The Enrichment of Exchange Bankers
This article series explains how the exchange bankers of the 16th century were able to make profits from bills of exchange. A bill of exchange is a written order used primarily in international trade that binds one party to pay a fixed sum of money to another party on demand or at a predetermined date, similar to a cheque. Merchant traders importing and exporting goods abroad would use bills of exchange as a safe alternative to shipping payment in specie (coins or precious metal). They could simply hand over the bill of exchange to their local exchange banker and receive payment in return. The exchange banker would then draw the bill onto the party that owes the money, and the transaction is completed.
Given the fact that bills of exchange appear to be simply cheques, as well as the fact that in Catholic Europe a banker was not allowed to make a profit from the changing of money, what was the incentive for these exchange bankers to deal in bills of exchange? The truth is that the exchange bankers could indeed profit from bills of exchange, but through a complex series of transactions, involving associate bankers, other traders and a hierarchical system of exchange rates. The 16th century Italian economist Bernardo Davanziti details one such account in his book Notizia de Cambi, involving bankers and traders from Florence and Lyons. In this book, Davanzati places himself in the role of a merchant trader, and advises an exchange banker on how to take advantage of the foreign exchange system to profit from a bill of exchange...
"If you (A) have money in Florence and want to transfer it Lyons, because you can make a profitable return exchange, give me (B), who need money, 64 ecus in Florence, when the exchange rate reaches this level, in exchange of which I promise to have a gold marc paid to Tommaso Sertini in Lyons. I give you a bill of exchange drawn on Salviati (C), you send it to Tommaso (D) to cash it and use it at its best advantage for a return exchange. The consignment letter is called "notification" or spaccio. Tommaso (D) will obey your orders, he will pay your gold marc to Piero (E) in Lyons and receive from him a bill of exchange drawn on Federigo (F) in Florence, on which the latter has to pay you (A) 65 and a half ecus in so many days. Tommaso will send you this exchange in return, and when it falls due, you will have gained 1 ecu and a half. But you have to run the risk of three bankruptcies, mine, Tommaso's and Piero's. So you will have to search with Argus eyes to whom you can give money to exchange at the greatest advantage, to whom you can hand over your bill and through whome the return exchange will be carried out... The person who does not resort to the mediation of a banker should, once he has deducted the 1 1/2 percent local charges, gain an average of 8 percent interest a year."
There's a lot going on here, so let's go through step by step this series of transactions and learn how we could also side step usury laws and make a neat profit from the art of exchange banking...`