The importance of trust in facilitating trade

Our Florentine merchant could now contact his banker to say that he wanted to buy wool in Amsterdam, and the bank would in return give him a letter of credit, in exchange for payment on account. This letter could have various stipulations, such as the maximum amount for the trade, how it would be paid (at once or in parts), what goods it could be used for, and so forth. The merchant would now travel to Amsterdam, and after selecting wool from a wool merchant, he would offer the letter or credit as payment. The Amsterdam merchant would happily exchange the wool for the letter because Florentine bankers were famed throughout Europe as being trustworthy when it came to money. The Amsterdam merchant could bring the letter of credit to his banker, who in turn would credit their account. Of course, the Florentine and Amsterdam bankers charged their respective clients—the merchants—for this service! It was good for everyone.

Periodically, Amsterdam bankers and the Florentine bankers would meet up to settle their accounts, but this was of no importance to the wool trader and wool merchant. Effectively, what was happening was that the Florentine and Amstel merchants were using the trust between their respective bankers to establish a trust relationship with each other—a very sophisticated idea when you think about it. This is why the letter of credit process remains a fundamental way of conducting business worldwide to this day.