Canton System and Hong Merchants

It is understandable to presume, when the world first became better connected by trade, that this trade was an unregulated free-for-all. However, though governments then might have been weaker than those of today, they were if anything even more motived then than now to regulate and control trade. This was true in Europe, where governments often gave official monopolies to massive trading companies, and in Asia, where authorities restricted trade, often limiting it to favored parties in particular cities on the outskirts of empires. In Canton, these sets of restrictions overlapped until the old ‘Canton System’ came to a rapid end in the mid-19th century.

Canton System

In the late 18th and early 19th century, Western trade with China was growing rapidly. This trade was conducted by the old European trading companies, like the British East India Company and those of countries like Sweden and Denmark, along with individual merchants, both European and American, who operated outside the monopoly. They did so by importing Chinese goods into countries without their own trading companies or by trading within Asia. Western merchants were most interested in tea but also bought rhubarb, silk, spices, and handcrafted articles like tortoise shell combs, china plates, and lacquer trays for sale abroad. However, during the past several centuries, China oscillated between degrees of openness and closedness to outsiders.

The southern port of Canton, or Guangzhou, was the center of Western trade with China. By law, European trade was restricted to this city from 1757 until 1842, however, it had already been a thriving commercial center before then, in part because of its proximity to Macao, not too far to its south, where foreign trade was confined in an earlier era.

Along with limiting foreign merchants to one city, the Chinese government had imposed restrictions on who the foreigners could hire as interpreters, suppliers, and pilots and regulated which local merchants they could trade with. Essentially, authorities licensed those who could have practically any contact with foreigners and all trade had to be conducted under the watchful eye of local officials. This strict control over external trade in China, centered on Canton until the mid-19th century, was known as the ‘Canton System’.

‘View of the Canton Factories’, Painting by William Daniell (c. 1805-10)

Hong Merchants

The government authorized specific local merchants in Guangzhou to trade with foreigners, the hong merchants. They were given these licenses to act as exclusive agents to intermediate all trade with foreigners in exchange for a large fee paid to the government. Together, these merchants formed a guild called the Co-hong. The hong purchased the products of foreigners and arranged exports of Chinese goods. They were charged with guaranteeing the good behavior of foreign merchants including making sure they paid customs duties.

While controlled, there were usually sufficient hong merchants given the privilege of trading to allow for some competition. Efforts to fix prices arose but were usually short-lived. Still, local merchants could amass huge fortunes. One Hong merchant, Houqua, amassed a fortune equal to $26 million making him one of the wealthiest men in the world. The hong maintained relationships with foreign merchants as valuable as their licenses since both were crucial for success in trade.

From the middle of the 18th century to the middle of the 19th, trade grew quickly; the numbers of ships visiting Canton each year chart the growth. In the 1760s, just twenty foreign ships visited China; this rose to fifty by the 1790s, seventy in the 1810s, and more than 180 in the 1830s. Guangzhou developed an industry around trade as victualling, or supplying ships, became a big business as did guiding foreign ships into Canton, a city slightly inland. Pilots guiding ships up the Pearl River might employ crews of sixty to seventy by the early 1800s as ships got larger.

Foreign Merchants

Exports of opium to China, largely from India, allowed British and to some extent other merchants to accumulate the profits in Chinese currency with which to buy Chinese tea for sale abroad. Opium was banned but by bribing officials, contraband could be imported. In any case, foreign merchants relied on hong merchants to arrange their trade and a combination of European and Chinese banks to finance it on credit. Foreign and hong merchants alike operated out of the ‘Thirteen Factories’ area of Guangzhou; in the case of foreigners, they were confined to this area.

A foreign community of commission agents, essentially brokers, also lived in Canton. Some may have traded with their own ships or owned warehouses but others simply rented rooms and space in the holds of others’ ships. These agents charged a fee to broker trade and also raised money abroad that could be invested in China.

Financing

Despite the controls that regulated trade, there developed in Canton a large capital market for merchants, whether Chinese or foreign. Regulations made it illegal for Chinese to borrow money from foreigners but this happened anyway. Chinese merchants lent to foreign merchants including the officers and crews of merchant ships carrying out their own private trade but the creditors included not only Chinese but fellow foreigners and borrowers in this market included both Western and Chinese merchants.

Credit was an important dimension to the business relationships between hong and foreign merchants. Deals between merchants often included credit, often on favorable terms, making stand-alone ‘market prices’ a bit murky. This suggests a less than liberal market for financing, one in which merchants often had to do business with parties that could also offer loans.

Lending often took the form of bottomry, a loan combined with insurance. Unlike a conventional loan, a bottomry bond did not have to be repaid if a ship was lost at sea. Someone might mortgage their ship with a bottomry bond and have essentially insured their ship against loss. This was not cheap; interest rates could be as high as 40% per voyage even for ships not leaving Asia. Interest on a bottomry bond was levied per voyage rather than per month or year.

One Swedish merchant, Jean Abraham Grill, developed a diverse portfolio of such loans in the 1760s. It was common for investors to pool their money and write a single large contract covering several vessels. Individuals in Europe were investing in bottomry loans in Canton through local correspondents.

Besides bottomry, foreign merchants could secure ordinary loans in Canton at between 10% to 12% per year. There was a financial community raising ordinary loans on good credit and relending this money to Chinese merchants at rates of 18% to 36% per year or making bottomry loans at 40% interest per voyage. European merchants could generally offer better security for their borrowing than Chinese merchants and so could borrow at lower interest rates. Jean Abraham Grill, together with fellow Swede Jacob Hahr, developed a business borrowing money at 10% to 12%, largely from Portuguese residents in nearby Macao and relending it to Chinese merchants at 20%.

An especially prominent foreign financier in Canton and Macao was the Armenian Matheus Johannes. He amassed a fortune offering financial and commercial services to the foreign trading companies, private traders, and local merchants. By the time of his death, his fortune exceeded the public budget of Macao and the government there blocked the transfer of his estate out of the city for fear that would wreck the economy.

Treaty of Nanking

Business continuity in Canton had always been threatened by war. War, largely between European countries, would reduce trade volumes and cut off foreign markets temporarily. This strained foreign and hong merchants alike though the disorder could benefit those foreign merchants from non-belligerent countries. Nonetheless, war would force some merchants to secure emergency loans as revenues fell.

The war that ultimately ended the Canton System was the First Opium War. This was a war which began in part because of British exports of opium into China, a product banned in China, and otherwise because of trade restrictions imposed by the Chinese on a growing population of largely British merchants. British firms momentarily abandoned Canton and relied on American firms in the meantime.

Once the fighting ended with the Treaty of Nanking, China was required by the terms of the treaty to open more ports to foreign traders and so five new ‘treaty ports’ were designated. With this, the special status of Canton was diminished and the Canton System abolished. The hong monopoly was no more and the Canton neighborhood of Thirteen Factories was destroyed in the war. The relative importance of Canton was also falling on account of the fact that products like tea, porcelain, and silk could now be acquired elsewhere in the world.

Lesson

The Canton System was in multiple respects emblematic of an era of restricted trade. Firstly, much of the long-distance trade was controlled by monopolistic trading companies; private traders resorted to operating in niches outside the official monopolies. They also had to work through the restricted environment that was the Canton System. However, there was a power imbalance in favor of the Europeans that grew with time, just as Europe was favoring free trade over protectionism. The old monopolies were abolished and the Opium Wars fought to open more of China to trade. Thus, the end of the Canton System represented the end of an era in economic history, both in Europe and Asia.

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Read about the role of agency houses in the India trade, those Brits enriched by trade in Asia, and the private trade conducted by ship crews. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.