Cents and sensibility
Without it, modern economies would be impossible. And it really is worth the paper it’s printed on. Howard Davies explains the history of money. It grows on trees you know
“YOU AIN’T GOT ANY REAL money, ’av yer guv?” asked my taxi driver last week as I offered him a Clydesdale Bank tenner, proudly decorated with a lithograph of one Mary Slessor, not a household name this side of the Wall. I had just flown in from Edinburgh, where even the Alliance & Leicester cash machines dish out Monopoly money, so the answer was no. Grudgingly, he trousered Ms Slessor, grumbling that he would never find anyone else mug enough to take it. Wait for a Scottish accent, I helpfully suggested, or maybe an Australian, as Clydesdale belongs to the National Australia Bank Group.
Scottish banknotes are among the more exotic flora of the
monetary landscape in
The most basic test of a financial instrument — confidence in it as a promise to pay — will be met by a Clydesdale tenner. But there are three other principles on which our financial system is based. The first is what theorists call intertemporal value transfer — what you and I call loans — that allow the long and the short to transact with each other. The second we might call contingent claims, in which one side of the contract pays the other depending on the outcome of some event. These include straightforward gambles, futures and options, but also insurance policies, whether life or general.
The third key principle is negotiability, in other words the ability to buy and sell financial contracts after they have been agreed. If I lend you money for five years, but then find I need it back earlier, I can sell the promise to someone else, perhaps at a discount, in return for cash today. Your obligations are thereby transferred, usually without your permission.
These three fundamental principles underlie most of what goes on in financial markets today. The language may sound different, but the underlying economics are the same. The principles seem simple, but they all depend heavily on respect for property rights, and on trust. In many societies these essential underpinnings have been lacking. Where that is so, the financial system remains underdeveloped, with damaging consequences for economic growth and prosperity.
The Chinese play a crucial role in the story. The earliest
financial contracts for which we have reliable records date from the Zhou
period, beginning around 1000BC. (It is a nice irony that now
In the early modern period the West took up the cause of
financial innovation, most notably the Dutch, whose claim to have invented the
joint stock company is the strongest. The Dutch East India Company was the
first major limited liability venture. The British followed close behind, and
from 1694 the Bank of England played a crucial role in overseeing the
One key characteristic of financial innovation is mobility.
There are few durable patents in financial markets. So the tables were quickly
turned on the
The other, of course, is the New York Stock Exchange, built
on the back of the Buttonwood Agreement, a deal struck between the market
brokers in 1792 to fix commissions and implement a closed shop. An
anti-competitive arrangement of that kind would now be outlawed almost
The Origins of Value, written by a star-studded cast of
economic historians, rightly emphasises the elements
of continuity in financial markets. But we are left with an uncomfortable
question. Have financial markets now become detached from the real economy that
they are supposed to serve? Can we make sense of the massive escalation in the
scale of financial transactions? In the
Are we heading for another crash, like the South Sea Bubble,
In another context, Gordon Brown often likes to say that the Government has done away with “boom and bust”. In financial markets, he is unlikely to have succeeded, and in the long run we would suffer if he did.
THE ORIGINS OF VALUE
Edited by William N. Goetzman and K. Geert Rouwenhorst
OUP, £30; 404pp
£27 (free p&p) 0870 1608080
From the Magazine | Time Bonus Section October 2005: Global Business
The year was 1262, and the glorious city-state of
That is just one of the stories colorfully told and illustrated in The
Origins of Value (Oxford), edited by William N. Goetzmann and K. Geert
Rouwenhorst. The two economic historians turn what could have been a bone-dry
survey of arcane financial instruments into a lively history of finance. Even
more improbably, the book is gorgeous. You can see the crimson illumination on
the Ligatio pecuniae and
read the fine print on a futures contract from the Dutch West India Co. Each
chapter is a minihistory written by stars like
The Origins of Value: The Financial Innovations that Created Modern Capital Markets. Edited by William N. Goetzmann and K. Geert Rouwenhorst. Oxford University Press; 416 pages; $50 and £30
An academic history of the development of financial markets, from the invention of interest and Roman shares to 20th-century bonds, this book has more attractive pictures than mind-boggling equations. Possibly the first book designed expressly for Wall Street coffee tables.
Geld und Mehr
Geld und Mehr
BÜCHER & THESEN / 4000 Jahre Geldanlage
reserved. Copyright Frankfurter Allgemeine Zeitung GmbH,
Von der Einführung der Zinsen in Mesopotamien weit vor Christi Geburt, über die Erfindung des Papiergeldes in China, bis zur Entstehung von Investmentfonds und anderen modernen Finanzprodukten im 20. Jahrhundert: "The Origins of Value" beschreibt, wie Finanzinnovationen in den vergangenen 4000 Jahren die Welt verändert haben.
Der Leser erfährt, warum Kredite, Zinsen, Aktien, Anleihen oder Börsen entstanden sind. Er lernt zum Beispiel, wie im antiken Rom eine frühe Form des Aktieninvestments entwickelt wurde und was es mit dem ersten weltumspannenden Unternehmen auf sich hatte, der Dutch East India Company, die von Europa aus Asien eroberte. Neugierige entdecken, wie in Amsterdam der Handel mit Optionen und Futures zum Blühen kam und warum die Rothschilds nach dem Ende des Napoleonischen Krieges zwischen England und Frankreich die ersten Eurobonds auf den Markt brachten.
Geschrieben ist all das von wohlbekannten Ökonomen wie
William N. Goetzmann und K. Geert Rouwenhorst: The Origins of Value, Oxford University Press 2005, 416 Seiten, Preis: 50 Dollar oder rund 47 Euro
All rights reserved. (c)
Business books can, of
course, be things of beauty. The Origins of Value (
A globe-trotting history of modern finance BOOK REVIEW THE ORIGINS OF VALUE: Stephen Fidler on an edifying account of financial markets, from
pawnshops in seventh-century
By STEPHEN FIDLER
(c) 2005 The Financial Times Limited. All rights reserved
Loans, bets and trades. These three words, more or less, encapsulate all transactions in the world's financial markets. Raw computing power in the past 20 years has pushed modern finance to levels of sophistication that make it hard for laymen to grasp. But understand these building blocks and you understand, at root, what financial markets are about.
Academics like to use posher words for these three ideas. Loans are a mechanism
for allowing an intertemporal transfer of value, a
procedure first recorded in written loan contracts in
Bets are contingent claims
in which one side pays the other depending on the outcome of a future event.
They also seem to have emerged in
Trades, which allow the
transfers of financial claims, are the key to financial markets. True
negotiability was evident in
This academic but beautifully produced and revealing book casts light on where, when and why these concepts first emerged and how they developed.
Consider interest, for example, an extraordinary and hardly self-evident innovation, mistrusted throughout history. According to Aristotle: "The most hated sort (of wealth) and with the greatest reason is usury."
Its development in the
The book does not argue that concepts developed in one place necessarily influenced the subsequent development of similar financial instruments. But it roams around the world from China - where pawnshops, noted in the seventh century, were almost the only private financial institutions before the 19th century - to Italy, where the beginnings of modern state finance emerged, and beyond to the US and Africa.
The raising of money from
the citizens of the Italian cities of
The importance of
developments in the
These innovations found
their way across the
In doing so, they created
the City of
The authors have also uncovered some fascinating historical footnotes, including a financial instrument that has been paying interest since it was issued in the 17th century: the oldest live security in the modern capital markets.
That perpetual security
was a bond issued by one of
The book also describes how speculators moved in to benefit from anomalies that emerged in the market for annuities in the 1830s - which the British government used to finance itself. In return for an up-front sum, the government would pay an annual amount until the person specified in the contract died.
At age 90, life expectancy was so short that about two-thirds of an annuity's purchase price was repaid every year.
As a result, speculators scoured the countryside looking for hearty 90-year-olds, who found themselves suddenly the subject of unusual and unexpected attention and often the best medical care. In 1834, the government ended the anomaly, putting an upper age limit of 80 on annuities.
I must, however, quibble
with the eminent historian
The Best Books of 2005
By Jay Palmer
(c) 2005 Dow Jones & Company, Inc.
Throughout the year, oil
prices have been blamed for practically every twitch of the stock market. But
if you really want to worry, turn to Twilight in the Desert (Wiley, $24.95) by
the provocative Matt Simmons, an investment banker to the energy industry. He
suggests there is worse to come -- that
DisneyWar (Simon & Schuster, $29.95), by
noted business writer James Stewart, is an anecdote-filled tale of the
corporate battle between Disney's former chief executive, Michael Eisner, and,
among others, the founder's nephew Roy Disney. The stories of angst, egos and
stress speak volumes about life in
industry, of course, is endlessly entertaining. The Big Picture (Random House,
$25.95), by Edward Jay Epstein, tells how
An earlier era of
Some of the books from 2005 could help investors make some real dough. Just published and receiving much buzz, The Little Book That Beats the Market (Wiley, $19.95) by hedge-fund manager and Columbia Business School professor, Joel Greenblatt, offers elegantly simple advice for both children and accomplished investors. The focus: buying good companies (those with high returns on capital) at bargain prices (compared with earnings).
Wharton professor Jeremy
Siegel warns against "the constant pursuit of growth" in The Future
for Investors (Crown Business, $27.50). He recommends that investors buy stocks
with sustainable cash flows and dividend payouts and recognize the economic
power shifts from the West to
In Unconventional Success (Free Press, $27.50), David Swensen, Yale's chief investment officer, delivers what our reviewer called "a devastating critique of investment firms that hypocritically prattle about putting their clients' interests first." Swensen says individuals would be best off with an indexed portfolio, spread over the core asset classes.
There are always other
approaches. Fortune's Formula (Hill and Wang, $27), by William Poundstone, is the tale of how physicists from Bell Labs
developed a formula for gambling based on probability theory. After meeting
with wild success in
The unsavory side of brokerage-house research gets a full airing in Blood on the Street (Free Press, $26) by former Wall Street Journal reporter Charles Gasparino. It details how corrupt research proliferated during the dot-com boom. Although the boundless optimism of that era has faded, the lessons are well worth remembering.
Kurt Eichenwald's Conspiracy of Fools (Broadway, $26) takes a fresh approach to another scandal of the bubble era: Enron. Written, according to our reviewer, "in the manner of a breezy crypto-thriller and told from the viewpoint of a fly on the wall," the book follows the rise and fall of the company in gory detail.
founder of the Vanguard mutual-funds group, launches a personal crusade against
all that he sees as wrong in business and finance in The Battle for the Soul of
Capitalism (Yale, $25). Among his targets: inflated corporate pay, the shaky
state of the
Plenty of others on Wall Street also have opinions. In What Goes Up (Little Brown, $27.95), author Eric Weiner stitches together interviews with 173 men and women of the Street. They speak out, our reviewer wrote, "on everything from Mayday (the end of fixed commissions) and Black Monday to LBO orgies, M&A mania, Milken's milkings, the collapsing of Long-Term Capital Management, crusading Spitzer and grabby Grasso."
Business books can, of
course, be things of beauty. The Origins of Value (
What were 2005's big
ideas? Jared Diamond's Collapse (Viking, $29.95) looks at why some societies
Simon Winchester's A Crack
in the Edge of the World (Harper Collins, $27.95) looks at the repercussions of
the Great California Earthquake of 1906. Along the way, it delves into the
geological forces that created the Asian tsunami and that still threaten not
The World Is Flat (Farrar,
Straus, $27.50), by New York Times Pulitzer Prize-winner Thomas Friedman,
examines the trends bringing tech innovation, foreign investment and capital flows
to the Third World. But if the
Billion Customers (Free Press, $27), by James McGregor, zeros in on the
ultimate developing market,
Few subjects divide Americans more than genetic manipulation -- from cloning and stem cells to modifed foods. Gina Smith's The Genomics Age (Amacom, $24) paints what our reviewer called "an enjoyable, easy-reading picture of the science for the nonscientist."
Luckily, there is always wine. And in this world, no one, absolutely no one, has had more impact on drinking and buying habits than Robert Parker. In The Emperor of Wine (Ecco, $25.95), Elin McCoy explains how Parker became so important that he can ruin a vineyard with a wine rating and influence what kinds of wines are made.
Let's raise a glass to the books of 2005.
SECTION: BOOKS; No.1722; Pg.22
LENGTH: 1587 words
HEADLINE: Flying Cash Was Start Of Easy Money
BYLINE: Christopher Ondaatje
The Origins of Value: The Financial Innovations that Created Modern Capital Markets Edited by William N. Goetzmann and K. Geert Rouwenhorst Oxford University Press 403pp, Pounds 30.00 ISBN 0 19 517571 9
This volume, edited by two professors of finance at the Yale School of Management, is an all-embracing historical survey of the financial innovations that have changed the world. The 21 essays by a distinguished and adventurous group of historians and economists trace the "origins of value" from its beginnings in the
Innovations in finance have been based on surprisingly few basic principles. The editors single out three: "The intertemporal transfer of value through time, the ability to contract on future outcomes and the negotiability of claims." These principles underlie every essay. The simplest financial instrument is an intertemporal transfer of value - that is, a loan with interest payable by the borrower to the lender. The editors remind us that "civilisation has had an ambiguous attitude towards lending and interest". The Roman Catholic Church discouraged the use of interest during the 13th and 14th centuries, and Islam still discourages usury.
The first essay, by Marc van de Mieroop, a historian of the ancient Near East, concerns "The invention of interest". The earliest financial contracts appear to have been in the form of clay balls called bullae.
These hollow envelopes contained small clay tokens that represented some type of economic agreement. Signs impressed into the "envelope" represented the tokens sealed inside and prevented anyone from tampering with the contents of a bulla. By about 1800BC, Babylonians were using clay tablets with loan contracts written in cuneiform script and fired so as to form a permanent record of an agreement. Babylonians used a sophisticated arithmetic based on a sexagesimal system of numerals, which made ratios and multiples easy to calculate. Tablets from the old Babylonian period question, for example, how long it would take for a unit of silver to grow to 64 times its original value if the value doubled every five years - which corresponds to a 20 per cent annual interest rate that compounds every five years.
Comparable examples from
Negotiability of claims, the third principle, is a defining characteristic of a capital market such as the New York Stock Exchange. As the editors note, although "negotiability does not make finance, it makes it easier".
Essays by Ned Downing and by Richard Sylla explain how historical forces shaped the liquidity of this powerful institution.
The first application of negotiability, however, was in
As Richard von Glahn explains in an illuminating essay (which the editors dub "the first truly comprehensive study of the development of paper money in China"), unlike in the West: "Chinese monetary thought and policy was predicated on enabling the ruler to overcome the vicissitudes of dearth and plenty and to provide for the material needs of his subjectsI by tightly controlling the supply of money to ensure stable prices and ample supplies of goods." Chinese philosophers and statesmen always asserted that "money is an artefact of the supreme ruling authority". They believed that it was the ruler's stamp and not the intrinsic value of the monetary medium that conferred value. With such a belief among the rulers, it is not surprising that paper money should emerge.
The idea came about like this. The Tang Government had used bronze coins, but when bronze became scarce it introduced an iron coinage, too. The inconvenience of transporting this coinage led the Tang rulers to create depositories at their imperial capital where merchants could deposit coins in return for promissory notes known as feiqian ("flying cash") redeemable in provincial capitals. The Song Dynasty continued this practice. These "exchange bills" gained significant credibility. In 1005, the Prefect of Chengdu, Zhang Yong, undertook strategic reforms to try to stabilise the monetary system and regulate what had become a de facto paper currency.
Technological innovations in paper-making and printing also helped the advance of paper money. The experiment lasted more than 400 years.
Other chapters detail the development of the first modern corporation, the Dutch East India Company, which in 1602 provided a novel mechanism for financing the exploration and commercial expansion of European business ventures around the globe; and the earliest mutual funds, which were developed in
All this history makes for fascinating reading and provides a good grounding for understanding the creation of corporate capitalism - the defining economic institution of the 20th century. Its growth in the early part of the century culminated in the first age of globalisation.
So what lessons can we learn? In one of the later essays,
His clinical and daunting study of the psychological origins of volatility in financial markets also warns us of the extraordinary growth in the mutual funds industry. The disappearance of the individual stockholder as the backbone of the
Although Shiller's recent unnerving warnings do not belong in The Origins of Value, they cannot be ignored. As the editors note: "Innovations in the modern world of finance have come to be almost expected, financial instruments spring from the minds of investment bankers almost overnight, and then are analysed, valued, traded, saved and hedged themselves - sometimes to be replaced by new financial instruments, and other times to be part of the permanent toolkit of financial engineers and investors."
The incredible ability of human beings to create has now reached frightening levels. It seems almost inevitable that such innovation must lead to abuse and self-destruction. If it achieves nothing else, this remarkable book gives us an invaluable historical perspective on a terrifying age of financial revolution.
Christopher Ondaatje retired in 1988 after some three decades as an investment banker and became a philanthropist and author. His latest book is Woolf in