6 International Organization large quantity-note issuing,which in many countries already was,or about to be- come,regulated by government,and equity;deposits played a marginal role.By midcentury,however,the spread of industrialization led to a relative enlargement of the saving public and to a shift of the public's preferences from cash to checks(or credit transfers)for transaction purposes.Demand for deposit accounts,long and short,grew so much that it became thinkable for private bankers to finance lending with deposits taken from numerous individuals with whom they had no prior or other dealings.Banks saw in deposit-taking a way of improving profitability.Depositors typically earned less than bank shareholders;by increasing the share of deposits relative to capital,banks could increase earning on capital.The second part of the nineteenth century thus saw in most countries a rush toward deposit banking.Lead- ing in this new type of banking were the clearing banks in England and Wales,the Credit Lyonnais in France,and the Deutsche Bank in Germany. Deposits grew in the economy as a whole relative to gross national product (GNP)and in the banking sector relative to other banking resources.I8 The rising importance of deposits created a liquidity problem for the banks for two reasons. First,deposits were short-term assets.Although banks tried to lengthen the maturity of deposits by creating term deposits,according to which early withdrawals carried penalties,they could never prevent depositors confronted with the danger of a bank run from cashing their savings rather than facing the risk of losing them all.Second, unlike stockholders,depositors had no insider information on the good management and solvency of the bank.They could not monitor the management nor draw a reliable assessment of the bank's solvency.They relied instead on rumor,with the result that banks were subject to "sunspot"panics,that is,runs on deposits with no other rationale than each depositor's fear of being the victim of other depositors'fear of runs.A run on a bank would trigger a run on other banks if it were believed that the collapse of the first bank would weaken the liquidity of the others,as was often the case.19 The liquidity problem arising from the generalization of deposits was com- pounded by another circumstantial change,taking the form of the progressive replace- ment of the bill of exchange by overdrafts.20 The substitution was caused by multiple separate changes,including the reduction in transport costs,changes in sale and payment practices (buyers paying cash to take advantage of discounts),the tele- graphic transfer of payments,and firms relying on checks in general to effect pay- ment.21 Overdrafts were better remunerated than bills,but they were easily renewed and thus less liquid.Unlike bills,moreover,advances could not be readily recycled through rediscounting at the central bank. 18.Data on commercial and savings bank deposits are found in Mitchell 1983,1992;for Australia, Butlin,Hall,and White 1971;and,for Denmark,in Johansen 1985.Data on financial assets are found in Goldsmith 1969. 19.The liquidity problems arising from the greater importance taken by deposits in banks resources are underscored in Lamoreaux 1994.107. 20.The terms bill of exchange and overdraft are defined in footnote 14. 21.Cottrell1980,204
large quantity—note issuing, which in many countries already was, or about to be- come, regulated by government, and equity; deposits played a marginal role. By midcentury, however, the spread of industrialization led to a relative enlargement of the saving public and to a shift of the public’s preferences from cash to checks (or credit transfers) for transaction purposes. Demand for deposit accounts, long and short, grew so much that it became thinkable for private bankers to nance lending with deposits taken from numerous individuals with whom they had no prior or other dealings. Banks saw in deposit-taking a way of improving pro tability. Depositors typically earned less than bank shareholders; by increasing the share of deposits relative to capital, banks could increase earning on capital. The second part of the nineteenth century thus saw in most countries a rush toward deposit banking. Leading in this new type of banking were the clearing banks in England and Wales, the Cre´dit Lyonnais in France, and the Deutsche Bank in Germany. Deposits grew in the economy as a whole relative to gross national product (GNP) and in the banking sector relative to other banking resources.18 The rising importance of deposits created a liquidity problem for the banks for two reasons. First, deposits were short-term assets. Although banks tried to lengthen the maturity of deposits by creating term deposits, according to which early withdrawals carried penalties, they could never prevent depositors confronted with the danger of a bank run from cashing their savings rather than facing the risk of losing them all. Second, unlike stockholders, depositors had no insider information on the good management and solvency of the bank. They could not monitor the management nor draw a reliable assessment of the bank’s solvency. They relied instead on rumor, with the result that banks were subject to ‘‘sunspot’’ panics, that is, runs on deposits with no other rationale than each depositor’s fear of being the victim of other depositors’ fear of runs. A run on a bank would trigger a run on other banks if it were believed that the collapse of the rst bank would weaken the liquidity of the others, as was often the case.19 The liquidity problem arising from the generalization of deposits was com- pounded by another circumstantial change, taking the form of the progressive replace- ment of the bill of exchange by overdrafts.20 The substitution was caused by multiple separate changes, including the reduction in transport costs, changes in sale and payment practices (buyers paying cash to take advantage of discounts), the tele- graphic transfer of payments, and rms relying on checks in general to effect pay- ment.21 Overdrafts were better remunerated than bills, but they were easily renewed and thus less liquid. Unlike bills, moreover, advances could not be readily recycled through rediscounting at the central bank. 18. Data on commercial and savings bank deposits are found in Mitchell 1983, 1992; for Australia, Butlin, Hall, and White 1971; and, for Denmark, in Johansen 1985. Data on nancial assets are found in Goldsmith 1969. 19. The liquidity problems arising from the greater importance taken by deposits in banksresources are underscored in Lamoreaux 1994, 107. 20. The terms bill of exchange and overdraft are de ned in footnote 14. 21. Cottrell 1980, 204. 6 International Organization
Capital Market Internationalization 7 Relying on more volatile resources (deposits)to finance less liquid assets (over- drafts),banks were caught in a liquidity squeeze.They became aware of it in the wake of a string of banking crises,during which deposits were withdrawn in ex- change for coin and central bank notes.Hence,Michael Collins notes that after each crisis in England and Wales,the most severe being the crash of the City of Glasgow Bank in 1878,the banks tended to maintain a higher proportion of very liquid as- sets.22 Jean Bouvier notes that the crash of 1882 in France served to disqualify loans to industry in the eyes of Henri Germain,the director of the Credit Lyonnais.2 The standard response to the liquidity crisis was for banks to move to a form of banking that was safer.This meant developing standard lending procedures and thus more interchangeable and negotiable instruments,which could be used as secondary forms of liquidity.But since standardization could more easily be achieved in short- term lending than in long-term lending,standardization amounted to shortening the maturity of most assets:commercial banks would abandon their initial universality, specializing instead in short-term lending.24 Short,standardized assets had the advan- tage of being readily disposable in periods of crisis.But they had two drawbacks. First,they yielded lower profits.Second,safe paper was hard to find,especially now that overdrafts were displacing trade bills.In London,Paris,Milan,and Berlin,bank- ers complained about a persistent shortage in"good"paper,increasingly limited to international acceptances,that is,to bills generated by the settlement of international trade.25 The important role played by good paper in the smooth functioning of the monetary market placed these international centers into competition for the natural- ization of the market for acceptances.2 This shortage was also responsible for the revival of competition,noted in several countries,between the central bank and the deposit banks.27 The higher demand for good paper elicited new profit-making strategies amalgamation,centralization,and internationalization.All three aimed at relieving the need for good paper through greater productivity and higher volume.Amalgam- ation allowed banks to take advantage of the internal scale economies released by the move toward standardization.It is important to note that no such economies of scale existed during the first half of the century,when banking was still a matter of per- sonal connections and when profits sanctioned investments in high-yield,low- volume loans to local industries.Only after banks had been forced to abandon their long-term positions in local firms and to compensate for low yield through high volume did amalgamation become a profitable strategy.Amalgamation reduced bank capital requirements,improving earning potential.Amalgamation also allowed merg- 22.Collins1991,41. 23.Bouvier 1968,221.See also Levy-Leboyer 1976.462. 24.See Bouvier 1968,162;and Lamoreaux 1994.89. 25.See Conti 1993,311:Polsi 1996.127;and Riesser 1911,306. 26.The Deutsche Bank was organized in 1870 by a group of private bankers to capture a greater share of the foreign short-term credit and payments business:Tilly 1991.93.Broz argues that the Federal Reserve Bank was established to develop a market for acceptances in New York:Broz 1997. 27.On Britain,see De Cecco 1974,101;and Ziegler 1990,135;on France,see Bouvier 1973.160:and Lescure 1995,318;and on Belgium,see Kauch 1950,235,260
Relying on more volatile resources (deposits) to nance less liquid assets (over- drafts), banks were caught in a liquidity squeeze. They became aware of it in the wake of a string of banking crises, during which deposits were withdrawn in ex- change for coin and central bank notes. Hence, Michael Collins notes that after each crisis in England and Wales, the most severe being the crash of the City of Glasgow Bank in 1878, the banks tended to maintain a higher proportion of very liquid assets.22 Jean Bouvier notes that the crash of 1882 in France served to disqualify loans to industry in the eyes of Henri Germain, the director of the Cre´dit Lyonnais.23 The standard response to the liquidity crisis was for banks to move to a form of banking that was safer. This meant developing standard lending procedures and thus more interchangeable and negotiable instruments, which could be used as secondary forms of liquidity. But since standardization could more easily be achieved in shortterm lending than in long-term lending, standardization amounted to shortening the maturity of most assets: commercial banks would abandon their initial universality, specializing instead in short-term lending.24 Short,standardized assets had the advantage of being readily disposable in periods of crisis. But they had two drawbacks. First, they yielded lower pro ts. Second, safe paper was hard to nd, especially now that overdrafts were displacing trade bills. In London, Paris, Milan, and Berlin, bank- ers complained about a persistent shortage in ‘‘good’’ paper, increasingly limited to international acceptances, that is, to bills generated by the settlement of international trade.25 The important role played by good paper in the smooth functioning of the monetary market placed these international centers into competition for the naturalization of the market for acceptances.26 This shortage was also responsible for the revival of competition, noted in several countries, between the central bank and the deposit banks.27 The higher demand for good paper elicited new pro t-making strategies— amalgamation, centralization, and internationalization. All three aimed at relieving the need for good paper through greater productivity and higher volume. Amalgam- ation allowed banks to take advantage of the internal scale economies released by the move toward standardization. It is important to note that no such economies of scale existed during the rst half of the century, when banking was still a matter of per- sonal connections and when pro ts sanctioned investments in high-yield, low- volume loans to local industries. Only after banks had been forced to abandon their long-term positions in local rms and to compensate for low yield through high volume did amalgamation become a pro table strategy. Amalgamation reduced bank capital requirements, improving earning potential. Amalgamation also allowed merg- 22. Collins 1991, 41. 23. Bouvier 1968, 221. See also Le´vy-Leboyer 1976, 462. 24. See Bouvier 1968, 162; and Lamoreaux 1994, 89. 25. See Conti 1993, 311; Polsi 1996, 127; and Riesser 1911, 306. 26. The Deutsche Bank was organized in 1870 by a group of private bankers to capture a greater share of the foreign short-term credit and payments business; Tilly 1991, 93. Broz argues that the Federal Reserve Bank was established to develop a market for acceptances in New York; Broz 1997. 27. On Britain, see De Cecco 1974, 101; and Ziegler 1990, 135; on France, see Bouvier 1973, 160; and Lescure 1995, 318; and on Belgium, see Kauch 1950, 235, 260. Capital Market Internationalization 7
8 International Organization ing banks to rationalize their asset portfolio,taking over the best paper held by their competitors and liquidating less desirable items.28 Amalgamation naturally led to centralization-the relocation of bank headquar- ters in financial centers.Centralization allowed banks to capture external scale econo- mies:central clearing allowed banks to economize on working balances,and the greater breadth of the market increased the liquidity of security issues.29 Moreover. centralization allowed banks to enter lucrative lines of activity,such as the underwrit- ing of government and railroad loans.Centralization finally led to internationaliza- tion,since among these government loans figured those to foreign governments,until then the exclusive province of prestigious private banking houses.30 In sum,the liquidity squeeze that characterized commercial banking during the second half of the nineteenth century created a demand for short assets and led banks to pursue a profit-making strategy geared to the capture of a larger share of the relatively diminishing supply of short assets. The Gold Standard and the Supply of Short Assets The gold standard gave a boost to international capital markets,making possible an absolute increase in the coveted short instruments.It did so directly,though to a small extent,by assisting the market for acceptances,and indirectly,yet to a greater extent,by giving a boost to long-term credits. The gold standard first assisted the market for short-term capital,that of interna- tional acceptances,by reducing the currency risk.We do not know to what extent. Surely,the currency risk was already low under preceding bimetallism.Moreover, the market for international acceptances was,from 1870 on,monopolized by Lon- don;international acceptances did play substitute for vanishing bills of exchange in Britain,but not elsewhere.The greatest contribution to the uniform supply of short assets across financial centers,I believe,was more indirect;it was a spin-off of the boom in long-term foreign investment.I first develop the impact of the gold standard on long-term foreign investment and then its related effects on banks'short assets. The gold standard stimulated the long-term financial market.Operating as a com- mitment rule,according to which gold countries pledged to maintain a fixed parity between one unit of their currency and a given quantity of gold,the gold standard made possible the systematic transfer of capital from capital-rich and slow-growing economies to capital-poor and fast-growing economies.31 Countries seeking long- 28.Lamoreaux 1994,144. 29.Kindleberger 1978,72-75. 30.See Bouvier 1968:and Cameron 1991.14-16. 31.The gold standard is viewed by Bordo and Kydland 1995 as a solution to the time-inconsistency problem analyzed by Kydland and Prescott 1977.In the initial story,a government with discretion over the formulation of monetary policy will have an incentive to engineer a surprise inflation to stimulate employ- ment.Absent a binding commitment,the public will come to anticipate the outcome,leading to an infla- tionary equilibrium.A solution to the dilemma is for the government to waive discretion and pledge to abide by a binding rule.A variation on that story,one that makes time-inconsistency relevant to the gold standard,runs like this:a government with discretion over its monetary and fiscal policy will have an
ing banks to rationalize their asset portfolio, taking over the best paper held by their competitors and liquidating less desirable items.28 Amalgamation naturally led to centralization—the relocation of bank headquartersin nancial centers. Centralization allowed banks to capture external scale econo- mies: central clearing allowed banks to economize on working balances, and the greater breadth of the market increased the liquidity of security issues.29 Moreover, centralization allowed banks to enter lucrative lines of activity,such asthe underwriting of government and railroad loans. Centralization nally led to internationalization, since among these government loans gured those to foreign governments, until then the exclusive province of prestigious private banking houses.30 In sum, the liquidity squeeze that characterized commercial banking during the second half of the nineteenth century created a demand for short assets and led banks to pursue a pro t-making strategy geared to the capture of a larger share of the relatively diminishing supply of short assets. The Gold Standard and the Supply of Short Assets The gold standard gave a boost to international capital markets, making possible an absolute increase in the coveted short instruments. It did so directly, though to a small extent, by assisting the market for acceptances, and indirectly, yet to a greater extent, by giving a boost to long-term credits. The gold standard rst assisted the market for short-term capital, that of international acceptances, by reducing the currency risk. We do not know to what extent. Surely, the currency risk was already low under preceding bimetallism. Moreover, the market for international acceptances was, from 1870 on, monopolized by Lon- don; international acceptances did play substitute for vanishing bills of exchange in Britain, but not elsewhere. The greatest contribution to the uniform supply of short assets across nancial centers, I believe, was more indirect; it was a spin-off of the boom in long-term foreign investment. I rst develop the impact of the gold standard on long-term foreign investment and then its related effects on banks’short assets. The gold standard stimulated the long-term nancial market. Operating as a com- mitment rule, according to which gold countries pledged to maintain a xed parity between one unit of their currency and a given quantity of gold, the gold standard made possible the systematic transfer of capital from capital-rich and slow-growing economies to capital-poor and fast-growing economies.31 Countries seeking long- 28. Lamoreaux 1994, 144. 29. Kindleberger 1978, 72–75. 30. See Bouvier 1968; and Cameron 1991, 14–16. 31. The gold standard is viewed by Bordo and Kydland 1995 as a solution to the time-inconsistency problem analyzed by Kydland and Prescott 1977. In the initial story, a government with discretion over the formulation of monetary policy will have an incentive to engineer a surprise in ation to stimulate employ- ment. Absent a binding commitment, the public will come to anticipate the outcome, leading to an in ationary equilibrium. A solution to the dilemma is for the government to waive discretion and pledge to abide by a binding rule. A variation on that story, one that makes time-inconsistency relevant to the gold standard, runs like this: a government with discretion over its monetary and scal policy will have an 8 International Organization
Capital Market Internationalization 9 term foreign capital paid lower interest rates on loans contracted in London,Paris, Berlin,and other financial centers if they adhered to the gold standard.32 In the Rus- sian and Austrian empires,partisans of industrialization thought that industrialization could be a speedy process if foreign capital intervened to stimulate it-foreign capi- tal would come by adopting the gold standard.33 Reflecting on the experience of Spain,which suspended gold convertibility in 1883,Pablo Martin-Acena argued that,by staying out of the gold standard,"Spain missed on growth."34 Not only did imports of foreign capital cease from 1883 until 1906,when a new administration finally opted for a return to gold,but yields on the public debt were "'consistently maintained above British,French,and even Italian yields."35 The generalization of the gold standard coincided with a rise in international capi- tal outflows to levels that were never approached before and have never been ap- proached since.Paul Bairoch's estimates for capital fows for all net creditor coun- tries show a slowdown in the depression decades of the gold standard,followed by an unprecedented surge after 1900: 1840-1870:2.5-3.5 percent GNP 1870-1900:1.5-2.0 percent GNP 1900-1913:5.5 percent GNP36 Comparable data for the 1920s,1960s,and 1970s were below 1 percent. Most of this investment,about three-fourths,came from three countries (United Kingdom,France,and Germany),which were running persistent current account surpluses by generating savings in excess of domestic investment.Relative to total domestic savings,net capital outflows in 1910 represented 52 percent for the United Kingdom and 15 percent for France.37 The rest was contributed by the Netherlands, Belgium,Switzerland,and,toward the end of the period,Sweden.Most of this invest- ment went to a few countries-the United States,Canada,Australasia,Argentina, Brazil,Mexico,Russia,Spain,Portugal,Italy,Austria-Hungary,and the Scandina- vian countries.38 What made foreign investment so popular among savers in Britain,France,Ger- many,and other creditor countries was its greater safety,at equivalent yield,than domestic paper.In the case of Britain,Michael Edelstein found that overseas returns exceeded home returns over the years 1870-1913;he also found that overseas re- incentive to borrow and then default on its debt through inflation or suspension of payments.Anticipating default,bond holders will either ask for a higher interest rate or not purchase govemment debt.A solution to the dilemma is for the government to commit to gold convertibility at a fixed rate-a transparent and simple rule:Bordo and Kydland 1995.Bordo and Schwartz found that those countries that adhered to the gold standard rule generally had lower fiscal deficits,more stable money growth,and lower inflation rates than those that did not;Bordo and Schwartz 1994. 32.Bordo and Rockoff 1995,18. 33.De Cecco 1974,52 34.Martin-Acena 1994,160. 35.Ibid.,144. 36.Bairoch1976.103 37.Green and Urquhart 1976.241,244. 38.Cameron1991.13
term foreign capital paid lower interest rates on loans contracted in London, Paris, Berlin, and other nancial centers if they adhered to the gold standard.32 In the Russian and Austrian empires, partisans of industrialization thought that industrialization could be a speedy process if foreign capital intervened to stimulate it—foreign capital would come by adopting the gold standard.33 Re ecting on the experience of Spain, which suspended gold convertibility in 1883, Pablo Martin-Acen˜a argued that, by staying out of the gold standard, ‘‘Spain missed on growth.’’ 34 Not only did imports of foreign capital cease from 1883 until 1906, when a new administration nally opted for a return to gold, but yields on the public debt were ‘‘consistently maintained above British, French, and even Italian yields.’’ 35 The generalization of the gold standard coincided with a rise in international capital out ows to levels that were never approached before and have never been ap- proached since. Paul Bairoch’s estimates for capital ows for all net creditor countries show a slowdown in the depression decades of the gold standard, followed by an unprecedented surge after 1900: 1840–1870: 2.5–3.5 percent GNP 1870–1900: 1.5–2.0 percent GNP 1900–1913: 5.5 percent GNP 36 Comparable data for the 1920s, 1960s, and 1970s were below 1 percent. Most of this investment, about three-fourths, came from three countries (United Kingdom, France, and Germany), which were running persistent current account surpluses by generating savings in excess of domestic investment. Relative to total domestic savings, net capital out ows in 1910 represented 52 percent for the United Kingdom and 15 percent for France.37 The rest was contributed by the Netherlands, Belgium, Switzerland, and, toward the end of the period, Sweden. Most of thisinvest- ment went to a few countries—the United States, Canada, Australasia, Argentina, Brazil, Mexico, Russia, Spain, Portugal, Italy, Austria-Hungary, and the Scandina- vian countries.38 What made foreign investment so popular among savers in Britain, France, Ger- many, and other creditor countries was its greater safety, at equivalent yield, than domestic paper. In the case of Britain, Michael Edelstein found that overseas returns exceeded home returns over the years 1870–1913; he also found that overseas reincentive to borrow and then default on its debt through in ation or suspension of payments. Anticipating default, bond holders will either ask for a higher interest rate or not purchase government debt. A solution to the dilemma is for the government to commit to gold convertibility at a xed rate—a transparent and simple rule; Bordo and Kydland 1995. Bordo and Schwartz found that those countries that adhered to the gold standard rule generally had lower scal de cits, more stable money growth, and lower in ation rates than those that did not; Bordo and Schwartz 1994. 32. Bordo and Rockoff 1995, 18. 33. De Cecco 1974, 52. 34. Martin-Acen˜a 1994, 160. 35. Ibid., 144. 36. Bairoch 1976, 103. 37. Green and Urquhart 1976, 241, 244. 38. Cameron 1991, 13. Capital Market Internationalization 9
10 International Organization turns were not significantly riskier than domestic returns,but in fact tended to be less so.39 The greater safety of foreign investments relative to home investments is easily explained;it derived from the nature of these investments,which,according to Arthur Bloomfield,"depended directly or indirectly on government action."40 Loans either went to foreign governments(Russia and countries in central and southern Europe), or,even when loans went to private companies,as in the case of railroad construction and other public investments (utilities,roads,bridges,harbors,telegraph and tele- phone networks),they were made possible by government assistance in the form of guarantees,land loans,and cash grants.Finally,the bulk of this investment was portfolio;a generous estimate places the relative share of direct investment of the total long-term international debt in 1914 at only 35 percent.4 The higher yield of foreign over domestic investments holding risk constant,albeit empirically established,is more difficult to explain.Edelstein offered two interesting hypotheses.42 A first hypothesis,which the author thought to be valid in the case of the United States,views foreign returns constantly running ahead of expectations: "Overseas regions had a tendency to generate greater amounts of profitable innova- tions and new market opportunities,periodically fostering greater disequilibria,which in turn left their mark on realized returns."A second hypothesis looks for higher returns in market imperfection:"Overseas areas evinced a tendency to generate more circumstances involving imperfect competition and,possibly,greater monopoly rents."The active role played by host governments in attracting foreign capital pre- dictably was a consequential source of monopoly rents. A third hypothesis,I venture,was the relative backwardness of receiving coun- tries.With the exception of the Netherlands,creditor countries(Britain,France,Ger- many,Belgium,Switzerland)were generally more advanced industrially than debtor countries.The differential timing of industrialization triggered a product-cycle ef- fect:high-growth sectors in debtor countries were already stable-(or low-)growth sectors in creditor countries.Although yields on new ventures may have been the same,risks were lower in newly industrializing economies.In contrast,investing in an advanced economy meant putting one's money into new ventures with untested rates of return. The boom in long-term flows would supply banks with the short assets they were so desperately looking for in two ways.First,the joint-stock commercial banks on the continent,and later in Britain,took over the floating and placement of long-term bonds.Although these bonds were nominally long term,and banks standardly held onto such bonds no longer than it took to place them among their clienteles,the safety and trading volume of these instruments made them easily disposable assets, easily convertible into cash,and thus de facto substitutes for short-term paper. Second,commercial banks would float a government or government-guaranteed long-term bond issue provided that they be given a share in the more lucrative short- 39.Edelstein 1982.138. 40.A.Bloomfield 1968,4. 41.Dunning1992,116. 42.Edelstein 1982.140
turns were not signi cantly riskier than domestic returns, but in fact tended to be less so.39 The greater safety of foreign investments relative to home investments is easily explained; it derived from the nature of these investments, which, according to Arthur Bloom eld, ‘‘depended directly or indirectly on government action.’’ 40 Loans either went to foreign governments (Russia and countries in central and southern Europe), or, even when loans went to private companies, asin the case of railroad construction and other public investments (utilities, roads, bridges, harbors, telegraph and tele- phone networks), they were made possible by government assistance in the form of guarantees, land loans, and cash grants. Finally, the bulk of this investment was portfolio; a generous estimate places the relative share of direct investment of the total long-term international debt in 1914 at only 35 percent.41 The higher yield of foreign over domestic investments holding risk constant, albeit empirically established, is more difficult to explain. Edelstein offered two interesting hypotheses.42 A rst hypothesis, which the author thought to be valid in the case of the United States, views foreign returns constantly running ahead of expectations: ‘‘Overseas regions had a tendency to generate greater amounts of pro table innovations and new market opportunities, periodically fostering greater disequilibria, which in turn left their mark on realized returns.’’ A second hypothesis looks for higher returnsin market imperfection: ‘‘Overseas areas evinced a tendency to generate more circumstances involving imperfect competition and, possibly, greater monopoly rents.’’ The active role played by host governments in attracting foreign capital pre- dictably was a consequential source of monopoly rents. A third hypothesis, I venture, was the relative backwardness of receiving countries. With the exception of the Netherlands, creditor countries (Britain, France, Ger- many, Belgium, Switzerland) were generally more advanced industrially than debtor countries. The differential timing of industrialization triggered a product-cycle effect: high-growth sectors in debtor countries were already stable- (or low-) growth sectors in creditor countries. Although yields on new ventures may have been the same, risks were lower in newly industrializing economies. In contrast, investing in an advanced economy meant putting one’s money into new ventures with untested rates of return. The boom in long-term ows would supply banks with the short assets they were so desperately looking for in two ways. First, the joint-stock commercial banks on the continent, and later in Britain, took over the oating and placement of long-term bonds. Although these bonds were nominally long term, and banks standardly held onto such bonds no longer than it took to place them among their clienteles, the safety and trading volume of these instruments made them easily disposable assets, easily convertible into cash, and thus de facto substitutes for short-term paper. Second, commercial banks would oat a government or government-guaranteed long-term bond issue provided that they be given a share in the more lucrative short- 39. Edelstein 1982, 138. 40. A. Bloom eld 1968, 4. 41. Dunning 1992, 116. 42. Edelstein 1982, 140. 10 International Organization