Book Summary: The Ascent of Money

A gripping book about the financial history of the world by Harvard Professor Niall Ferguson. It’s a great walkthrough of the evolution of services like banking, insurance, stock and bond markets and development of real estate. The book is full of great analyses of several financial crises and the systems people create to counter them.

Chapter 1 — Origins of Finance & Banking

The story starts with the need for finance during the barter days. It describes the journey of Pizarro, a Spanish explorer to Peru where he established the Spanish rule. Pizarro’s plunder of rich mountains of silver like Cerro Rico at Potosi was to take back what was currency in those days, silver and gold. This made the Spanish crown rich in early 1500s beyond anything ever before. This newfound wealth provided the entire continent economic stimulus and the Spanish piece of eight (thaler, and later dollar) became the world’s first global currency. This resulted in the world’s first inflation as well.

We then move on to beginnings of lending in 1300s Italy near the banks in Venice at benches called banci through mercenary lenders, most of whom were Jewish. Shakespeare’s Merchant of Venice touches the reality of those times in not only depicting the lenders in Venice and their shrewdness, perils and losses at sea and the dangers of being an ethnic minority. Niall describes the rise of the Medici for banking in the 14th & 15th century. The Medici accounts were maintained in the libro segreto, literally the secret book. The next innovation happened in 17th century in Bank of England (the history page of the bank today mentions this story) which became the first joint stock holding company and was the first bank that enjoyed monopoly over issue of banknotes.

Next we move on to foundational pieces of modern banking with the story of Bank of England in the 19th century: playing pivotal role in inter-bank transactions, monopoly over currency issue, setting up ratio between banknote circulation and reserves, bullion reserves etc. By 1913, about a quarter of British savings were in banks.

Evolution of banking in the US was slightly different, with the barriers to enter banking being significantly reduced in the 19th century it saw a mushrooming of 30k banks at peak. The ability to go bankrupt without criminal or civil liabilities is what has primarily been responsible for promotion of entrepreneurship but has also seen being taken advantage of.

Chapter 2 Bond Market

Bonds are a great way for governments and corporations to borrow money from the greater public. Bonds are promises by the government to post back at a certain interest rate. The market decides the prices of the bonds. The bond market is a daily judgement on the government’s fiscal and monetary policies.

In the 14th and 15th century, Italy’s different factions were constantly at war and the primary source of borrowing for the governments was bonds. Buying a government bond while it is at war is taking a high risk for a potential high reward. You are betting that the government will be able to pay your bond after the way is over. In the Netherlands, new instruments such as life annuities, lottery loans etc were also being introduced.

Nathan Rothschild ran the most successful bank in the world in the 19th century. The first few millions of the Rothschild family were due to the successful speculation by Nathan on the outcome of the battle between France and Britain during Napoleon. Nathan on purpose bribed French generals to ensure victory of Duke of Wellington and deliberately misreported the outcome in London in order to trigger panic selling of bonds. Moreover by setting up offices in various parts of Europe, the Rothschilds could take advantage of arbitrage or cost differences in price of gold in various markets. Nathan then used the money they made to buy huge quantities of bonds of British government. Similarly they got involved during the American civil war and were betting against the confederates. At the same time there was high inflation in the South.

Essentially, 5 stages of inflation are:

1. War leading shortages of goods and
2. the government needing to borrow large sums of money from the central bank
3. This turned debt into cash expanding the money supply
4. this caused demand for cash balances to fall
5. this in turn caused prices of goods to rise

There were similar cases of hyperinflation during the second world war in Germany and in Argentina in 1970s. Since then the inflation has definitely come down in most parts.

Chapter 3- Stock Markets

A fundamental entity in modern world: the company. Stock markets are mirrors of human psyche. This is what Alan Greenspan referred to as irrational exuberance.

Insiders can exploit information about companies fraudulently.

No stock market run has outperformed the American one, average rate of 4.73% yoy from the 1920s to 1990s. Stocks have outperformed bonds and bills.

The greatest Dutch invention in finance was the joint stock company. The United East India company was formed by uniting 2 Dutch companies, called VOC to enjoy the monopoly of all Dutch trade with Nations of East Indies in 1602. They raised capital from the public by issuing stocks. In 1612, it was reduced that the company would not be liquidated as was originally planned. The shareholders could in that case be either repaid in spices or sell their stocks to another shareholder. Thus the modern stock trading was born. Dutch bankers also started to take VOC stocks as collateral. Soon directors of the company were made temporary.

VOC was the first company to combine economies of scale and reduce transaction costs and network externalities. They were also the first ones to come up with a turnover based sales approach.

A compulsive gambler, convicted murderer and financial genius named John Law, was the first to distinguish paper currency as a means of exchange from the wealth of the nation. He was fascinated by the evolution and relationship of East India Company, Exchange Bank and the stock exchange. He proposed the introduction of paper currency to several countries. France was the only country that accepted his scheme.

Law built a system taking over the company of the West (Mississippi company) worth 100 million livres, took over the collection of direct tax, and agreed to lend 1.2 billion livres to the royal crown. It was as if one man was running the top 500 US corporations, the US treasury, and the federal reserve. He effectively created a bubble to make his share prices soar. Shares rose till 1720 till record high. It was here that the word millionaire was coined.

So this man was in control of: the collection of all France’s indirect taxes; the entire French national debt; the twenty-six French mints that produced the country’s gold and silver coins; the colony of Louisiana; the Mississippi Company, which had a monopoly on the import and sale of tobacco; the French fur trade with Canada; and France’s trade with Africa, Asia and the East Indies.

In 1929, America experienced it’s first depression, the causes of which are harder to explain than the one in 1914. For the first time, depression was linked to the mental state of the people.

In fact strengths of the American market and industry may have provided the initial impetus to the crash. Stocks of certain companies had the largest bull runs, precipitating IPOs of more companies. And for the very first time Milton Friedman and Anna Schwartz argued that it was the federal reserve that made the crash the great Britain. They did not blame the bubble itself, since they had maintained price stability and the gold bullion. The main reason here was the Fed should’ve expanded lending and liquidity instead of trying to reduce the progress of gold.

The bubble of the late 1980s resembled a lot the one with John Law of 1710s. But another company tried to do exactly the same. Enron was Mississippi company all over again.

Chapter 4- Insurance

The beginning of insurance can be traced to several of the natural disasters. Hurricane Katrina is an interesting example here since it exposed the defects of the insurance system in New Orleans. The wind damage was the responsibility of the private insurance companies and the flooding the responsibility of the government. The private insurance companies ended up blaming most of the damage on flooding instead of the wind. Scruggs, the man who received a $200 billion settlement from tobacco companies for Medicaid costs related to lung illnesses, helped out several policy holders fighting against these insurance companies but later himself for indicted on charges of bribing a judge. Insurance companies later on declared the whole zone as no insurance zone.

Bottomry’ — the insurance of merchant ships’ ‘bottoms’ (hulls) — was where insurance originated as a branch of commerce in 14the century. Yet it was mathematicians in the 18th century that have birth to modern actuarial science. The 6 crucial breakthroughs included probability science, life expectancy calculations, certainty, normal distribution, utility of an object calculations and inference.

The first insurance company in that case was for serving Scottish widows whose husbands died in service when they were ministers. Wallace and Webster in the 18th century were the first ones to actually apply principles of actuarial maths to life and death calculations.

This all in turn led to the origins of governing states becoming welfare states. The primary motivation of this however was to finance warfare from the earnings of the people. The state that perfected being a welfare state is Japan and not the western world or LatAm.

All of this leads to the origin of hedging, which started with agricultural losses.

Chapter 5- Housing

Here Niall largely talks about how housing which is seen traditionally as one of the safest bets for investing, might not always be so.

Another reason why people like property is because it’s easier to lend money to people with property since the property can be used as collateral.

The chapter ends with how a source of income and not necessarily property is a better thing to have.