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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.

Suggested Citation

  • Flandreau, Marc & Sussman, Nathan, 2004. "Old Sins: Exchange Rate Clauses and European Foreign Lending in the 19th Century," CEPR Discussion Papers 4248, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4248
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    References listed on IDEAS

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    Cited by:

    1. Marc Flandreau, 2006. "The logic of compromise : monetary bargaining in Austria-Hungary 1867-1913," Working Papers hal-01065619, HAL.
    2. Marc Flandreau & Kim Oosterlinck, 2011. "Was the Emergence of the International Gold Standard Expected? Melodramatic Evidence from Indian Government Securities," Working Papers 0005, European Historical Economics Society (EHES).
    3. Flandreau, Marc & Jobst, Clemens, 2005. "The Ties that Divide. A Network Analysis of the International Monetary System," CEPR Discussion Papers 5129, C.E.P.R. Discussion Papers.
    4. Marc Flandreau & Juan H. Flores & Norbert Gaillard & Sebastián Nieto-Parra, 2010. "The End of Gatekeeping: Underwriters and the Quality of Sovereign Bond Markets, 1815–2007," NBER Chapters, in: NBER International Seminar on Macroeconomics 2009, pages 53-92, National Bureau of Economic Research, Inc.
    5. Michael D Bordo & Christopher M Meissner & Marc D Weidenmier, 2006. "Currency Mismatches, Default Risk, and Exchange Rate Depreciation: Evidence from the End of Bimetallism," WEF Working Papers 0010, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
    6. Eichengreen, Barry, 2008. "Sui Generis EMU," CEPR Discussion Papers 6642, C.E.P.R. Discussion Papers.
    7. Arnaud Mehl & Julien Reynaud, 2008. "Domestic debt structures in emerging markets: new empirical evidence," Documents de travail du Centre d'Economie de la Sorbonne bla08059, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    8. Claudio Borio & Frank Packer, 2004. "Assessing new perspectives on country risk," BIS Quarterly Review, Bank for International Settlements, December.
    9. Eichengreen, Barry & Flandreau, Marc, 2009. "The rise and fall of the dollar (or when did the dollar replace sterling as the leading reserve currency?)," European Review of Economic History, Cambridge University Press, vol. 13(3), pages 377-411, December.
    10. Maurice Obstfeld & Alan M. Taylor, 2003. "Sovereign risk, credibility and the gold standard: 1870-1913 versus 1925-31," Economic Journal, Royal Economic Society, vol. 113(487), pages 241-275, April.
    11. Guido Sandleris, 2016. "The Costs of Sovereign Default: Theory and Empirical Evidence," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Spring 20), pages 1-27, April.
    12. Kang Yong Tan & Prasanna Gai, 2004. "Good Housekeeping? Reputation, Fixed Exchange Rates, and the 'Original Sin' Problem," Econometric Society 2004 Far Eastern Meetings 446, Econometric Society.
    13. Barry Eichengreen, 2005. "Sterling's Past, Dollar's Future: Historical Perspectives on Reserve Currency Competition," NBER Working Papers 11336, National Bureau of Economic Research, Inc.
    14. Marc Flandreau & Clemens Jobst, 2005. "The Ties that Divide: A Network Analysis of the International Monetary System, 1890-1910," Sciences Po publications n°5129, Sciences Po.
    15. Bordo, Michael D. & Meissner, Christopher M. & Weidenmier, Marc D., 2009. "Identifying the effects of an exchange rate depreciation on country risk: Evidence from a natural experiment," Journal of International Money and Finance, Elsevier, vol. 28(6), pages 1022-1044, October.
    16. Mr. Paolo Mauro & Yishay Yafeh, 2003. "The Corporation of Foreign Bondholders," IMF Working Papers 2003/107, International Monetary Fund.
    17. Mauro, Paolo & Sussman, Nathan & Yafeh, Yishay, 2006. "Bloodshed or Reforms? The Determinants of Sovereign Bond Spreads in 1870-1913 and Today," CEPR Discussion Papers 5528, C.E.P.R. Discussion Papers.
    18. Mehl, Arnaud & Reynaud, Julien, 2005. "The determinants of "domestic" original sin in emerging market economies," Working Paper Series 560, European Central Bank.
    19. Jeanne, Olivier, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," CEPR Discussion Papers 4030, C.E.P.R. Discussion Papers.
    20. Paul Lejot & Douglas Arner & Liu Qiao & Mylene Chan & Mshall Mays, 2003. "Asia's Debt Capital Markets: Appraisal and Agenda for Policy Reform," Working Papers 192003, Hong Kong Institute for Monetary Research.
    21. Barry Eichengreen & Marc Flandreau, 2008. "The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency?," NBER Working Papers 14154, National Bureau of Economic Research, Inc.
    22. Hausmann, Ricardo & Panizza, Ugo, 2003. "On the determinants of Original Sin: an empirical investigation," Journal of International Money and Finance, Elsevier, vol. 22(7), pages 957-990, December.
    23. Mehl, Arnaud & Reynaud, Julien, 2010. "Risky public domestic debt composition in emerging economies," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 1-18, February.
    24. Michael D. Bordo & Christopher Meissner & Angela Redish, 2003. "How "Original Sin" was Overcome: The Evolution of External Debt Denominated in Domestic Currencies in the United States and the British Dominions," NBER Working Papers 9841, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    exchange clauses; key currencies; N32; original sin; sovereign debt;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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