WEBVTT NOTE The Protection of British Overseas Property, 1870-1914 1 00:00:00.000 --> 00:00:05.500 I'm currently an investment consultant at Peter Schiff's Euro-Pacific Capital. 2 00:00:05.500 --> 00:00:12.260 My views are not the views of Euro-Pacific. 3 00:00:12.260 --> 00:00:20.320 So basically, what I was looking at was the first major period of foreign direct investment 4 00:00:20.320 --> 00:00:28.400 that started in a large way in the modern era, and that was from the British Empire emanating 5 00:00:28.400 --> 00:00:35.360 around the world roughly between the years of 1870 and 1914. 6 00:00:35.360 --> 00:00:41.180 The question I wanted to know is why did British investors feel comfortable investing in another 7 00:00:41.180 --> 00:00:48.320 country when they lost access to the impartial court systems in Britain? 8 00:00:48.320 --> 00:00:56.260 I focused on four regions, four nations actually, China, Japan, Nigeria and Argentina because 9 00:00:56.260 --> 00:01:00.940 Because I wanted to look outside of the British Commonwealth. 10 00:01:00.940 --> 00:01:07.060 To start out, yields were generally higher overseas, so there was a risk premium that 11 00:01:07.060 --> 00:01:13.740 investors could gain by investing in areas of the world that were seen as more risky. 12 00:01:13.740 --> 00:01:18.580 But on top of that, my conclusion is that there were three main developments in the 13 00:01:18.580 --> 00:01:24.500 19th century that contributed to this feeling among the investing public that their property 14 00:01:24.500 --> 00:01:30.920 Rights Could Be Secure Overseas. The first was technological advancements in communications 15 00:01:30.920 --> 00:01:37.920 and in transportation. The second was the establishment of new institutional frameworks 16 00:01:39.440 --> 00:01:46.440 such as the growth of global free trade movements and new business practices. The third was 17 00:01:47.460 --> 00:01:54.240 the advent of limited liability banking for the first time in Britain, combined with concessions 18 00:01:54.240 --> 00:02:06.000 So to start out, the first being technological advancements. 19 00:02:06.000 --> 00:02:15.760 In the 18th century, if you wanted to communicate with an overseas area, you had to put a letter 20 00:02:15.760 --> 00:02:18.240 on a ship, cross the oceans. 21 00:02:18.240 --> 00:02:26.680 would take much time to receive, sometimes months to receive the response. 22 00:02:26.680 --> 00:02:34.160 But in 1858, the transatlantic cable was completed and all of a sudden, an investor in London 23 00:02:34.160 --> 00:02:42.560 could send a business question to Argentina and receive a response later that day. 24 00:02:42.560 --> 00:02:49.720 Also, communication with Africa and Asia was tremendously increased with ship technology 25 00:02:49.720 --> 00:02:52.540 and the opening of the Suez Canal. 26 00:02:52.540 --> 00:02:57.680 So the business communication made investors feel more comfortable. 27 00:02:57.680 --> 00:03:05.120 Also, advancements in rail technology led to emerging nations to have a desire to connect 28 00:03:05.120 --> 00:03:07.600 their major cities via rail. 29 00:03:07.600 --> 00:03:12.600 But in most cases, they lack the internal capital stock to do this. 30 00:03:12.600 --> 00:03:17.400 So this created a demand for British capital around the world. 31 00:03:17.400 --> 00:03:20.800 So those conclude the first element. 32 00:03:20.800 --> 00:03:23.780 The second element being new institutional frameworks. 33 00:03:23.780 --> 00:03:29.240 During the second quarter of the 19th century, a movement swept Britain, which claimed that 34 00:03:29.240 --> 00:03:36.160 its old mercantilist policies were detrimental to British commercial interests, citing the 35 00:03:36.160 --> 00:03:42.600 The work of people like Adam Smith and David Ricardo, citing comparative advantage, people 36 00:03:42.600 --> 00:03:49.400 began to question the policy of seeing trade as a war, with the producers of goods being 37 00:03:49.400 --> 00:03:54.200 the winners of that war and the consumers of goods being the losers. 38 00:03:54.200 --> 00:04:01.000 Under mercantilism, tariffs were imposed on imported goods, but were not only imposed 39 00:04:01.000 --> 00:04:05.580 was to raise revenue for the state, but were implemented to systematically protect British 40 00:04:05.580 --> 00:04:09.560 manufacturing from foreign competition. 41 00:04:09.560 --> 00:04:17.200 The arguments against this were mainly that tariffs led to retaliatory tariffs, which 42 00:04:17.200 --> 00:04:22.140 constrained British industries' exports. 43 00:04:22.140 --> 00:04:23.880 Then there was a moral argument. 44 00:04:23.880 --> 00:04:29.640 There was an argument made very forcefully by a member of parliament named Cobden. 45 00:04:29.640 --> 00:04:41.600 And he sort of led this movement and he was concerned about the special tariff legislation 46 00:04:41.600 --> 00:04:47.400 which was pushed by certain special interests to benefit them. 47 00:04:47.400 --> 00:04:54.480 So through this movement, through the middle of the 19th century, eventually there were 48 00:04:54.480 --> 00:04:58.960 a series of free trade agreements that were drawn up by the Foreign Office, the first 49 00:04:58.960 --> 00:05:04.760 The first of which being the 1860 Free Trade Treaty with France. 50 00:05:04.760 --> 00:05:10.280 This system led to a vast and growing international trade, which helped make London the center 51 00:05:10.280 --> 00:05:16.120 of the world, drawing banking, insurance and similar concessions from other countries. 52 00:05:16.120 --> 00:05:21.120 I believe that the major outflows of capital that started in about 1870 likely could not 53 00:05:21.120 --> 00:05:24.340 have happened under a mercantilist system. 54 00:05:24.340 --> 00:05:30.540 The second is the advent of institutions such as freestanding companies. 55 00:05:30.540 --> 00:05:34.340 Much of the investment that came out of the British Empire during this period was not 56 00:05:34.340 --> 00:05:40.180 channeled through multinational corporations, rather was channeled through freestanding 57 00:05:40.180 --> 00:05:41.180 companies. 58 00:05:41.180 --> 00:05:46.220 And what these were is they were companies that registered in Britain, that held offices 59 00:05:46.220 --> 00:05:48.760 in London. 60 00:05:48.760 --> 00:05:53.920 They issued common shares, preferred shares and fixed income debentures. 61 00:05:53.920 --> 00:05:58.440 But they usually only did operations in one single foreign country. 62 00:05:58.440 --> 00:06:02.520 So the average Brit, I believe, felt more comfortable that they could walk into an office 63 00:06:02.520 --> 00:06:03.520 in London. 64 00:06:03.520 --> 00:06:05.880 They knew that this firm had British management. 65 00:06:05.880 --> 00:06:10.560 They knew that this firm being registered in Britain had fell under the jurisdiction 66 00:06:10.560 --> 00:06:12.200 of British common law. 67 00:06:12.200 --> 00:06:16.800 And so therefore they had access in a way to an impartial court system. 68 00:06:16.800 --> 00:06:21.700 The companies benefited because they had access to limited liability. 69 00:06:21.700 --> 00:06:26.860 So the utilization of British management and engineering teams caused British investors 70 00:06:26.860 --> 00:06:31.420 to be more likely to invest in a foreign operation. 71 00:06:31.420 --> 00:06:41.620 The next institutional advancement or new institution were private bondholders associations. 72 00:06:41.620 --> 00:06:45.660 A large amount of the capital that came out of the British Empire during this period was 73 00:06:45.660 --> 00:06:50.060 was used to purchase foreign sovereign debt. 74 00:06:50.060 --> 00:06:56.900 But individual bondholders would pool their influences into bondholders' associations, 75 00:06:56.900 --> 00:07:01.580 the largest of which was the Corporation of Foreign Bondholders. 76 00:07:01.580 --> 00:07:06.380 When a default was threatened by a foreign debtor, these associations would send representatives, 77 00:07:06.380 --> 00:07:15.380 usually very well-known businessmen, to these countries to negotiate for the pool of members. 78 00:07:15.380 --> 00:07:26.140 Reports. Mediation and arbitration were pursued as a first means, though if the counterparty 79 00:07:26.140 --> 00:07:36.580 was not willing to negotiate or there was an impasse, there was a method that the bondholders' 80 00:07:36.580 --> 00:07:42.100 associations would use to force the other party back to the negotiating table. And that 81 00:07:42.100 --> 00:07:49.660 That was that the British bondholders associations worked in concert many times with other continental 82 00:07:49.660 --> 00:07:55.400 bondholders associations, whether it be Amsterdam or Frankfurt, other major capital centers. 83 00:07:55.400 --> 00:08:01.580 So if a country would not negotiate or would threaten default, they potentially lost access 84 00:08:01.580 --> 00:08:06.180 to all of the world's major financial markets. 85 00:08:06.180 --> 00:08:15.540 So most of the time, mediation and arbitration would lead to a satisfactory compromise. 86 00:08:15.540 --> 00:08:23.900 But there are instances where countries were not allowed to access future capital. 87 00:08:23.900 --> 00:08:29.540 In 1873, with the cooperation of the Amsterdam Credit Market, the Corporation of Foreign 88 00:08:29.540 --> 00:08:35.460 Bondholders prevented the issuance of new bonds by the government of Guatemala onto 89 00:08:35.460 --> 00:08:38.500 to the European Credit Markets as punishment for, quote, 90 00:08:38.500 --> 00:08:41.260 fallacious promises to repay old loans. 91 00:08:43.060 --> 00:08:45.020 Perhaps the most successful example 92 00:08:45.020 --> 00:08:47.160 of British bondholders' associations 93 00:08:47.160 --> 00:08:48.940 cutting off future investment 94 00:08:48.940 --> 00:08:51.900 comes from the 1890 case of Peru. 95 00:08:51.900 --> 00:08:55.380 Finding itself in dispute with the Peruvian Corporation, 96 00:08:55.380 --> 00:08:57.540 a British bondholder association, 97 00:08:57.540 --> 00:09:02.000 the Peruvian government and all private Peruvian corporations 98 00:09:02.000 --> 00:09:04.740 found themselves cut out of the European capital markets 99 00:09:04.740 --> 00:09:10.000 for 32 years. 100 00:09:10.000 --> 00:09:14.660 The bondholders' associations found that the deterrence of this was very 101 00:09:14.660 --> 00:09:22.220 likely to coerce compliance with loan terms. 102 00:09:22.220 --> 00:09:26.080 Now, in rare cases, the bondholders' associations would actually go to the court 103 00:09:26.080 --> 00:09:27.780 systems of these countries. 104 00:09:27.780 --> 00:09:33.220 And the funniest example I could find was during the Civil War, the 105 00:09:33.220 --> 00:09:37.920 The Confederacy was funded in a large part by these British bondholders and they purchased 106 00:09:37.920 --> 00:09:39.360 cotton bonds. 107 00:09:39.360 --> 00:09:48.160 After the war, the North and the new Reconstructionist governments in the South called this debt 108 00:09:48.160 --> 00:09:51.260 odious debt and refused to pay it. 109 00:09:51.260 --> 00:09:57.260 So representatives of the Corporation of Foreign Bondholders went to Virginia and they looked 110 00:09:57.260 --> 00:10:05.660 for Lawyers to Help Them File Case to have this challenged and to have them repaid. 111 00:10:05.660 --> 00:10:13.620 And every time that a lawyer would agree to take the case, they would be disbarred. 112 00:10:13.620 --> 00:10:21.020 So it was very hard to enforce these sorts of property rights in foreign court systems, 113 00:10:21.020 --> 00:10:27.840 even in a relatively advanced industrializing country like the United States. 114 00:10:27.840 --> 00:10:39.460 So the next element that was important are the limited liability banking, but also the 115 00:10:39.460 --> 00:10:45.980 collateralization of loans and the guarantees of loans by foreign governments. 116 00:10:45.980 --> 00:10:52.220 So loans to foreign governments and corporations usually had to be secured with some sort of 117 00:10:52.220 --> 00:10:57.920 inalienable asset which could be seized and operated in the event of a default. 118 00:10:57.920 --> 00:11:04.420 Usually these took the form of a specific tax stream or an asset that had been financed 119 00:11:04.420 --> 00:11:09.380 by the loans themselves, such as a specific railway line. 120 00:11:09.380 --> 00:11:15.360 Many times these assets would be put under the direct supervision of foreign banks or 121 00:11:15.360 --> 00:11:23.360 for Bondholders Committees. Now, guarantees were also many times required to attract British 122 00:11:23.360 --> 00:11:32.360 capital. Foreign investment into private companies overseas were seen as being extremely risky 123 00:11:32.360 --> 00:11:38.020 in this day. Some of the reasons are that most of these companies held limited liability 124 00:11:38.020 --> 00:11:45.860 Status in Their Own Jurisdiction. They were over-leveraged and in the event of a bankruptcy 125 00:11:45.860 --> 00:11:52.940 and forced liquidation, creditors would likely take enormous losses. So to mitigate the increased 126 00:11:52.940 --> 00:11:59.300 risk, British investors demanded that investments in private companies usually partially be 127 00:11:59.300 --> 00:12:06.220 guaranteed by the foreign governments that these companies operated within. The experience 128 00:12:06.220 --> 00:12:12.340 Experience of Argentina highlights the experience of many Latin American countries seeking capital 129 00:12:12.340 --> 00:12:15.320 from Britain. 130 00:12:15.320 --> 00:12:22.260 The Argentinian government guaranteed returns of 8 percent. 131 00:12:22.260 --> 00:12:27.500 So if you were a British investor and you invested in a private British railway, you 132 00:12:27.500 --> 00:12:33.200 were guaranteed the return of your principal, plus you were guaranteed 7 percent return 133 00:12:33.200 --> 00:12:42.360 on Your Capital, which was tremendous in those days. Obviously, this created malinvestments 134 00:12:42.360 --> 00:12:47.320 because a tremendous amount of capital flowed into Britain. There were examples of railroads 135 00:12:47.320 --> 00:12:53.880 being built to places that didn't need railroads. So, in many ways, this could foment a bubble. 136 00:12:53.880 --> 00:13:01.180 There was a law passed in Argentina, the law of 16 November 1863, which said that any guarantee 137 00:13:01.180 --> 00:13:04.540 The guarantee entered into the government was considered sovereign debt. 138 00:13:04.540 --> 00:13:06.700 So that took it up another level. 139 00:13:06.700 --> 00:13:13.100 So you actually, under the system, by holding debt of a private company in Argentina that 140 00:13:13.100 --> 00:13:18.460 had a guarantee, you had the same creditor status under Argentinian law as sovereign 141 00:13:18.460 --> 00:13:19.640 debt holders. 142 00:13:19.640 --> 00:13:23.000 So again, this was an incentive towards malinvestment. 143 00:13:23.000 --> 00:13:29.420 In the 1870s and the 1880s, there was a massive inflow of British capital into Argentina. 144 00:13:29.420 --> 00:13:36.780 And I wish I could show you a graph but it's parabolic and then it crashes like many bubbles. 145 00:13:36.780 --> 00:13:42.100 So on top of that, there was limited liability banking. 146 00:13:42.100 --> 00:13:51.780 For the very first time in Britain in 1858 and 1862, there was, banks were granted limited 147 00:13:51.780 --> 00:13:58.260 liability status and this led to a huge move into the financial sector by many business 148 00:13:58.260 --> 00:14:05.260 This again, I believe, created an incentive for malinvestment because investors in Britain, by putting deposits in many of these banks, those loans would then be multiplied through the fractional reserve system and sent overseas. 149 00:14:28.260 --> 00:14:34.860 guarantees to places like Argentina which guaranteed handsome returns. 150 00:14:34.860 --> 00:14:44.020 So I believe that the combination of limited liability banking with these guarantees in 151 00:14:44.020 --> 00:14:50.060 many ways contributed to the capital bubble that was built in Argentina, mainly built 152 00:14:50.060 --> 00:14:57.380 on the back of railroads, which eventually crashed in 1890 and it was called the Bearings 153 00:14:57.380 --> 00:15:01.680 Banking Crisis, and it led to a worldwide depression. 154 00:15:01.680 --> 00:15:09.100 Based on what I found, again, I feel that private British investors found that investing 155 00:15:09.100 --> 00:15:17.380 overseas was relatively, or that they were likely able to guarantee their property rights 156 00:15:17.380 --> 00:15:19.820 overseas for various reasons. 157 00:15:19.820 --> 00:15:23.420 They were able to communicate with these areas much faster. 158 00:15:23.420 --> 00:15:28.700 They were able to invest in companies which had British management teams and British engineering 159 00:15:28.700 --> 00:15:34.060 teams and that they could speak with representatives in London. 160 00:15:34.060 --> 00:15:43.340 Also there was the advent of free trade, the advent of private bondholders associations 161 00:15:43.340 --> 00:15:50.580 and then again limited liability banking combined with concessions made to British foreign capital 162 00:15:50.580 --> 00:15:54.980 made investing overseas relatively profitable 163 00:15:54.980 --> 00:15:58.620 and seem relatively safe. 164 00:15:58.620 --> 00:15:59.620 That's it. Thank you so much.