Monday, February 06, 2012

That's What I Want

Harvard-based historian Niall Ferguson is something of a bête noire for people on the left of the political spectrum. His unabashed affection for America and the capitalist system, along with accusations of Imperial apoligism, are frequently cited as reasons why this Scottish academic is not deserving of the celebrity he has achieved, both in the UK and across the pond. Anybody who has taken the trouble to read him in his own words, however, knows that Ferguson is a much more dispassionate observer than these labels imply.

Ferguson is a prolific writer and programme maker with a seemingly inexhaustible passion for his subject. He also has a tendency to think big - titles such as Empire, The Ascent of Money and Civilisation make clear his aim to address the 'dominant narratives' that have shaped global history over the past 500 years. This is the sort of storytelling for which the adjective sweeping was made to apply.

The Ascent of Money, punning on the title of Jacob Bronowski's famous book and BBC TV series The Ascent of Man, tells the story of 5,000 years of financial history, drawing parallels between past events and the 2008 global financial crisis, which was still in its infancy during the period when Ferguson was researching and writing his book.

The book begins in Ancient Babylon, which is widely believed to be the first place to accept the of idea of currency as a store of value and a form of exchange. The story then moves to Renaissance Italy, where so many of the financial innovations that have come to define the modern world took root. Mathematicians such as Leonardo Fibonacci (perhaps most famed for the Fibonacci Number Sequence, which recurs with peculiar frequency in nature) were responsible for introducing the Arabic number system, which was far better suited to modern accounting practices than the existing system of Roman numerals.

Venice was also home to perhaps the most readily recognisable money lender in Western literary history - Shylock - whose demand for his "pound of flesh" is reflective of a deep seated animus between creditors and debtors, which persists to this day. Despite the fact that Antonio refuses to pay his debt, it is Shylock who is the victim of humiliation and punishment, eventually being forced to undergo a Christian baptism to absolve him of his sins. Though illegal under Papal Law, usury was permitted in 14th century Europe, provided it was between Jews and Gentiles. But money lenders from ethnic minorities were always vulnerable to default. The solution was to realise that, in the world of finance, small is rarely beautiful. Banks were another invention of the Italian Renaissance. The Medici family built an empire based on foreign currency exchange that would become a seat of political and economic power for centuries to come. The family's history was written by Machiavelli, the "supreme theorist" of political power, and its patronage of the arts and sciences "ran the gamut of genius" from Michelangelo to Galileo.

The third great innovation described in The Ascent of Money is the bond market. The story Ferguson tells is dominated by a boy born into a Frankfurt ghetto whose wealth and influence would make his name infamous - Nathan Rothschild, who, along with his four brothers, dominated 19th century finance. According to Ferguson, it was Rothschild who enabled the British (along with German and Dutch) troops, led by the Duke of Wellington, to defeat Napoleon's army at the Battle of Waterloo. Although, it was very nearly a different story. Rothschild backed the British and bought an enormous amount of gold to be shipped to Wellington at the front line, in anticipation of a typically long Napoleonic War. It was a near fatal miscalculation. The conflict was over in a matter of days and Rothschild was sat on a pile of gold nobody needed. Faced with the prospect of massive losses, he made an audacious bet and started buying British government bonds. His gamble was that a British victory and the prospect of lower government borrowing would result in increased demand for government bonds. Rothschild held his nerve for another year pocketing some £600 million in inflation adjusted money in the trade.

The world capital of financial innovation in the 17th century was Amsterdam, but perhaps "the single greatest Dutch invention" was the joint-stock company. This financially superior model of ownership is what enabled the Dutch to dominate the spice route with the world''s first public sector corporation, the Dutch East India Company, at least until the British adopted the same system. Investors could now receive dividends for an equity share that could itself be traded, but if there is one thing everybody knows it is that shares can go down as well as up. The world's first stock market bubble was apparently the work of a Scotsman called John Law, a convicted murderer and prison escapee who took what he learned in Amsterdam to Paris, where he gained control of the French central bank and several colonial investment vehicles and was responsible for a policy of massive "capital expansion", which he convinced better off Parisians to invest in colonial investment vehicles, which he made available by simply liquidating new shares. The inevitable consequence, once French nobles, dukes and royalty cottoned onto the con, was to unleash an inflationary crisis that, in Ferguson's view laid the groundwork for the resentment that would eventually lead to the French Revolution. He also holds to the view that the mistrust of financial markets Law engendered significantly retarded French investment in industry and was probably a consequence for its slower rate of industrialisation, as compared to Britain.

Scottish people the world over are known for their parsimoniousness. But it is a cruel joke of history that the origin of modern actuary insurance should conform to such an unfair national stereotype. Created by a pair of Scottish Presbyterian priests whose unerringly accurate mathematical models for calculating life insurance premiums, Scottish Widows became a massively successful business and gave birth to the global insurance industry. Ferguson also addresses the rise of what might be called public insurance; typically referred to as the Welfare State. Commonly regarded as an idea that was "Made in Britain" by a liberal Labour government, the world's first welfare state was actually introduced in a newly unified Germany in the 1880s where Bismark saw the benefit of the system as maintaining a fit and loyal workforce who could be conscripted into the armed forces at a moments notice. Also, it was post-war WWII Japan that increased the size of its welfare state the most, and post 1990-bubble Japan that is the unfortunate prototype for what Western governments might face if public sector debt is not brought under control.

Ferguson also challenges the idea that investment in property is "as safe as houses". He explains the origins of the subprime mortgage crisis in the US housing market, which was exacerbated by the practice of securitisation that enabled banks to package these "bad debts" with other financial "products" to create collateralised debt obligations or CDOs, which were, in turn rated Triple A (the same as US government treasury bonds), all egged on by a Federal Government convinced that universal home ownership was a universal good. When the people who had taken out what were in some cases 100 percent mortgages, with no assets, no job and no income of any kind, started to default, it led to what became known as the credit crunch and eventually the global financial crisis.

The final chapter in The Ascent of Money details precipitous waves of financial globalisation. The gunboat capitalism of the British Empire, which forced China (among others) to open its borders to foreign capital flows; the much debated role of the IMF and World Bank in supporting the global capitalist system; and finally, the emergence of a new breed of lightly regulated financial institution known as hedge funds, which have made individuals such as George Soros rich beyond the dreams of avarice. The final chapter also discusses the mysterious 'black box' trading in credit default swaps, which emerged in the 1990s and led a new breed of traders known as 'quants' to fool themselves and others into thinking they had developed a guaranteed way to make money; a kind of perpetual motion machine for trading stocks. Using a complicated formula known a Value at Risk to assess when was the best time to buy an option and at what price, these would-be astrophysicists made billions and then lost even more billions before the whole edifice came crashing down around their ears, the fallout from which was more severe than any the world had ever known because finance truly was now part of a global system.

When a financial butterfly flaps it's wings in Beijing, you really do indeed get a hurricane in New York. But the area of the world that was least affected by the crisis was China, which, in an odd turn of events has, over the last 30 years, become the Eastern creditor to the debtor nations of the West; while the Americans spent, the Chinese saved, a fact that may have enormous geopolitical implications.

Ferguson's conclusion is surprising prosaic, drawing on the hackneyed metaphor of financial markets as type of Darwinian evolutionary system, but he pulls it out of the fire with some more pragmatic thoughts about people's almost incurable inability to assess risk and our tendency to be "fooled by randomness". Ferguson writes with alacrity and wit throughout and brings makes what could quite easily be a dry and technical subject to life.


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