The Ascent of Money

"I really enjoyed it. I had to read it for uni, but it's got some really good content in it (some more interesting than others) but I reccommend everyone try it."

"Niall Ferguson's "The Ascent of Money" is another incredibly wide-ranging and thoroughly comprehensive account of economic development from early coinage to high speed quant trading. Impossible to summarize, so I've just included some of the more interesting, insightful, and controversial passages below (sorry for the length - but there's a lot of stuff in here!) Didn't give this book 5 stars though because I've heard tell (and am now investigating) that some of Ferguson's claims about the financing of the Confederacy during the Civil War are just blatantly false.<br/><br/>########################<br/><br/>Or they could plunder precious metal by making war on the Muslim world. The Crusades, like the conquests that followed, were as much about overcoming Europe’s monetary shortage as about converting heathens to Christianity<br/><br/>Money is worth only what someone else is willing to give you for it. An increase in its supply will not make a society richer, though it may enrich the government that monopolizes the production of money. Other things being equal, monetary expansion will merely make prices higher.<br/><br/>Money is not metal. It is trust inscribed.<br/><br/>To discover modern finance, Europe needed to import it. In this, a crucial role was played by a young mathematician called Leonardo of Pisa, or Fibonacci. The son of a Pisan customs official based in what is now Bejaia in Algeria, the young Fibonacci had immersed himself in what he called the ‘Indian method’ of mathematics, a combination of Indian and Arab insights. His introduction of these ideas was to revolutionize the way Europeans counted.<br/><br/>The real key to the Medicis’ success, however, was not so much size as diversification. Whereas earlier Italian banks had been monolithic structures, easily brought down by one defaulting debtor, the Medici bank was in fact multiple related partnerships, each based on a special, regularly renegotiated contract. Branch managers were not employees but junior partners who were remunerated with a share of the profits. It was this decentralization that helped make the Medici bank so profitable<br/><br/>It was in Stockholm nearly half a century later, with the foundation of the Swedish Riksbank in 1656, that this barrier was broken through. Although it performed the same functions as the Dutch Wisselbank, the Riksbank was also designed to be a Lanebank, meaning that it engaged in lending as well as facilitating commercial payments. By lending amounts in excess of its metallic reserve, it may be said to have pioneered the practice of what would later be known as fractional reserve banking, exploiting the fact that money left on deposit could profitably be lent out to borrowers.<br/><br/>Indeed, the Spanish crown ended up defaulting on all or part of its debt no fewer than fourteen times between 1557 and 1696<br/><br/>Bankruptcy may have been designed to help entrepreneurs and their businesses, but nowadays 98 per cent of filings are classified as non-business. The principal driver of bankruptcy turns out to be not entrepreneurship but indebtedness. In 2007 US consumer debt hit a record $2.5 trillion. Back in 1959, consumer debt was equivalent to 16 per cent of disposable personal income. Now it is 24 per cent.<br/><br/>After the creation of credit by banks, the birth of the bond was the second great revolution in the ascent of money<br/><br/>The bond market began by facilitating government borrowing. In a crisis, however, it can end up dictating government policy<br/><br/>The ability to finance war through a market for government debt was, like so much else in financial history, an invention of the Italian Renaissance<br/><br/>A new standard was set by their 1818 initial public offering of Prussian 5 per cent bonds, which - after protracted and often fraught negotiationsm - were issued not only in London, but also in Frankfurt, Berlin, Hamburg and Amsterdam.30 In his book On the Traffic in State Bonds (1825), the German legal expert Johann Heinrich Bender singled out this as one of the Rothschilds’ most important financial innovations : ‘Any owner of government bonds . . . can collect the interest at his convenience in several different places without any effort.’<br/><br/>The finances of the Confederacy are one of the great might-have-beens of American history.39 For, in the final analysis, it was as much a lack of hard cash as a lack of industrial capacity or manpower that undercut what was, in military terms, an impressive effort by the Southern states. At the beginning of the war, in the absence of a pre-existing system of central taxation, the fledgling Confederate Treasury had paid for its army by selling bonds to its own citizens, in the form of two large loans for $15 million and $100 million. But there was a finite amount of liquid capital available in the South, with its many self-contained farms and relatively small towns. To survive, it was later alleged, the Confederacy turned to the Rothschilds, in the hope that the world’s greatest financial dynasty might help them beat the North as they had helped Wellington beat Napoleon at Waterloo... Yet the South’s ability to manipulate the bond market depended on one overriding condition: that investors should be able to take physical possession of the cotton which underpinned the bonds if the South failed to make its interest payments. Collateral is, after all, only good if a creditor can get his hands on it. And that is why the fall of New Orleans in April 1862 was the real turning point in the American Civil War. With the South’s main port in Union hands, any investor who wanted to get hold of Southern cotton had to run the Union’s naval blockade not once but twice, in and out. Given the North’s growing naval power in and around the Mississippi, that was not an enticing prospect<br/><br/>Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country’s political economy<br/><br/>[During hyperinflation] Only entrepreneurs were in a position to insulate themselves by adjusting prices upwards, hoarding dollars, investing in ‘real assets’ (such as houses or factories) and paying off debts in depreciating banknotes.<br/><br/>[Regarding bubbles] So familiar is this pattern that it is possible to distil it into five stages: 1. Displacement: Some change in economic circumstances creates new and profitable opportunities for certain companies. 2. Euphoria or overtrading: A feedback process sets in whereby rising expected profits lead to rapid growth in share prices. 3. Mania or bubble: The prospect of easy capital gains attracts first-time investors and swindlers eager to mulct them of their money. 4. Distress: The insiders discern that expected profits cannot possibly justify the now exorbitant price of the shares and begin to take profits by selling. 5. Revulsion or discredit: As share prices fall, the outsiders all stampede for the exits, causing the bubble to burst altogether.<br/><br/>Finally, and most importantly, without easy credit creation a true bubble cannot occur. That is why so many bubbles have their origins in the sins of omission or commission of central banks<br/><br/>No stock market has out-performed the American over the long run. One estimate of long-term real stock market returns showed an average return for the US market of 4.73 per cent per year between the 1920s and the 1990s. Sweden came next (3.71), followed by Switzerland (3.03), with Britain barely in the top ten on 2.28 per cent<br/><br/>For these reasons, it made sense for merchants to pool their resources. By 1600 there were around six fledgling East India companies operating out of the major Dutch ports. However, in each case the entities had a limited term that was specified in advance - usually the expected duration of a voyage - after which the capital was repaid to investors.10 This business model could not suffice to build the permanent bases and fortifications that were clearly necessary if the Portuguese and their Spanish alliest were to be supplanted. Actuated as much by strategic calculations as by the profit motive, the Dutch States-General, the parliament of the United Provinces, therefore proposed to merge the existing companies into a single entity. The result was the United East India Company - the Vereenigde Nederlandsche Geoctroyeerde Oostindische Compagnie (United Dutch Chartered East India Company, or VOC for short), formally chartered in 1602 to enjoy a monopoly on all Dutch trade east of the Cape of Good Hope and west of the Straits of Magellan<br/><br/>As was true of the English East India Company, the VOC’s biggest challenge was the principal-agent problem: the tendency of its men on the spot to trade on their own account, bungle transactions or simply defraud the company. This, however, was partially countered by an unusual compensation system, which linked remuneration to investments and sales, putting a priority on turnover rather than net profits. Business boomed.<br/><br/>On 16 October 1929 Yale University economics professor Irving Fisher declared that US stock prices had ‘reached what looks like a permanently high plateau’.77 Eight days later, on ‘Black Thursday’, the Dow Jones Industrial Average declined by 2 per cent. This is when the Wall Street crash is conventionally said to have begun, though in fact the market had been slipping since early September and had already suffered a sharp 6 per cent drop on 23 October.<br/><br/>Of all the lessons to have emerged from this collective effort, this remains the most important: that inept or inflexible monetary policy in the wake of a sharp decline in asset prices can turn a correction into a recession and a recession into a depression<br/><br/>The causes of the crash were much debated at the time. True, the Fed had raised rates the previous month from 5.5 to 6 per cent. But the official task force chaired by Nicholas Brady laid much of the blame for the crash on ‘mechanical, price-insensitive selling by a [small] number of institutions employing portfolio insurance strategies and a small number of mutual fund groups reacting to redemptions’, as well as ‘a number of aggressive trading-oriented institutions [which tried] to sell in anticipation of further market declines<br/><br/>We tend to think of the welfare state as a British invention. We also tend to think of it as a socialist or at least liberal invention. In fact, the first system of compulsory state health insurance and old age pensions was introduced not in Britain but in Germany, and it was an example the British took more than twenty years to follow. Nor was it a creation of the Left; rather the opposite. The aim of Otto von Bismarck’s social insurance legislation, as he himself put it in 1880, was ‘to engender in the great mass of the unpropertied the conservative state of mind that springs from the feeling of entitlement to a pension.’ In Bismarck’s view, ‘A man who has a pension for his old age is . . . much easier to deal with than a man without that prospect<br/><br/>In Japan, as in most combatant countries, the lesson was clear: the world was just too dangerous a place for private insurance markets to cope with. (Even in the United States, the federal government took over 90 per cent of the risk for war damage through the War Damage Corporation, one of the most profitable public sector entities in history for the obvious reason that no war damage befell the mainland United States.)<br/><br/>But these institutions worked in quite different ways in the two countries. In Japan egalitarianism was a prized goal of policy, while a culture of social conformism encouraged compliance with the rules. English individualism, by contrast, inclined people cynically to game the system. In Japan, firms and families continued to play substantial supporting roles in the welfare system. Employers offered supplementary benefits and were reluctant to fire workers. As recently as the 1990s, two thirds of Japanese older than 64 lived with their children.52 In Britain, by contrast, employers did not hesitate to slash payrolls in hard times, while people were much more likely to leave elderly parents to the tender mercies of the National Health Service. The welfare state might have made Japan an economic superpower, but in the 1970s it appeared to be having the opposite effect in Britain<br/><br/>What went wrong in China between the 1700s and the 1970s? One argument is that China missed out on two major macroeconomic strokes of good luck that were indispensable to the North-West’s eighteenth-century take-off. The first was the conquest of the Americas and particularly the conversion of the islands of the Caribbean into sugar-producing colonies, ‘ghost acres’ which relieved the pressure on a European agricultural system that might otherwise have suffered from Chinese-style diminishing returns. The second was the proximity of coalfields to locations otherwise well suited for industrial development. Besides cheaper calories, cheaper wood and cheaper wool and cotton, imperial expansion brought other unintended economic benefits, too. It encouraged the development of militarily useful technologies - clocks, guns, lenses and navigational instruments - that turned out to have big spin-offs for the development of industrial machinery. Many other explanations have, needless to say, been offered for the great East-West divergence: differences in topography, resource endowments, culture, attitudes towards science and technology, even differences in human evolution. Yet there remains a credible hypothesis that China’s problems were as much financial as they were resource-based. For one thing, the unitary character of the Empire precluded that fiscal competition which proved such a driver of financial innovation in Renaissance Europe and subsequently. For another, the ease with which the Empire could finance its deficits by printing money discouraged the emergence of European-style capital markets.<br/><br/>At first sight, it may seem bizarre. Today the average American earns more than $34,000 a year. Despite the wealth of people like Wu Yajun and Yin Mingsha, the average Chinese lives on less than $2,000. Why would the latter want, in effect, to lend money to the former, who is twenty-two times richer? The answer is that, until recently, the best way for China to employ its vast population was through exporting manufactures to the insatiably spendthrift US consumer. To ensure that those exports were irresistibly cheap, China had to fight the tendency for the Chinese currency to strengthen against the dollar by buying literally billions of dollars on world markets - part of a system of Asian currency pegs that some commentators dubbed Bretton Woods II.109 In 2006 Chinese holdings of dollars almost certainly passed the trillion dollar mark. (Significantly, the net increase of China’s foreign exchange reserves almost exactly matched the net issuance of US Treasury and government agency bonds.) From America’s point of view, meanwhile, the best way of keeping the good times rolling in recent years has been to import cheap Chinese goods. Moreover, by out-sourcing manufacturing to China, US corporations have been able to reap the benefits of cheap labour too. And, crucially, by selling billions of dollars of bonds to the People’s Bank of China, the United States has been able to enjoy significantly lower interest rates than would otherwise have been the case<br/><br/>The point is that economies of scale and scope are not always the driving force in financial history. More often, the real drivers are the process of speciation - whereby entirely new types of firm are created - and the equally recurrent process of creative destruction, whereby weaker firms die out"