Friday, December 2, 2011

The Ascent of Money

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Title: The Ascent of Money – A Financial History of the World
Author: Niall Ferguson
Publisher: Penguin 2009 (First published: 2008)
ISBN: 978-0-141-03548-2
Pages: 362

A book long overdue..was my first impression on getting hold of the book and a quick rustling through the pages. Very few authors try this bold initiative to bring out the horrendous mass of data and facts behind the most ubiquitous invention of civilization – money. Niall Ferguson is one of Britain’s most renowned historians. He is a professor of history and a best selling author, combined in one person – another unique combination. Realizing that money is a lot more interesting to handle rather than pondering over it, and the sheer drudgery of most books on finance, this one is refreshingly original. The author also writes in newspapers and journals and has presented four highly successful television documentary series. The combination of sarcastic wit and insightful reading has produced one of the best results in the field so far.

Credit and debt are among the most essential building blocks of economic development. It enabled man to transcend the frontiers of his village or tribe and to reach other societies, nowadays situated half way around the globe. Evolution of banking was the first step in the ascent of money. Those who blindly oppose the financial institutions conveniently forget the fact that poor people are impoverished by the absence, rather than the presence of banks. In the absence of easy credit, the poor fall victim to the hideous devices of usurers and loan sharks. Traces of banking goes back to the second millennium BCE in Mesopotamia. The system flourished in the renaissance era in Italy. In Florence, where the renaissance produced its finest blossom, the Medici family, who were also the patrons of Da Vinci, were actively engaged in banking and politics. Strength in both the fronts was essential in those days to survive. Soon, the fashion spread to other parts of Europe, creating Amsterdam Exchange Bank (1609), Stockholms Banco (1657) and Bank of England (1694). Inexperience with banking lay behind the frequent bankruptcies of Spain, though it was endowed with mountains of silver collected from the New World. Spain effectively let the banks in Holland to manage their credit. Printing of notes were vested with central banks and fortified by the gold standard, by which banks were obligated to replace bank notes with a quantity of gold and hence had to keep a gold reserve in proportion to the notes in circulation. This bottleneck on finance was finally removed in 1970 in the U.S.

Bond market was the second step in the ascent of money. As usual, its origins can also be traced to medieval Florence. The Italian city states were always quarrelling with each other, and the states fought amongst themselves by military contractors, called Condottieri who had to be paid in cash. Contribution from the elites and public were sought, with a guarantee of annuities for the amount. The bonds originated like this. However, the bond is still only a promise and the ability of the state to pay the interest is one of the factors determining the price of the bond. The variation in price leads to differences in yield, effectively causing the bond market yield to control long term interest rate in the economy. Nathan Rothschild was a clever investor who made millions from the bond market in the aftermath of Napoleonic wars. His mastery of the ways and the brutality over his enemies had earned the nickname of ‘Bonaparte of Finance’ to himself. History also shows that bonds dictate the outcome of wars. In the American civil war, South’s cotton backed bonds failed to impress European investors, after the South’s only port at New Orleans came under Union forces’ occupation. Lack of money for war effort hampered the South’s efforts, which was made extremely worse by the hyperinflation set in soon after it resorted to printing paper money to cover the lack of revenue from bond market.

The third step in the ascent was the invention of joint-stock, limited-liability company. This, however, originated in Holland in the 17th century. Spice trade with the east over newly found trade routes around Africa was extremely lucrative and dangerous. Large capital was required for organizing journeys and traders began to pool their resources for a voyage. The capital was repaid to the investors when the ship returned. In 1602, the Dutch East India Company, named VOC was formed which issued shares to the public which was non-repayable for ten years. In 1612, when it was due, the repayment was postponed indefinitely, forcing the investors to sell them to another investor for realizing money. Thus was created the first stock market. Bubbles were an integral feature of stock markets and the first known occurrence of a stock bubble was in 1719 in France, when the Mississippi company stocks burst after a profound rally. Thousands of investors lost their money and it indirectly caused an aversion of the French people to stocks and financial markets for many decades thereafter.

The fourth step was the formation of insurance and the assimilation of risk by another party. Robert Wallace and Alexander Webster, two Scottish clergymen instituted a fund to fend for widows and underaged children of fellow ministers dying in harness. The company still exist today, even though the growth has been phenomenal over the centuries and is called Scottish Widows. Today’s insurance companies invest their collected premiums in other financial markets, like the stock market. Insurance is in fact a fund, the need for which arises from a chance event whose probability can be estimated in advance. Welfare state was a concept complimenting that of insurance, in which the government takes the liability of ensuring income to old age people in lieu of their savings to the corpus during their productive careers. Increased allocation to social security measures from taxation in developed countries are causing stagflation in their economies. Hedge funds is another option to guard against future risk, but it is open only to large business houses.

Investing in housing and real estate is a hallmark of the English-speaking peoples. The ratio of people who own their own residences are greater in those countries. Housing as a safe avenue for investment is jeopardized by the subprime mortgage crisis which engulfed the American system in 2007, which ultimately led to collapse of banks, hedge funds and resulting finally in recession. Collective financial propositions like the microfinance, which revolutionized the rural landscape in developing countries provide attractive investment options for the underprivileged. A part of the success of microfinance movements was extending credit to housewives, rather than their husbands, who in many cases proved to be credit risks, in fact.

The author concludes with a chapter on financial history after industrial revolution. Cheap transport paved the way for globalization of markets. The rising protest of the pre-industrial nations culminated in the disastrous first world war. Declining agricultural prices and soaring industrial output had dramatically widened the gulf between the nations which pursued a policy of global coverage and the conservatives who stuck to their preconceived notions. Almost hundred years after the first world war, globalization is still the most opposed financial concept, but the roles have reversed. The centre of financial acumen has shifted to China in the east. China calls the shots and controls the interest rates in the U.S. To keep renminbi – their currency – cheap, they accumulate dollar in every market, ratcheting it up. A strong dollar caused lower rates of interest in U.S., resulting in speculation and channeling of money to subprime mortgages. Ferguson coins the term Chimerica, to refer to the duo of Chinese and American economies which are so intertwined at present. The eastern side, China, saves the money and the west continues to indulge in spending. This may soon turn out to be chimera, should antagonism develop between the two great powers.

In the afterword provided in paperback editions, the author compares financial history to evolution, citing similar environmental and developmental factors. All recipes are in place in finance, like mutation and selection. Regulators and public sentiment form the environment on which organisms flourish. Several firms may die out, unable to compete with their neighbours in changing environments, while the fittest survive. Finance is like a mirror of society. If the face appears unattractive, that must be ascribed to the blemishes of individuals, rather than to the mirror.

The book is quite easy to read, at least the first half. It follows a structured approach, with each episode in the history of financial institutions neatly packaged into self-contained chapters. A casual reader can go through a single chapter, without reading the preceding and succeeding portions and could still come out with an enjoyable read. The author’s commendable effort in putting together two millennia of financial history in a book intelligible and appealing to ordinary readers is superbly successful. It may also be pointed out that in the second half of the book, the thread slightly gets knotty, raising financial jargons every now and then.

One serious disadvantage is the total neglect of financial institutions developed anywhere other than Europe. The author condescension to ascribe to Mesopotamia, the birth place of banking seems to be the result of his inner conviction that the Europeans owe their cultural continuity to those ancient people. India and China had experience with financial instruments many centuries before the European renaissance, but the total blackout to such events restricts the utility of the work as an authentic and comprehensive description of the world. It may well be worthwhile for Ferguson to remember that Asia also forms a part of the world, though not in the financial scale as its inhabitants want it to be. The financial lexicon is cumbersome at some places, the lack of glossary making it compounded.

The book is highly recommended.

Rating: 3 Star

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