Tuesday, April 3, 2012

From Gold To Bank Notes and Paper Currency: New Turkey ?

Ottoman Public Debt

By the mid-19th century the financial situation of the Ottoman Empire was precarious. The Empire had remained far behind from European technological progress and it was also not able to maintain the military strength it needed. Although the world was going through the early wave of globalization, which was giving a boost to world trade and capital flows, the Ottoman Empire was not able catch up with its pace. Economic and financial reforms were urgently needed.

The reform movements in the Ottoman Empire actually go back to the 18th century, however it was with the declaration of the Tanzimat Decree, which made way for a constitutional state in the Empire for the first time, when the reform movement entered a new phase in the sense that liberalism that rose and developed in Europe had begun to take steps in the Ottoman Empire. The Tanzimat period was to be one where European influence had a great influence not only on administrative and military, but also on economic transformations, although the latter lagged behind the general momentum of change.

Money was needed to finance the reforms. It was a time when the value of Ottoman currency was plummeting. When Sultan Mahmut II had ascended to the throne in 1808, one Pound Sterling was trading at 19 Piasters. When he died in 1839, the rate was 106 Piasters to one Pound Sterling. It was also a time when foreign borrowing was unimaginable in the eyes of those governing the Empire, because it was deemed synonymous with surrendering sovereignty. Hence, the only way left to create new resources was to imitate a European practice and print paper-money.

Printing Paper Money

The introduction of the first ever paper-money (in Turkish: kaime) took place in 1840. It had an interest of 12.5 percent, hence it was more a bond rather than banknote. It was to remain in circulation for 8 years, but the population found it hard to get used to this novelty. Soon its trading value fell 30-40 percent below its nominal value. Zafer Toprak explains the reason for the lack of confidence as follows: “In the West, banknotes were issued by strong banks authorized by the government. The banknotes in circulation were guaranteed by these banks. Furthermore, thanks to other tools of similar to money, there was an established confidence in paper. However, for the Ottomans money meant the gold and silver it contained rather than the imperial insignia on it. In an environment where even individual rights and freedoms were not secured and safety of life and property was questioned, it was extremely difficult to feel safe with paper money.”

One of the earlier Ottoman banknotes, which has a denomination of 100 Lira

The paper-money was followed by the adoption of a bi-metallic standard in 1844 and the establishment of Banque de Constantinople, a foreign currency regulating agency in 1845. Ethem Eldem states that these early measures had proved inefficient: “…mainly due to the fact that most of these innovations had remained at the level of —often contradicting— half-measures: the uncontrolled issue of paper-money had led to a disastrous depreciation of the kaimes while at the same time adding to the monetary chaos of the period; the 1844 monetary reform had been unable to eradicate the circulation of altered currency; and the Banque de Constantinople had been forced into bankruptcy by the government’s demand for cash advances which the insufficient capital basis and local resources of the bank had been unable to meet.”

The Crimean War of 1854-56 was a turning point in the history of the Empire, in the sense that for the first time ever Ottomans sided with two great European powers, Britain and France, fighting against Imperial Russia. The war ended with the signing of the Paris Peace Treaty in 1856, only one month after the Islahat Decree was issued by Sultan Abdülmecit. This decree introduced a number of reforms, including financial ones based on European support.

Foreign Borrowing

The Crimean War also marked the beginning of a period when the Ottoman Empire began to resort to foreign borrowing to finance its rapidly growing deficits. Additionally to attempting to finance the through repeatedly issuing new series of paper-money, the Sublime Porte took its first foreign loan in 1854. The £3 million loan, which was issued at a rate of 80 percent and an interest rate of 6 percent, was supported but not guaranteed by the British. It was the beginning of a series of loans obtained on European markets. The second one came in 1855, a £5 million loan issued at 102.6 percent with an interest rate of 4 percent and this time interests guaranteed by British and French governments. These were war time loans, Allies were supporting each other and therefore the conditions were favourable. Ethem Eldem comments: “Money was coming in at a much lower cost than when lent by local bankers; the temptation was strong to base the future of the Empire on the attractive prospect of a series of loans. Moreover, to a government that had decided to tie its destiny to a gradual process of integration with the West, it could easily be claimed that financial operations of this sort were bound to act as the cement of a future collaboration.”

The British and French governments were concerned about the stability of the loans they had given. In these early stages, there were not many concerns about the Empire’s ability to pack and in order to prevent any risk; the lenders selected the prime revenues of the Ottoman state as backing for the loans. In 1855, a commission was set up to control the expenditures and to verify the Treasury accounts. What pushed the Ottoman government down the debt spiral in this stage was that the money was not being efficiently, it was spent for irresponsible and useless projects such as building new palaces along the Bosphorus.

A third loan of £5 million was contracted in 1858 at a rate of 76 percent with an interest of 6 percent, but it was this time neither guaranteed nor supported by Western governments. It was supposed to be used for the redemption of paper money, but the government failed to realise this vital importance. Additionally, several foreign schemes to establish a firm control over Ottoman finances collapsed, which kept the European investors away from the Ottoman market. The Empire was in dire need for funds, but it was rapidly losing its creditworthiness. Soon the bubble burst and the state found itself in an intense financial crisis.

Sultan Abdülmecit died in 1861 and was succeeded by Sultan Abdülaziz. His Grand Vizier Fuat Paşa presented a formal budget in 1862 and also thanks to an encouraging report on the financial situation of the Empire drafted by the British commission, there has been an upturn in the financial situation. A new loan of £8 million, issued at 68 percent with an interest of 6 percent was organized successfully. It was intended for the once and for all redemption of the paper-money in circulation and managed to bring back confidence to the market. Behind this operation, there were two organizations, Deveaux and Co. from London and the Ottoman Bank. The latter was a small London based commercial bank, established in 1856, which had in time gained credibility in the Ottoman market. The Sublime Porte had decided in favour of this bank for organizing the 1862 loan, with the provision that French capital was to be included to its existing British capital. As Ethem Eldem wrote, Fuat Paşa’s plan was simple and sensible: “The prospect of having a foreign state bank was worrying enough, but practically unavoidable; however, dividing its capital between the French and the British was likely to minimize the risk of being completely ruled by the British alone.”

Imperial Ottoman Bank

The Ottoman Bank thus became a state bank and transformed into the Banque Impériale Ottomane (TR: Banka-i Şahane-i Osmani) in 1863. It had the privilege to issue banknotes, however it had no control over the financial decision making of the Empire. Foreign investors were disappointed by the fact that this bank was far from being able to constitute a mechanism of control over state finances; however its presence alone was still enough to create an atmosphere of security.

The Banque Impériale Ottomane organized two loans in 1863 and 1865, of £8 million and £6 million and at 71 and 66 percent respectively, both at an interest rate of 6 percent. Meanwhile, the paper-money in use was withdrawn from circulation.

The Ottoman government was now in a vicious cycle of debt. The new loans were being used for the payment of outstanding foreign and domestic debts. In addition to the foreign loans, the state was heavily involved in short-term borrowing from local bankers. There was also no incentive to bring this unhealthy situation to an end. Foreign investors, who were assured by the presence of the Banque Impériale Ottomane, had no intention to give up this lucrative business.

Announcement of the Imperial Ottoman Bank

Source: Ottoman Bank Archives

Over the five years between 1865 and 1870, foreign borrowing continued and the government contracted a debt of £86 million, which corresponds to 2.3 times the sums borrowed over the previous eleven years. However, due to low rates of issue, only half of this nominal value had been cashed in by the Treasury and most of it was used to redeem previous debts.

Between 1871 and 1874, five new loans were signed with a total value of £98.5 million. By then, 55 percent of the Empire’s budget was being absorbed by foreign debt. In May 1874, the Sublime Porte signed an agreement with the Banque Impériale Ottomane which extended this institution’s power in monitoring the revenues and expenditures. The government had agreed on harsher conditions in an attempt to restore western confidence in Ottoman bonds. A few months later the bank secured a £40 million loan at a very low rate of 40 percent.

Ottoman Finances Going Bankrupt

The agreement was, however, a futile attempt, since the Ottoman finances had already reached a point of insolvency. On 6 October 1875, the new Grand Vizier Mahmut Nedim Paşa issued a decree declaring that the payments on coupons would be reduced by half. By March 1876, payments ceased altogether and to make things works the troubles in Balkans resulted in the deposition of Sultan Abdülaziz and declaration of war by Serbia. The Empire was bankrupt and the investors in Europe were in panic.

The political situation was worsening rapidly. Abdülaziz’s successor Sultan Murad V was mentally unstable and had to be removed soon after his accession to the throne. He was replaced by Sultan Abdülhamit II. The Empire was at war with Serbia and there was a grave threat of Russian aggression. The threat became a full scaled war in April 1877. The Turco-Russian war ended in January 1878 with the defeat of the Ottoman Empire. The Congress of Berlin reduced the status of the Empire to a minor power in European politics.

Ottoman finances were already bankrupt and the war with Russia had put an additional pressure. Since organizing further foreign loans were impossible, the government resorted once again to printing paper-money. Three issues of paper-money within two years, totalling 1.8 billion piastres, caused a depreciation of paper-money by nearly 65 percent. By 1880, the paper-money had dropped to 10-15 percent of its original value.

The Sublime Porte was facing an urgent need to solve the problem of outstanding debts. With an agreement reached in November 1879 between the state and the local creditors, the problem of outstanding internal debts was solved to an extent by surrendering some indirect revenues to local creditors. Following the success of this arrangement, similar negotiations were started with foreign lenders as well. The negotiations led to the signing of the Muharrem Decree on 20 December 1881, which foresaw the establishment of the Ottoman Public Debt Administration (in Turkish: Düyun-u Umumiye), an organization of European bondholders (and through these bondholders, indirectly with the major powers of Europe except Russia) that was given the right to develop and collect taxes from some of the leading revenues sources of the Empire and direct them towards debt payments. The Muharrem Decree ceded irrevocably to the Ottoman Public Debt Administration, until the debt was liquidated, all the revenues from the stamp, spirits, fishing taxes, silk tithe, salt and tobacco monopolies as well as the Bulgaria tribute, surplus of Cyprus revenues and the revenues originating from Eastern Rumelia.

it was a great detriment to the sovereignty of the Empire, which had surrendered its rights over revenues and accepted unconditional control to foreigners, the establishment of the Ottoman Public Debt Administration proved to be successful in the sense that it restored the Ottoman creditworthiness. From 1886 to 1914, the government could secure another 23 loans, totalling £150 million at an average rate of issue of over 85 percent.

Furthermore, as Krasner wrote, “the council could –with the consent of the government- initiate measures that would improve more general economic conditions since a more prosperous Turkey would mean higher revenue collections.” It promoted the export of salt, introduced new technologies for the silk and wine industries and facilitated the development of railways in the Empire. Foreign capital started to enter the Ottoman market at an increasing rate and gained control of the most of the most crucial sectors of the economy. According to Eldem: “From the 1890’s on, Ottoman integration with Europe had started to take a substantially different course, much akin to imperialism.”

Despite the fact thatfore the Ottoman state managed to generate a budget surplus and to orderly pay its outstanding debt in the last two decades of the 19th century, rising military expenditures, especially after 1908, began to create serious problems again. Deficits appeared again and they had to be financed through further borrowing. By 1914, the outstanding debt of the government had reached £140 million, equivalent to nearly 60 percent of the Ottoman gross domestic product.

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