Show Me the Money

Stephen DeAngelis

December 9, 2008

When investing in real estate, the most oft given advice is to select the right location. In fact, “Location, location, location” is a real estate agent’s mantra. For many other of life’s activities, timing seems to be a critical factor. For Niall Ferguson, a Laurence A. Tisch Professor of History at Harvard University and William Ziegler Professor at Harvard Business School, the release of his new book, The Ascent of Money: The Financial History of the World, appears to be timed perfectly. People choking in the grasp of the current financial crisis are wondering how we got in this position and what we can do about it. Ferguson’s web site provides this synopsis of his new book:

“Bread, cash, dosh, dough, loot: Call it what you like, it matters. To Christians, love of it is the root of all evil. To generals, it’s the sinews of war. To revolutionaries, it’s the chains of labour. But in The Ascent of Money, Niall Ferguson shows that finance is in fact the foundation of human progress. What’s more, he reveals financial history as the essential back-story behind all history. The evolution of credit and debt was as important as any technological innovation in the rise of civilization, from ancient Babylon to the silver mines of Bolivia. Banks provided the material basis for the splendours of the Italian Renaissance, while the bond market was the decisive factor in conflicts from the Seven Years’ War to the American Civil War. With the clarity and verve for which he is famed, Niall Ferguson explains why the origins of the French Revolution lie in a stock market bubble caused by a convicted Scots murderer. He shows how financial failure turned Argentina from the world’s sixth richest country into an inflation-ridden basket case – and how a financial revolution is propelling the world’s most populous country from poverty to power in a single generation. Yet the most important lesson of the financial history is that sooner or later every bubble bursts – sooner or later the bearish sellers outnumber the bullish buyers – sooner or later greed flips into fear. And that’s why, whether you’re scraping by or rolling in it, there’s never been a better time to understand the ascent of money.”

A review of Ferguson’s book was recently published in the Washington Post [“Markets Don’t Make Bubbles, People Do,” by Shelby Coffey III, 30 November 2008]. Coffey, a senior fellow and trustee at the Newseum and former editor of the Los Angeles Times, begins his review with an experience from his own past.

“Big money is intoxicating. During the great bubble of the late 1990s, I escorted one of the newly really rich to be interviewed at CNN, where I headed the financial network. ‘I just made $400 million today,’ he boomed, taking the stairs two at a time. The air around him seemed charged with electric good fortune. Several years later, I saw him again. He was several billion dollars less wealthy. He seemed kind, more thoughtful, a touch fragile. (There are none of us so weak we cannot bear our friends’ misfortunes, as the acerbic French epigrammist has it.) The Really Rich man had become merely rich, and his pain seemed palpable. What would it be like, I wondered, to wake up thinking: I just lost $400 million yesterday? The curses and the blessings, the seductions and the traps of money give Niall Ferguson the most redolent of subjects for The Ascent of Money, his excellent, just-in-time guide to the history of finance and financial crisis.”

From the beginning, it’s clear that Coffey is going to give Ferguson’s book a good review.

“A lively writer (author of Empire and The War of the World), a professor of history at Harvard and a master of anecdote and aphorism, Ferguson says he took Jacob Bronowski’s hymn to human invention, ‘The Ascent of Man,’ as a model. Just as Bronowski’s 1973 BBC documentaries traced the beneficial impact of science and art, Ferguson shows how promises and paper have lifted humans from subsistence farmers in Babylon to Masters of the Universe on Wall Street. Among his core arguments is that ‘poverty is not the result of rapacious financiers exploiting the poor. It has much more to do with the lack of financial institutions, with the absence of banks, not their presence.’ Money, he contends, is essential to human progress; it is ‘trust inscribed’ on paper or metal, and without that trust we would all be poorer.”

That paragraph hits on two subjects I have written about before — access to credit and trust. As Coffey points out, the two subjects are inextricably connected. Credit requires trust. When Nobel Peace Prize winner Muhammad Yunus studied the poor near his university in Bangladesh, he realized that one of the things keeping them impoverished was a lack of access to credit. That is why he started his Grameen Bank and changed the lives of millions of people. He also demonstrated that the poor could be trusted — even more than the rich. The point is that Ferguson is correct, access to money (which really means access to credit) is essential to human progress and credit demands trust. Coffey continues:

“Right now in the dark autumn of 2008, comes the shadow of mistrust. It may fall over us at different times and places … somewhere between the relentlessly down-pointing red arrows on CNBC and the increasingly bitter 401(k) jokes of late-night comedians … between the latest Congressional testimony from used-to-be financial wizards and the lineup of bailout candidates winging to Washington, hands out. But who among us has not felt the chill? The financial system, Ferguson writes, ‘magnifies what we human beings are like … our tendency to overreact’ to booms and busts, enriching the ‘lucky and the smart, impoverishing the unlucky and not-so-smart.’ In this way, money is a mirror, and ‘it is not the fault of the mirror,’ he notes, ‘if it reflects our blemishes as clearly as our beauty.’ The pleasure of reading Ferguson’s treatment comes partly from the clarity of his explanations of financial concepts but mostly from his pen portraits of the extravagantly gifted and flawed characters who have led money’s long rise. He shows us how far we have come since Mesopotamian moneylenders developed rudimentary accounting around 1,000 B.C. and the Medici created elements of modern banking in 14th- and 15th-century Florence. But he also weaves a long series of manias, panics and crashes into his tale. The Medici family’s surviving papers, he notes, bear scorch marks from the vengeful reformist Savonarola, who set up a Bonfire of the Vanities to destroy sinful goods and sent the Medici packing in one of the periodic reversals of fortune to hit financial leaders over the centuries.”

It is the bursting of the housing bubble that makes the release of Ferguson’s book so timely. According to Coffey, Ferguson has a lot to say about bubbles.

“Ferguson sketches the rollicking career of John Law: Scottish con man, killer, genius, lover and creator, in 1719-20, of one of history’s great stock market bubbles. Law effectively took control of the French national debt, substituted paper currency for gold and sold shares in the company that controlled French Louisiana. As the shares rose in price and investors borrowed against them, the volume of paper money doubled in a year, breeding inflation, speculation and the new term ‘millionaire’ before Law’s system collapsed. From that day on, Ferguson writes, all bubbles have followed five stages: 1) Displacement, as economic change brings a chance for extraordinary profits; 2) Euphoria, as investors take advantage of the opportunity, 3) Mania, as novices, crowds and swindlers rush in; 4) Distress, as insiders see their prospects for profit declining because of the mania and start selling; and 5) Revulsion, as all stampede for the exits.”

What Coffey seems to enjoy most about Ferguson’s book, however, are the stories. He paints Ferguson as a master storyteller.

“Ferguson provides a more flattering portrayal of Nathan Rothschild, patriarch of the banking family and mastermind of empires. Nineteenth-century states needed to issue bonds to finance wars; Rothschild was at the ready. When Wellington defeated Napoleon at Waterloo, Rothschild made huge and risky bets on British bonds and secured his family’s dominance of the London market for half a century. When the Rothschilds turned down a plea to back the confederacy’s bonds, the fate of the Southern rebellion darkened irreversibly. ‘Money is the god of our time,’ declared the German poet Heinrich Heine in 1841, ‘and Rothschild is his prophet.’ From recent times, Ferguson gives deft summaries of the lives of Hernando de Soto, the Peruvian champion of property rights for the poor; Milton Friedman, the apostle of monetarism, who saw the supply of money as the key to the economy; and George Soros, the hedge fund philosopher and financier of liberal causes. I found myself understanding Soros’s theory of reflexivity for the first time. (Market prices, Ferguson explains, are ‘reflections of the ignorance and biases, often irrational, of millions of investors … [which] affect market outcomes, which in turn change investors’ biases, which again affect market outcomes’ — in short, reflexivity.)”

Coffey notes that the timing for the release of the book was not coincidence. Normally, historical texts take years to prepare, which means they rarely coincide with current events. Despite the breadth of the subject, however, Ferguson seems to have written this book quite quickly. Coffey continues:

“Judging from the text, Ferguson finished writing The Ascent of Money in mid-2008, after the sub-prime mortgage crisis had hit but before September’s credit freeze and the subsequent plunge in stock prices. As I turned his pages about the soaring trade in complex derivatives, I wanted to cry out to Wall Street: Don’t go down that road, the bridge is out! The shadow world of derivatives, credit-default swaps, the sales of U.S. bonds to China — all seem to bring brilliant results, until they get too big. Indeed, ‘Too Big to Fail’ is the catchphrase of this autumn. But the follow-up question is: How do we know that whatever institution is wearing that label doesn’t harbor a hidden cesspool of putrid assets? When should we withdraw our ‘inscribed trust?’ In a provocative afterword, Ferguson wrestles with ‘creative destruction,’ the benefits of allowing companies to fail and investments to sour. He doesn’t come to a definite conclusion, but he notes that viewing the financial world from an evolutionary perspective argues for weeding out what the political scientist Joseph Schumpeter called ‘the hopelessly unadapted’ — and quickly. ‘The experience of Japan in the 1990s,’ Ferguson comments, ‘stands as a warning to legislators and regulators that an entire banking sector can become a kind of economic dead hand if institutions are propped up despite underperformance, and bad debts are not written off.'”

Anyone familiar with the topic of innovation understands the concept of “creative destruction.” According to Wikipedia, “the economist Joseph Schumpeter popularized and used the term to describe the process of transformation that accompanies radical innovation. In Schumpeter’s vision of capitalism, innovative entry by entrepreneurs was the force that sustained long-term economic growth, even as it destroyed the value of established companies that enjoyed some degree of monopoly power.” One of the reasons I started Enterra Solutions® was because I could see that potentially profitable companies were becoming “hopelessly unadapted” because they were trying to solve information age challenges using industrial age solutions. As the pace of globalization speeds up, such companies find themselves with an increasingly unmanageable complexity gap. The business world, as Ferguson points out, is very Darwinian. Coffey concludes his glowing review:

“Ferguson has … written an admirably illuminating book that will take its place beside such modern classics as John Train’s The Money Masters, Peter L. Bernstein’s Against the Gods, and Adam Smith’s Supermoney. Fear, greed and folly — according to a Wall Street maxim, you always have them in the market. If only you knew in which order they come, then you could make some money. But past results, as investment companies sternly warn, are no guarantee of future returns, not in 2008. Money descends, too.”

The importance of Ferguson’s book is that it highlights how essential capital flows are for the success of globalization. The only way to bring millions of more people out of poverty is to create wealth. Ferguson’s book explains why financial systems are essential in that endeavor. When I brief people about Development-in-a-Box™, I always make a point of stressing the importance of developing trust. This is a particularly serious matter in places where no history of trust exists because no formal financial system conforming to international norms has been in place. I also stress the importance of basic investments that help build infrastructure, create jobs, diversify the economic base, and enhance human capital. Volatility may be a Wall Street broker’s best friend, but it is anathema for developing countries.