Death of a Reserve Currency

Stephen Quinn, Texas Christian University

William Roberds, Federal Reserve Bank of
Atlanta*
Asian Development Bank Institute
July 29, 2015
The views expressed in this presentation are the views of the author and do not necessarily reflect the views or
policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or
the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and
accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with
ADB official terms.

Motivation
Unconventional policies can create problems
for central banks.
Literature: critical point occurs when a CBs
net worth < 0 (policy bankruptcy).
net worth = equity + franchise value.

We verify this for a historically important

central bank, Bank of Amsterdam
(Amsterdamsche Wisselbank).
1

Why Bank of Amsterdam?

The Banks ledger money (bank florin or bank
guilder) was a dominant European currency
1680-1780.
Amsterdam was a top financial center built on
merchant banks (like modern shadow banks).
acceptance credit (commercial paper).

Bank florin collapsed 1781-1795.

A rare observation: reserve currencies do
not often fail.
2

Conclusionspreview
The Bank did not have the capacity to withstand
non performance of loans to a bankrupt GSE
(Dutch East India Company).

Market abandonment of the bank florin was

rapid and persistent.
Other policy actions by the Bank & City of
Amsterdam contributed to this weakness.
3

Research methodology
Reconstruct the balance sheets of the Bank
1775-1791 (17,000 transactions) to see when
1. markets lost faith in the Bank, and
2. the Bank lost its potential to recover without
recapitalization.

Relevant literature
History of Bank of Amsterdam: Mees 1838,
Van Dillen 1925, 1934, 1964, Dehing 2012.
CB accounting: Fry 1993, Stella 1997, Ize
2005, Stella 2005, Buiter 2008, Klh &
Stella 2008, Archer & Moser-Boehm 2013.
As applied to Fed: Stella 2009, Carpenter et
al. 2013, Hall & Reis 2013, Del Negro &
Sims 2014, Greenlaw et al. 2014.

Outline
1. Institutions
2. The Bank before 1780
3. Crisis 1780-1783 & policy
insolvency
4. Conclusion

The Dutch East India Company (VOC)

Chartered 1602.
First corporation with publicly traded stock.
Monopoly on much European trade with Asia
(>50% markup).
Annual revenue 10% of Dutch GDP during our
sample.
30,000 employees in Asia (12 in Dejima).
Labor market impact: about one-third of
employees sent to Asia did not return.
Company dissolved in 1799.
7

The Bank of Amsterdam

Chartered 1609 by City of Amsterdam.
Main function: settlement of commercial
debts (bills of exchange) by giro transfer.
After 1683, bank florin is quasi-fiat.
Bank liquidated in 1820.

Amsterdam: reserve currency status

Bank had about 2,000 accounts in our sample:
wealthiest 1-2% of Amsterdams population.

Typical Bank transaction: 3000 bank florins.

10 X average yearly wage USD 550,000 today.

Peak turnover during 7 Years War (1756-63):

Value:
GBP 1868:
USD 1955:

1.5 X Dutch GDP /year.

3.6 X UK GDP (London Bankers CH).
2.7 X US GDP (Fedwire).
9

Turnover-to-GDP ratios

Value transferred -to-GDP (log scale)

100

Germany
United Kingdom
United States
10

Japan
Netherlands

Euro Area
China

1
1760

1868

1900-7

1955

1960

1978

2000

2012

Outline
1. Institutions
2. The Bank before 1780
3. Crisis 1780-1783 & policy
insolvency
4. Conclusion

Table 1. Banks balance sheet in 1780

In bank florins
Assets

Coins
Loans
Company
Amsterdam
Holland

Liabilities

20,003,439 Accounts

2,600,000
482,000
227,264 Equity

23,312,703

23,191,541

121,162

23,312,703

12

Receipts and accounts

A depositor of a trade coin (high denomination, high
quality) into the Bank received account credit for the
coin at an official value, and a receipt.
A receipt was a renewable, negotiable American option
to repurchase the same coin, with
Expiration date: six months after deposit.
Strike price: sale price + 25 BP.

Receipts almost always redeemed, they functioned as

modern repo (repurchase) contracts.
Without a receipt, accounts could not be withdrawn:
they were fiat money.
13

Repos vs. outright OMOs

In addition to coins held under receipt, Bank
holds coins acquired through open market
operations (OMOs).
Banks OMOs were outright purchases and sales
of small-denomination (1-guilder) coins.
Such coins not eligible for receipts; traded at
secondary market price.
14

Table 1. The Narrow Bank

In Bank Florins
Assets

Coins
Under Receipt
Unencumbered
Loans
Company
Amsterdam
Holland

Liabilities

Accounts
16,186,210 Restricted
3,817,229 Unrestricted

2,600,000
482,000
227,264 Equity
23,312,703

16,186,210
7,005,331

121,162
23,312,703

15

Table 1. The Lending Bank

In Bank Florins
Assets

Coins
Under Receipt
Unencumbered
Loans
Company
Amsterdam
Holland

Liabilities

Accounts
16,186,210 Restricted
3,817,229 Unrestricted

2,600,000
482,000
227,264 Equity
23,312,703

16,186,210
7,005,331

121,162
23,312,703

16

Price stability
A daily secondary market existed for current
money (circulating coin) versus bank money.
Bank money customarily traded at a premium
(agio) over current money of 4-5%.
Receipts promoted agio stability by anchoring
bank florin to trade coin.
The Banks implicit policy goal was agio
stability (-> price stability; inflation 0) .
17

Jan-80

Jan-75

Jan-70

Jan-65

Jan-60

Jan-55

Jan-50

Jan-45

Jan-40

Jan-35

Jan-30

Percent Premium

Figure 1. Agio, 1730:1-1780:1

6

18

City of Amsterdam
The City owned and administered the Bank.
City took each years operating profits as
seigniorage.
Most Bank income off balance sheet, not capitalized
into Bank assets.

City occasionally borrowed from the Bank, but

did not pay interest nor repay principal.
Seigniorage recorded as gradual write-down of
debt.
19

Table 1. Negative equity

In Bank Florins
Assets

Coins
Under Receipt
Unencumbered
Loans
East India Co.
Amsterdam
Holland

Liabilities

Accounts
16,186,210 Restricted
3,817,229 Unrestricted

2,600,000
482,000
227,264 Equity
22,830, 703

16,186,210
7,005,331

-360,838
22,830, 703

20

The Bank before 1780: summary

The Bank enjoyed substantial market funding.
The bank florin maintained a stable value.

The Bank operated with plentiful reserves and

modest negative equity.

21

Outline
1. Institutions
2. The Bank before 1780
3. Crisis 1780-1783 & policy
insolvency
4. Conclusion

The events of 1780-1783

(Fourth Anglo-Dutch War)

Bank expanded loans to the Company.

Company debt nonperforming by mid-1782.
Markets stopped using receipts.
Open market operations helped maintain the
quantity of bank money.
Bank net worth went negative.
Agio target could not be maintained.
23

-5

-5

-10

-10

-15

-15

-20

-20

-25

-25
Jan-91

10

Jan-89

10

Jan-87

15

Jan-85

15

Jan-83

20

Jan-81

20

Jan-79

25

Jan-77

25

Jan-75

Millions of Bank Florins

Figure 2. Bank balance sheet, 1775:1-1792:1

Credit

Coin Under Receipt

Unencumbered Coin
Accounts Under
Receipt
Unrestricted Accounts

Adjusted Equity

24

12
10
8
6
4
2

Holland

Dutch East India Company

City Loan Chamber

Miscellaneous Credits

Jul-82

Jan-82

Jul-81

Jan-81

Jul-80

Jan-80

Jul-79

Jan-79

Jul-78

Jan-78

Jul-77

Jan-77

Jul-76

Jan-76

Jul-75

Jan-75

Millions of Bank Florins

Figure 3. The Banks loans outstanding, 1775:1-1783:1

25

16

12

Percent premium

20

January-81
April-81
July-81
October-81
January-82
April-82
July-82
October-82
January-83
April-83

Millions of bank florins

Figure 4. Receipt run, OMOs and impact

on the agio, 1781-1783

Coins under Receipt

Cumulative Change
from Operations
Agio (percent)
Purchase/Sale Rate
(percent)

26

Figure 5: Bank income & expenses, 1775-1792

300
275
250
225

175
150
125
100
75
50
25
0
-25
-50

Annual
Fee Income

East India Interest

Expenses

Holland Interest

Loan Chamber Interest

1791

1790

1789

1788

1787

1786

1785

1784

1783

1782

1781

1780

1779

1778

1777

1776

-75

1775

Thoursands of Bank Florins

200

Bank worth calculation

Net worth = Equity + Franchise value.
Net worth < 0 = policy insolvency.
Franchise value = ENPV (OBS net income).
Uses previous years income going forward.
Assumes the City stops taking dividends.
Discounts @ 3 percent (rate on high-quality bills
of exchange).

28

Net worth calculation, continued

Equity
Adjusted for takings by City.
Adjusted for possibility of Company default.
3 ways to value Company debt:
1. Value debt at auction price for new issues (no
secondary market prices are available).
2. Use Banks internal accounting (no accrual of interest;
occasional payments used to write off principal).
3. Assume Company debt is worthless (ex post the most
accurate).
29

Years
Company
loans
do not
perform

6
4
2
0
-2
-4
-6
-8
-10

1792

1791

1790

1789

1788

1787

1786

1785

1784

1783

1782

1781

1780

1779

1778

1777

-12
1776

Millions of Bank Florins

January
Net worth using internal valuation of restructured Company debt
Net worth if restructured debt does not perform
Net worth using market valuation of restructured Company debt
30

Jan-90

Jan-85

Jan-80

Jan-75

Jan-70

Jan-65

Jan-60

Jan-55

Jan-50

Jan-45

Jan-40

Jan-35

Jan-30

Percent Premium

Figure 6. Agio falloff, 1780:1-1792:1

6

-1

-2

31

Subsequent events
1784-1789: Bank languishes.
1790: new crisis, agio < 0.

1791: Bank recapitalized by City.

Too little, too late (Banks NW still << 0).

1795: France invades; Bank collapses.

1820: Bank liquidated.

32

Outline
1. Institutions
2. The Bank before 1780
3. Crisis 1780-1783 & policy
insolvency
4. Conclusion

Summary
Balance sheet reconstructions show
Before 1780, Bank equity <0, but NW >0.
Quasi fiscal policy drives NW << 0 by 1784.
Takings by City contributed to NW<0.
1791 recapitalization inadequate.
NW<0 coincides with policy bankruptcy.

34

Some comparisons
Bank of Amsterdam, 1780-1783:

Balance sheet 10% GDP.

Pre-crisis NW 0.5% GDP.
Crisis monetary interventions 9% GDP.
Post-crisis NW < -2.5% GDP.

Federal Reserve, 2008-2015:

2008 balance sheet 6% GDP.

Post-crisis balance sheet expansion 20% GDP.
NW > 17% GDP (Del Negro & Sims 2014).
Virtually all of NW from franchise value.