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Old Sins: Exchange Rate Clauses and European Foreign Lending in the 19th Century

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  • Flandreau, Marc
  • Sussman, Nathan

Abstract

This Paper challenges a popular explanation for ‘original sin’ - the default prone borrowing of long term debt in foreign exchange by emerging markets - that emphasizes the lack of credibility and commitment of governments that prevents them from borrowing in their own currency. Basing our account on the history of emerging market borrowing in the nineteenth century, we offer an explanation based on historical path dependence. We document that almost all IPO’s of governments in foreign markets were in foreign exchange, or with foreign exchange clauses, independent of those countries’ institutional features. We show that a small number of countries could circulate debt denominated in their own currency in secondary markets, again irrespective of their constitutional set-up. We argue that market liquidity can explain both phenomena. Having an internationally circulating currency allows countries to circulate their debt in secondary markets. Going for an IPO in a large financial centre is an attempt to tap the greater liquidity of that centre’s money market and currency. It makes perfect sense to borrow then, in that centre’s currency. The evolution of vehicle currencies and liquid money markets has more to do with historical evolution of trade, going back to medieval times, rather than with institutional reform. Escaping from original sin requires that the country emerge as a leading economic power - a rare historical event, reserved for the US of the nineteenth century and Japan of the twentieth century.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4248.

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Date of creation: Feb 2004
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Handle: RePEc:cpr:ceprdp:4248

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Keywords: exchange clauses; key currencies; N32; original sin; sovereign debt;

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References

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  1. Michael D. Bordo & Eugene N. White, 1991. "British and French Finance During the Napoleonic Wars," NBER Working Papers 3517, National Bureau of Economic Research, Inc.
  2. Neal, Larry, 2000. "How it all began: the monetary and financial architecture of Europe during the first global capital markets, 1648 1815," Financial History Review, Cambridge University Press, Cambridge University Press, vol. 7(02), pages 117-140, October.
  3. Flandreau, Marc, 2000. "The economics and politics of monetary unions: a reassessment of the Latin Monetary Union, 1865 71," Financial History Review, Cambridge University Press, Cambridge University Press, vol. 7(01), pages 25-44, April.
  4. Oppers, S.E., 1993. "The Interest Rate Effect of Dutch Money in Eitheenth- Century Britain," Working Papers, Research Seminar in International Economics, University of Michigan 329, Research Seminar in International Economics, University of Michigan.
  5. Sussman, Nathan & Yafeh, Yishay, 2000. "Institutions, Reforms, and Country Risk: Lessons from Japanese Government Debt in the Meiji Era," The Journal of Economic History, Cambridge University Press, Cambridge University Press, vol. 60(02), pages 442-467, June.
  6. Flandreau, Marc R, 2002. ""Water Seeks a Level": Modeling Bimetallic Exchange Rates and the Bimetallic Band," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 34(2), pages 491-519, May.
  7. Bordo, Michael D. & White, Eugene N., 1991. "A Tale of Two Currencies: British and French Finance During the Napoleonic Wars," The Journal of Economic History, Cambridge University Press, Cambridge University Press, vol. 51(02), pages 303-316, June.
  8. Elise S. Brezis, 1995. "Foreign capital flows in the century of Britain's industrial revolution: new estimates, controlled conjectures," Economic History Review, Economic History Society, Economic History Society, vol. 48(1), pages 46-67, 02.
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