The Protection of British Overseas Property, 1870-1914

0:00I'm currently an investment consultant at Peter Schiff's Euro-Pacific Capital. My views are not the views of Euro-Pacific. So basically, what I was looking at was the first major period of foreign direct investment that started in a large way in the modern era, and that was from the British Empire emanating around the world roughly between the years of 1870 and 1914. The question I wanted to know is why did British investors feel comfortable investing in another country when they lost access to the impartial court systems in Britain?

0:48I focused on four regions, four nations actually, China, Japan, Nigeria and Argentina because Because I wanted to look outside of the British Commonwealth. To start out, yields were generally higher overseas, so there was a risk premium that investors could gain by investing in areas of the world that were seen as more risky. But on top of that, my conclusion is that there were three main developments in the 19th century that contributed to this feeling among the investing public that their property Rights Could Be Secure Overseas. The first was technological advancements in communications and in transportation. The second was the establishment of new institutional frameworks such as the growth of global free trade movements and new business practices. The third was the advent of limited liability banking for the first time in Britain, combined with concessions So to start out, the first being technological advancements.

2:06In the 18th century, if you wanted to communicate with an overseas area, you had to put a letter on a ship, cross the oceans. would take much time to receive, sometimes months to receive the response. But in 1858, the transatlantic cable was completed and all of a sudden, an investor in London could send a business question to Argentina and receive a response later that day. Also, communication with Africa and Asia was tremendously increased with ship technology and the opening of the Suez Canal.

2:52So the business communication made investors feel more comfortable. Also, advancements in rail technology led to emerging nations to have a desire to connect their major cities via rail. But in most cases, they lack the internal capital stock to do this. So this created a demand for British capital around the world. So those conclude the first element. The second element being new institutional frameworks. During the second quarter of the 19th century, a movement swept Britain, which claimed that its old mercantilist policies were detrimental to British commercial interests, citing the The work of people like Adam Smith and David Ricardo, citing comparative advantage, people began to question the policy of seeing trade as a war, with the producers of goods being the winners of that war and the consumers of goods being the losers.

3:54Under mercantilism, tariffs were imposed on imported goods, but were not only imposed was to raise revenue for the state, but were implemented to systematically protect British manufacturing from foreign competition. The arguments against this were mainly that tariffs led to retaliatory tariffs, which constrained British industries' exports. Then there was a moral argument. There was an argument made very forcefully by a member of parliament named Cobden. And he sort of led this movement and he was concerned about the special tariff legislation which was pushed by certain special interests to benefit them.

4:47So through this movement, through the middle of the 19th century, eventually there were a series of free trade agreements that were drawn up by the Foreign Office, the first The first of which being the 1860 Free Trade Treaty with France. This system led to a vast and growing international trade, which helped make London the center of the world, drawing banking, insurance and similar concessions from other countries. I believe that the major outflows of capital that started in about 1870 likely could not have happened under a mercantilist system. The second is the advent of institutions such as freestanding companies. Much of the investment that came out of the British Empire during this period was not channeled through multinational corporations, rather was channeled through freestanding companies.

5:41And what these were is they were companies that registered in Britain, that held offices in London. They issued common shares, preferred shares and fixed income debentures. But they usually only did operations in one single foreign country. So the average Brit, I believe, felt more comfortable that they could walk into an office in London. They knew that this firm had British management. They knew that this firm being registered in Britain had fell under the jurisdiction of British common law. And so therefore they had access in a way to an impartial court system. The companies benefited because they had access to limited liability. So the utilization of British management and engineering teams caused British investors to be more likely to invest in a foreign operation.

6:31The next institutional advancement or new institution were private bondholders associations. A large amount of the capital that came out of the British Empire during this period was was used to purchase foreign sovereign debt. But individual bondholders would pool their influences into bondholders' associations, the largest of which was the Corporation of Foreign Bondholders. When a default was threatened by a foreign debtor, these associations would send representatives, usually very well-known businessmen, to these countries to negotiate for the pool of members. Reports. Mediation and arbitration were pursued as a first means, though if the counterparty was not willing to negotiate or there was an impasse, there was a method that the bondholders' associations would use to force the other party back to the negotiating table. And that That was that the British bondholders associations worked in concert many times with other continental bondholders associations, whether it be Amsterdam or Frankfurt, other major capital centers.

7:55So if a country would not negotiate or would threaten default, they potentially lost access to all of the world's major financial markets. So most of the time, mediation and arbitration would lead to a satisfactory compromise. But there are instances where countries were not allowed to access future capital. In 1873, with the cooperation of the Amsterdam Credit Market, the Corporation of Foreign Bondholders prevented the issuance of new bonds by the government of Guatemala onto to the European Credit Markets as punishment for, quote, fallacious promises to repay old loans.

8:43Perhaps the most successful example of British bondholders' associations cutting off future investment comes from the 1890 case of Peru. Finding itself in dispute with the Peruvian Corporation, a British bondholder association, the Peruvian government and all private Peruvian corporations found themselves cut out of the European capital markets for 32 years. The bondholders' associations found that the deterrence of this was very likely to coerce compliance with loan terms. Now, in rare cases, the bondholders' associations would actually go to the court systems of these countries. And the funniest example I could find was during the Civil War, the The Confederacy was funded in a large part by these British bondholders and they purchased cotton bonds.

9:39After the war, the North and the new Reconstructionist governments in the South called this debt odious debt and refused to pay it. So representatives of the Corporation of Foreign Bondholders went to Virginia and they looked for Lawyers to Help Them File Case to have this challenged and to have them repaid. And every time that a lawyer would agree to take the case, they would be disbarred. So it was very hard to enforce these sorts of property rights in foreign court systems, even in a relatively advanced industrializing country like the United States.

10:27So the next element that was important are the limited liability banking, but also the collateralization of loans and the guarantees of loans by foreign governments. So loans to foreign governments and corporations usually had to be secured with some sort of inalienable asset which could be seized and operated in the event of a default. Usually these took the form of a specific tax stream or an asset that had been financed by the loans themselves, such as a specific railway line. Many times these assets would be put under the direct supervision of foreign banks or for Bondholders Committees. Now, guarantees were also many times required to attract British capital. Foreign investment into private companies overseas were seen as being extremely risky in this day. Some of the reasons are that most of these companies held limited liability Status in Their Own Jurisdiction. They were over-leveraged and in the event of a bankruptcy and forced liquidation, creditors would likely take enormous losses. So to mitigate the increased risk, British investors demanded that investments in private companies usually partially be

11:59guaranteed by the foreign governments that these companies operated within. The experience Experience of Argentina highlights the experience of many Latin American countries seeking capital from Britain. The Argentinian government guaranteed returns of 8 percent. So if you were a British investor and you invested in a private British railway, you were guaranteed the return of your principal, plus you were guaranteed 7 percent return on Your Capital, which was tremendous in those days. Obviously, this created malinvestments because a tremendous amount of capital flowed into Britain. There were examples of railroads being built to places that didn't need railroads. So, in many ways, this could foment a bubble.

12:53There was a law passed in Argentina, the law of 16 November 1863, which said that any guarantee The guarantee entered into the government was considered sovereign debt. So that took it up another level. So you actually, under the system, by holding debt of a private company in Argentina that had a guarantee, you had the same creditor status under Argentinian law as sovereign debt holders. So again, this was an incentive towards malinvestment. In the 1870s and the 1880s, there was a massive inflow of British capital into Argentina. And I wish I could show you a graph but it's parabolic and then it crashes like many bubbles. So on top of that, there was limited liability banking.

13:42For the very first time in Britain in 1858 and 1862, there was, banks were granted limited liability status and this led to a huge move into the financial sector by many business 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.

14:28guarantees to places like Argentina which guaranteed handsome returns. So I believe that the combination of limited liability banking with these guarantees in many ways contributed to the capital bubble that was built in Argentina, mainly built on the back of railroads, which eventually crashed in 1890 and it was called the Bearings Banking Crisis, and it led to a worldwide depression. Based on what I found, again, I feel that private British investors found that investing overseas was relatively, or that they were likely able to guarantee their property rights overseas for various reasons.

15:19They were able to communicate with these areas much faster. They were able to invest in companies which had British management teams and British engineering teams and that they could speak with representatives in London. Also there was the advent of free trade, the advent of private bondholders associations and then again limited liability banking combined with concessions made to British foreign capital made investing overseas relatively profitable and seem relatively safe. That's it. Thank you so much.