The Ascent of Money, a Darwinian View of Finance
A Financial History of the World – Trust, Confidence and Crisis
May 25, 2009
In The Ascent of Money Niall Ferguson provides a proper perspective of the Credit Crunch as part of more than three thousand years history of money and finance. It will be readily understood by anyone with an interest in the workings of the financial system. It also makes a good story and takes the reader from the earliest days of money to the complex, modern financial devices that few, if anybody, understand.
Dreams of Avarice: Money, Metal, Credit, and the Rise of Banking
Originally money was almost entirely based around coinage so that control of precious metals was a secret of wealth. Access to South American gold and silver made Spain wealthy but also led to its marginalisation as finance moved away from coinage to banking and the use of financial instruments based on promises and trust.
As Fergusson says in The Ascent of Money “Money is not metal. It is trust inscribed” and as this became understood money took new forms such as banknotes which in the United Kingdom bear the phrase “I promise to pay the bearer on demand the sum of ...” However the earliest forms of money were just such promises inscribed into clay tablets in Mesopotamia (modern Iraq) around 1650 BC.
Bonds, Trust and Interest Rates
Bonds were invented 800 years ago by the City-states of what is now Italy and have become the principal indicator of where interest rates should be set. Bonds are based on a promise, originally by governments, to repay a debt and to pay interest in the interim. The market for bonds depends on investors’ view of the risk of default. Debt issuer’s reputation can be undermined by default and lead to financial crisis.
Bubbles, Depressions, Recessions and Other Financial Crises
The Ascent of Money shows the Credit Crunch is just another crisis amongst the many that have struck the financial world throughout its history. Some have been due to malfeasance and others to a lack of understanding of the mechanisms that underpin finance. As Ferguson goes on to explain in the Afterword there is a Darwinian evolutionary thread running through the development of financial services and such crises are part of the corrective process.
Risks, Insurance and Mathematics
Insurance was initially just a gamble and not based on any understanding of risk and fortunes were made and lost. In the 18th century the Scottish Ministers’ Widows’ Fund was established as the first insurance fund based on a proper mathematical understanding of the risk. This led to the modern pension and insurance industries and ultimately to financial derivatives. The latter then created some of the complex financial products that contributed to the Credit Crunch.
Houses and Property
Ferguson shows how wide spread property ownership distorts capital markets by concentrating investment narrowly. For many the family home represents two-thirds of the US household’s asset portfolio, in other countries it is even higher. This despite knowing that risk is best managed by holding a wider portfolio of assets and the fall in property values has contributed to the Credit Crunch.
Globalisation and the Financial Ascent of China
At one time it was felt that the risks to the financial system originated on the periphery from emerging markets. Recent events, not just the Credit Crunch, have proved that simplification unreliable. The Ascent of Money explores how financial systems across the world are now interdependent and there is a mutual dependency between the established economies, America in particular, and the cash rich emerging economies, especially China.
Niall Ferguson makes the case that financiers should study financial history as the cycles and big crisis events typically occur only once in a bankers career. That means that financial manager cannot draw on their own experience of previous events but must rely on knowledge of history. It is perhaps a lack of that historical knowledge that causes mistakes to be repeated.
Darwinian Evolution of Finance
In the Afterword (updated for the paperback to incorporate the Credit Crunch) Ferguson sets out a Darwinian model for finance with the failures providing correction for developments that are not sustainable. The author is at pains that the analogy with Darwinian evolution is not perfect and should not be overplayed. However it provides a useful framework for understanding what has happened both historically and more recently.
A Good Tale: Credit Crunch and its Place in History
The Ascent of Money should be essential reading for all those involved with finance whether working in financial services or as an investor or borrower. It puts the Credit Crunch into its proper historical context and explains why it is just another crisis amongst many that has befallen the financial world since the advent of money. Above all it is a good read that explains a complex topic in a very straightforward way.
Niall Ferguson is one of Britain’s leading historians. He is the Laurence A. Tisch Professor of History at Harvard University and a Senior Fellow at both Stanford and Oxford Universities. He is also a bestselling author and television presenter
The Ascent of Money, A Financial History of the World (ISBN: 978-0-141-03548-2) by Niall Ferguson is published in paperback on 4th June 2009 by Penguin priced at £9.99.
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