Medici Money: Banking, metaphysics and art in fifteenth-century Florence

Keep your eye on the ball. Our customer takes his 1,000 florins in Florence, where the florin is declared to be worth 40 English pence. The bill of exchange is written out at that rate. He instructs his agent in London to pay out in three months’ time. He does so. Our correspondent collects 40,000 pence (or £166 1s. 6d.). We, the bank, then instruct the correspondent to look for — and let us assume he finds — a local client, in London, wishing for a loan of the same amount and offering to pay it back in florins in, of course, three months’ time, the time it takes (officially!) to go from London to Florence. Perhaps he is a merchant buying a consignment of wool, speculating that when it arrives in Italy he can sell it for far more than what he paid for it in the Cotswolds.

So another bill of exchange is written out. But, even disregarding temporal fluctuations, the exchange rate is different in London. Here the pound is worth more. Here it will only take 36 pence to buy a florin. So the bill is written out at that exchange rate: Pay as is the custom £166 1s. 6d. (40,000 pence) in florins at a rate of 36 pence to the florin. And three months later, if all goes according to plan, we collect 40,000/36 = 1,111 florins. In six months we, the original lending bank, have made 11 percent, which is to say, an annual interest rate of 22 percent.

The Medici made hundreds of these deals. Basically, the trick is that the currency quoted as a unit is always worth a small percentage more in the country of issue. As far as Florence and northern Europe are concerned, the difference in the two exchange rates, which determines the banker’s profit, tends to be greatest in early spring, just before the Florentine galleys set out from Pisa for their long trip to Bruges. Because this is when demand for credit to finance trade is highest. It then narrows in the summertime. Manuals are written to help merchants and bankers get their minds around the system. Who needs interest rates?

But was it usury or wasn’t it? The theologians pondered. The bankers consulted them. No one wants to go to hell. Was it a loan with an interest rate, or was it an exchange deal? Remember, if currency rates changed drastically during the period of the transaction, then even the institutional difference between currency rates in different countries would not be enough to save the banker from a loss, or at least a very low profit. Conversely, the borrower could find himself paying a very high price for his loan if rates went further against him than they already were — if the pound, for example, rose vertiginously while those galleys were fighting their way up the Portuguese coast. As long as the geographical distance was maintained, the theologians decided, as long as there was a real exchange of currencies, as long as there was an element of risk, it wasn’t usury.

But to retain their credibility, the doctors of divinity cried a very loud foul at the so-called cambio secco, or dry exchange. In this kind of deal, when the bill of exchange became due in the foreign currency — say, sterling — the client did not pay up, but, after consulting the going currency rate, bought another bill for the exact amount owed. It is as if the first and second customers of the legitimate exchange described above, the man borrowing florins and the man borrowing pounds, were in fact the same person. This second bill then became due in the place where the first bill was issued — say, Florence — in florins, after the required period and at the new exchange rate. In this way, the period of the loan was doubled while the parties involved avoided actually using a foreign currency at all, although the element of speculation on rates, and hence of risk, was still there, since the exchange rates in London on the day in question were observed and a bill of exchange was written up. Hence, to be perfectly logical, there was no reason to say that this was any more or less usury than the regular bill of exchange. All the same, it was vigorously condemned by theologians because now it had become obvious that what the client really wanted was a loan, and not an exchange deal. Motivation is important. In 1429 the government of Florence banned the practice. It was clearly no more than a scam for usury. “To trade in licit exchanges.” Such was the declared purpose of the Medici bank. Yet it frequently dealt in “dry exchanges.” In 1435, when Cosimo took a dominant position in Florentine politics, the law forbidding such exchanges was swiftly revoked.