III'5 Global Financing: An Historical Overview

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III.5 Global FinancingAn Historical Overview

• International Finance
• Prof. David S. Bates
• Lecture 24

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Finance studies how household savings are
transmuted into (hopefully) productive
investments, in a risky world with uncertain
payoffs.
Firm
Equity
Banks
Bonds
Household

• corporate viewpoint (corporate finance)
• household viewpoint (investments)

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International finance the household and the
firm need not be of the same nationality
Domestic Firms
Foreign Firms
Domestic Households
Foreign Households
International capital flows
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International Capital Flows

• Historically, large borrowers have often resorted
  to foreign financing
• Methods
• Foreign bank loans
• Equity-financedforeign direct investment
• Foreign bonds
• Foreign equity

• Beginning in
• Middle Ages
• 16th century (joint-stock companies)
• 19th century
• Late 20th century

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Middle Ages

• Governments borrowed from large mercantile
  establishments/banks
• Source of capital deposits, and retained
  earnings
• 14th century King Edward III of England
  defaulted on loans from the Bardo and Peruzzi
  banks in Florence

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16th century Joint-stock companies

• England, Netherlands Permitted broad investor
  participation (and risk-sharing) in highly
  speculative foreign trade ventures
• Muscovy Company
• East India Company
• South Seas Company
• Equity-like payoffs
• Initially set up roughly as partnerships, with
  obligations to make up firms losses.
  Limited-liability not legal until 1840s.

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19th century bonds

• Bond-financed government budget deficits
• E.g., Rothschild banks underwrote British,
  French, governments.
• Bonds sold mostly to domestic investors but also
  to British investors
• Bond-financed capital expenditures of the
  Industrial Revolution
• Canals, railroads,
• United Kingdom led the Industrial Revolution.
• Substantial current account surplusses
• Major capital exporter to the rest of the world.

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International Capital Flows 1830-40
Britain
Europe
United States
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International Capital Flows 1880-1913
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United States
Britain
Europe
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20
COMMONWEALTH (esp. Canada, Australia)
Latin America
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British Foreign Investments

• Scale of Investments
• 1880 200 million pounds invested overseas
• 1913 4 billion pounds (20 billion)
• 25 of British national wealth
• Structure of investments
• 70 social overhead capital (railroads, harbors,
  bridges, power stations, etc.)
• Mostly bonds held by British investors (portfolio
  investment)
• Some defaults, but overall returns were
  comparable to domestic bond returns

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International Capital Flows 1880-1913
Russia
Germ.
France
Balkans
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French, German Foreign Investments

• Governments encouraged private investment in
  countries that were political allies
• France
• 1900 25 of foreign investment (20 bln FF, or
  4 bln) was in Russia -- mostly railway bonds
• Russian defaulted after 1917
• Invested in Balkans (e.g., Serbia, Greece)
• Also defaulted post-WWI
• Overall, France lost 2/3 of foreign bond holdings
• Germany also invested in the Balkans (Ottoman
  Empire) with subsequent losses

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United States

• Pre-World War I major net debtor
• Current account deficit 10 of GDP, financed by
  British capital inflows
• WWI large c/a surpluses
• Post-WWI major net creditor
• C/a surpluses, and capital outflows
• New York a major financial center in 1920s
• 1919 65 foreign capital issues, raising 771 mln
• 1922 152 issues
• 1927 265 issues, raising 1.8 bln (2 US GDP)

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International Capital Flows 1920s
U.S.
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Post-WWI war debts and reparations
Britain
reparations
France
War debt
U.S. investments
Germany
United States
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1930s

• Worldwide recession, and widespread defaults on
  overseas obligations due to
• bankruptcy of borrowers (Bolivia 12/30 Peru,
  Chile, Brazil, Uruguay, Central American
  republics)
• Repudiation by new nationalistic governments
• Germany, Italy, Eastern Europe
• Few defaults outside Europe Latin America
• Bolivia, Chile, Columbia Peru ultimately repaid
  52-85 of debt

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Post-WWII 1945 - 1980

• Many types of capital outflows from U.S
• Government capital flows (Marshall Plan)
• Equity-financed U.S. direct investment abroad
• Foreign bonds floated in New York
• 1960s and 70s substantial bank lending to
  developing countries
• 1982 LDC debt crisis
• Development of equity-based international capital
  flows (country funds, ADRs, )

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Post-WWII 1980 - present

• Since 1980, U.S. capital outflows have been more
  than offset by capital inflows
• Foreign portfolio investment in U.S. stocks,
  bonds, real estate
• Direct investment by foreign companies
• Purchases of U.S. bonds by foreign central banks
  (China, Japan, )