recovered. All told,

65 Wells and Wills, "Revolution," p. 434.



612 Quinn

E Govemmant 200,000 M* Im-Baring

ONon-Jnfl-Beorn

150,000

0

zM 1ia 334 104 san is 1632 1s 1on IM 170 r7m 1704

FIGURE 3 CHILD'S TOTAL LENDING, 1680-1705

Source: See the text.

Child seems to have squeezed private lending during the war and expanded it again thereafter. Thus his activity during the war years supports the crowding-out hypothesis, but after the war it suggests an increased demand for funds.

Combining the available measures for the private-debt market, crowding out during the Nine Years' War appears to have been followed by a demand shock in the period following. Higher private rates during and after the war rule out a supply shock. The increased spread after the war supports the demand-shock hypothesis, especially because the spread did not change under pressure of high govenment borrowing during the war. While the reduction in the length of his loans raises questions about the mechanism by which expectations of future growth may have translated into greater borrowing, he did increase his total volume of lending after the war.

CONCLUSION

Given the paucity of data from the late seventeenth century, Francis Child's lending records contribute greatly to our understanding of what occurred in those critical years. Four findings stand out: the risk premium on government debt disappeared quickly after the Nine Years' War ended




in 1697; private rates were higher after the war than before; the spread between long rates and short rates increased after the war; and the banking system adopted government debt both as a direct investment and as a form of collateral. In effect, political changes altered private lending behavior but did not lower private interest rates.66 These results suggest the opera- tion of two processes that are conceptually and chronologically distinct. During the war years, government debt may have acted as a substitute for private debt, thereby crowding the latter out. After the war, improved expectations may have stimulated private borrowing. The increase in the spread between long and short rates indicates that the Glorious Revolution may have bolstered demand for loanable funds, rather than supply, as emphasized in the literature.

The idea that limited, representative government secures property rights and stimulates investment continues to be an attractive one; and the revi- sions offered here do not challenge this principle, even if they do suggest a different path of causation. Child's records show that the mechanics of private debt were transformed by the dual revolutions in England's systems of constitutional power and public finance. Bankers and their customers began to use the improved financial instruments of the government to facilitate private lending. Child's experience also suggests a growth mechanism that transmitted optimism directly to investors, instead of coaxing more private activity through reduced interest rates. Still, crowding out remained a problem. So the English story cannot escape the irony that political up- heaval can both foster and stifle economic growth.

66 Pressnell has concluded private and government rates rarely moved together over the eighteenth century ("Rate of Interest," pp. 206-07). That question, however, has continued to require sufficient data to test quantitatively.

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the glorious revolution's effect on english private finance: a microhistory, 1680-1705

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