The Ascent of Money

Money, says the song, makes the world go round. It can also, as the current crisis shows, threaten to stop it. If there is one thing we all share in the midst of continuing uncertainty and bad news in the current financial crisis, it is that — in company with no less a personage than Warren Buffett, as he himself informs us — we do not understand what has been happening in the financial markets. And quite likely the debacle among banks and stock exchanges everywhere is the result of not much less ignorance, though doubtless much more greed, on the part of all the rest of the money men themselves.

A book that explains the origin and growth of money, banks, stock markets, and the exotic growth of the financial instruments and institutions that now bewilder even those who live by them, is a valuable thing. Despite the fact that Niall Ferguson finished writing The Ascent of Money in the late spring of 2008, while the international financial crisis was still gathering momentum, this is a very timely book. Not the least of its merits is that Ferguson shows how alert he was to the possibilities for disaster inherent in the loose credit and securitization of bad debt from which so much money was until lately made. His was an alertness made possible by a grasp of history; Ferguson thereby vindicates the utility as well as the beauty of his craft.

The story, a fascinating one, covers 4,000 years. Money is the concrete expression of the relationship between lenders and borrowers — it is the embodiment of debt made tradeable — and it gave rise to banks, which in turn gave a vast boost to the development of credit. From medieval times to the present, the Darwinian evolution (as Ferguson convincingly characterizes it) of money and markets proceeded at an increasing pace and sophistication. Bonds came first, from the 13th century onward securitizing revenue from interest. The 17th-century Dutch invented equity in corporations in the form of shares carrying limited liability. In the 17th and 18th centuries, economies of scale and an understanding of mathematical probability yielded protection against risk in the form of insurance and pension funds. The 19th century saw the rise of the first derivatives in the form of options and futures. In the20th century individuals were encouraged to redirect their portfolios toward real estate, accepting the need for greatly increased leverage to do so.

Ferguson points out that the economies where all these things happened — that is, the property-owning democracies with banks, bonds and stock markets, and insurance cover — have consistently performed better than other economies. Or rather: at least until now. But in the last couple of decades there has been a “Cambrian explosion” of new types of financial services and assets and a seemingly boundless appetite for asset-backed securities, not least mortgages. Perhaps the long roots of this lay in the collapse of the Bretton Woods control of capital movements in the early 1970s, following which the globalization of financial dealings has mushroomed, aided by substantial deregulation in the 1990s and since. The result has been a huge bubble, the pricking of which we are now witnessing.

In fact there have been scores of periodic financial crises in recent history, as Ferguson shows, illustrating the inherent volatility of the financial markets, in which greed and — when greed has over-gorged itself — fear are the principal sentiments. One thing Ferguson’s book emphatically shows is that the new concept of “behavioral economics” provides a far better description of what happens in the markets than any of the theories previously mooted, including the fancy mathematical models that were supposed to make investment foolproof. These latter depended upon the markets being rational and predictable; history shows that matters are otherwise.

There is a good deal of riveting information here about the buildup to the current crisis, in discussions of the Enron scandal, the way speculators such as George Soros make their money, the unparalleled mushrooming of securitized debt obligations that — because so many of them are of such poor quality — has rocked previously secure banks to their foundations around the world. Ferguson describes what went wrong with Long Term Capital Management, the once-so-successful investment company that failed despite the intricacy of its model and spread of its assets. Because, Ferguson points out, its managers knew too little history, they learned the hard way John Maynard Keynes’s insight that in times of crisis, “markets can remain irrational longer than you can remain solvent.”

Not only is there much that is instructive and illuminating in Ferguson’s account, there is much that is absorbing. Until you begin reading you might not imagine how engrossing a book about the history of money and finance can be. The story of money’s origins, of the Italian Renaissance cities, of the founding and operation of the first limited liability company in the Netherlands, of the Rothschild banking dynasty’s rise in the 19th century, of what caused the Great Depression, of the turn to house-owning debt, of today’s massive and perhaps unhealthy symbiosis between borrowing America and lending, cheaply manufacturing China to make “Chimerica” with most of the world’s money and population in it, make an altogether gripping tale.