Was the Bank of Amsterdam the world’s first central bank?

The Bank of Amsterdam is to central banking history what Little Richard is to rock ‘n’ roll. While the public might like to think it was Elvis or the Fab Four that invented it, the purists know they merely popularised it.

Google “what was the first central bank in the world” and you’ll get Sweden’s Riksbank, but — as we found out from a Bank for International Settlements paper out on Tuesday — an increasing number of academics think that this honour should go to the Dutch lender.

The reason this matters is that economists at the BIS and elsewhere draw lessons from the Bank’s failure to come up with today’s policy conclusions.

The main arguments in its latest paper, An early stablecoin? The Bank of Amsterdam and the governance of money , posits that stablecoins are not fit for purpose and that central banks need a strong fiscal authority behind them.

Here’s how the BIS puts it:

First, rigid stablecoins are poorly suited as the foundation for a modern monetary system….

...In the case of the Bank of Amsterdam, it began life as a rigid stablecoin, but its public policy function at the heart of the financial system pushed it increasingly to taking on the role of lending (an elastic structure). Without the ability to lend, it could not have performed its central role in supporting the financial system and international trade as long as it did.

Our second key lesson is that for a central bank to play its role, the fiscal backing of the sovereign and its fiscal sustainability are essential....

The ultimate backing for the value of money is the solvency of the public sector — ie central bank solvency subject to the flow constraints in its interaction with the government. The Bank of Amsterdam’s failure is a vivid lesson in how a central bank that loses public trust can push its luck too far, beyond the threshold for failure.

We buy the first argument, we’re less sure about the reasoning that goes into the second.

Here’s the back-story in brief.

The Bank of Amsterdam was set up in 1609, almost 60 years before the Riksbank. It was fully owned by the city of Amsterdam and its coins fully backed by gold and silver.

According to the paper the Bank’s strong performance over more than 170 years, including through times of turbulence, helped to solidify trust in it as an institution. This drew attention from the likes of Adam Smith, who mentioned the lender in his seminal work The Wealth of Nations . Here’s an excerpt:

At Amsterdam, however, no point of faith is better established than that for every guilder, circulated as bank money, there is a correspondent guilder in gold or silver to be found in the treasure of the bank. The city is guarantee that it should be so.

Fiat Uno

All very stablecoin. Until 1683, when deposits were no longer fully backed by gold and silver — something which turned the lender into an issuer of fiat money, as central banks are today.

While it was able to survive bouts of political turmoil in spite of this, where the bank eventually ran into trouble was in its lending to the Dutch East India Company.

Its relationship with the Dutch East India Company began in 1615, just six years after the bank was founded. But the real problems came when panic arose and the company drew heavily on the lenders’ resources:

The outright lending to the [company] was in contravention to the charter of the Bank of Amsterdam, and such lending was not disclosed…

...In the Anglo-Dutch war, the Bank relied in particular on unsecured lending and on open market operations. During 1775—92, the Bank of Amsterdam maintained stable money balances through the provision of loans and purchase and sale of coins… However, when credit quality deteriorated due to the strains posed by war, this led to a more far-reaching failure of the governance of the Bank of Amsterdam. The volume of loans increased drastically and the Bank de facto became lender of last resort to [the company].

...The pivotal event was the shock of the Fourth Anglo-Dutch war (1780—84) which led to extensive naval confrontations between the Dutch Republic and England in several theatres of conflict — in European, West Indian and Asian waters. This conflict was an economic shock that strained [the company], which was the main borrower of the Bank of Amsterdam…

...With the conclusion of the war in May 1784, the Bank had accumulated a large credit exposure which soon [became] non-performing. The temporary shock had become one of chronic insolvency.

The problems became more pronounced as time went on, as the charts below show:

Which leads the paper to conclude:

The Bank’s insolvency, and the refusal of the city authorities to recapitalise it, are important elements in its downfall.

It finally closed in 1820*, five years after William I set up the Netherlands Bank, which exists to this day. This is a very short summary of the bank’s history — and we’d recommend reading the full paper, it’s fascinating. There are many other parallels with modern central banking too which we’ve left out.

Our quibble

So why are we quibbling with one of the conclusions?

Back to Little Richard. The story of rock ‘n’ roll began when he wailed Awop Babalooba Wap Bamboo because that same plaintive cry was later echoed in everything from Hound Dog to She Loves You. Yet the relationship between the Bank and the East India Company that was to prove its downfall sounds nothing like something a central bank would do today.

An excerpt:

Over time, such lending [to the company] in the form of overdrafts became a recurring activity. These overdrafts bridged the difference in timing between outgoing and incoming payments, often related to incoming and outgoing ship voyages, thereby providing working capital to [the company] in its trading activities.

This practice sounds suspiciously like trade and development finance to us. Essentially the Bank of Amsterdam offered a form of credit insurance. And while that was common practice for central banks back in the day to have important relationships with companies — see the Bank of England’s relationship with the East India Company — that is no longer the case.

The European Central Bank does not finance trade. The European Bank for Reconstruction and Development may do, but it is a completely different beast. And if you don’t buy the argument that it really was the first central bank, then it becomes more difficult to argue the same lessons apply.

By trying to apply the lessons of the Bank’s failure to the modern era, the paper overplays the degree to which recapitalisation actually matters. More recently history tells us much the same thing. Negative capital is something that many central banks — among them very well respected ones like the Bank of Israel and the Czech National Bank — have experienced without any reputational damage. For a currency to be credible, they need a sound sovereign behind them. But that does not necessarily mean that the central bank needs to be recapitalised.

The paper is not blind to this, noting that the Bank of Amsterdam lacked the seigniorage income — that is the cash flows from the production and distribution of notes and coins — which modern central banks have.

Yet the historical parallel falls flat in the sense that the bank did not run into trouble primarily because of the health of the sovereign and its lack of access to it. It ran into trouble because it bet the house on the fortunes of the Dutch East India Company, and its failure was therefore more like that of a private lender than a monetary guardian. It went bust because it lost sight of its core purpose, not because that purpose was inherently flawed in the first place.

*Corrected. Original article wrongly stated that the bank closed in 1720 and attributed this incorrectly to the BIS paper.