The Trafalgar Squeeze of Global Liquidity
The severity of financial crises is exacerbated by the lack of international liquidity or the absence of a global lender of last resort. This was evident during the Long Depression (1873–1896), the Great Depression (1929–1936), and, as we show in this paper, during the 1805–1806 crisis that followed the Battle of Trafalgar. The latter took Atlantic trade routes away from Spain and cut off Europe’s access to silver, the key high-powered money of the time. This silver shortage led the Banque de France to cut lending by nearly 50% within three months, deliberately tightening credit to hoard species and restore the value of its bank notes. In turn, no less than 20 Parisian banks failed, credit collapsed between 1804 and 1806 and European financial markets underwent severe stress, including rising silver prices and strained bills of exchange markets from Cadiz to Hamburg. The 1805–1806 crisis highlights how the economic costs of shortages in global liquidity can be amplified by the accumulation of currency reserves by central banks.
Vincent Bignon is an advisor for communication and economic content in the Communication directorate at Banque de France and an adjunct professor in the Aix-Marseille School of Economics at the University of Aix-Marseille.
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