Subtitle: A Financial History of the World, The Penguin Press, NY.,
2008, 442 pgs., index, notes, illustrations
This book is not really about the entire 'financial history of the world'. It
is focused on the last several hundred years and on the development of banks as
the creators of the largest component of 'money' namely credit. The detail
increases over the time period to 2008. The author's purpose is to explain what
happened in the financial crisis generated by the collapse of the home mortgage
system. The deep background the author provides is valuable for this purpose.
But the book was written in 2008, before the full financial crisis when Lehman
collapsed. There have been many books and articles written since then claiming
various different causes for the financial 'great recession'. Ferguson's own
follow-up book published in 2012 is The
As is usual for historians who write very large scale books covering a broad
subject, he relies on secondary and 3rd level sources as can be seen in the
notes. Thus, he does make the same mistakes as are common in this literature.
But these are about very minor and tangential topics, some times just
interesting side notes. Some are included just to make the reading fun as he
expounds in great detail, for instance in the biography of John Law or of some
Italian bankers. He has chosen various incidents, events, actors as examples
and some of these are very relevant key incidents in the full story. But he
jumps back and forth between the US and UK. He visits New Orleans, Detroit and
Memphis among other places, choosing each as an example for one of this themes.
The general theme is how and why the historical development of the banking -
finance - system itself enabled the latest crisis, that of 2008. Each chapter
is devoted to one step in the cumulative process. His method is to skip along
through history from one example to another to develop his theme. His term
'assent' is relevant in that he shows that the process by which the role of
money and of banks as the central institutions in its creation has indeed
raised 'money' to a level in which it dominates all economic activity very far
more than it ever did in societies prior to modern times. This is his excuse
for not really describing the whole history of finance - money, but money has
always played at least a role of some importance in societies once they became
'civilized' and built cities. For instance, money was very much on the minds of
Plato, Aristotle and Cicero and was continually discussed throughout the Middle
Ages as well.
Kwasi Kwarteng also focuses mostly on the recent past in his
War and Gold, but also provides a bit more
on early monetary history. Felix Martin in his book the
Unauthorized Biography of Money
provides much more on earlier eras. Of course there are many books
written about the history of money and of banking.
The chapter titles serve as a table of contents outline.
Professor Ferguson begins with a comparison of the recent annual salaries of
the average American ($34,000) and a typical big banker, Lloyd Blankfein (68.5
million ). That year Goldman had net revenues of $46 billion and total assets
over $1 trillion. But hedge fund managers gain even more. He writes that this
is seen by many as unfair. But, he notes, this is nothing new as this opinion
has existed through out history.
He believes there are three reasons:
"It is partly because debtors have tended to outnumber creditors and the
former have seldom felt very well disposed towards the latter. It is partly
because financial crises and scandals occur frequently enough to make finance
appear to be a cause of poverty rather than prosperity, volatility rather than
And it is partly because, for centuries, financial services in countries all
over the world were disproportionately provided by members of ethnic or
religious minorities, who had been excluded from land ownership or public
office but enjoyed success in finance because of their own tight-knit networks
of kinship and trust."
However, he insists, money has been the root of most progress. "Behind
each great historical phenomenon there lies a financial secret, and this book
sets out to illuminate the most important of these".
He mentions several, beginning with the Renaissance. But several of these he
describes in rather luridly excessive prose.
For instance, "The Dutch Republic prevailed over the Habsburg Empire
because having the world's first modern stock market was financially preferable
to having the world's biggest silver mine".
Well, the Dutch had no opportunity to have a silver mine and the Hapsburg's had
to deal with many more enemies and problems than the Dutch., thus it was not a
matter of Dutch 'preferance'.
"The problems of the French monarchy could not be resolved without a
revolution because a convicted Scots murderer had wrecked the French financial
system by unleashing the first stock market bubble and bust".
Well, John Law was convicted of wining a duel. But he found the French
financial system already on the verge of bankruptcy due to profligate spending
and did create a potentially possible help that was wrecked despite his
efforts. Furthermore, after that the French reverted to the same ruinous
financial methods as before and wrecked themselves without his assistance.
"It was Nathan Rothschild as much as the Duke of Wellington who defeated
Napoleon at Waterloo".
Well, it was the creation of the Bank of England and establishment of the dual
credit system of its 'consols', that is perpetual bonds, as a huge credit
creating financial system, plus sovereign backing with gold coins that had
enabled the British to defeat the French repeatedly for a century prior to
Waterloo, as Napoleon himself ruefully complained. And it was rather
Wellington's victory, astutely manipulated by Rothschild that enabled the
latter's private financial system to greatly profit.
The author continues: "Read this book and you will understand why,
paradoxically, the people who live in the world's safest country are also the
world's most insured".
Well, I see no paradox but rather a simple coincidence. They have the world's
safest country because they are the most concerned about creating insurance
against risk. The very cost of insuring itself increases efforts to avoid
against insured risk.
And, most convolutedly he states: "Perhaps most importantly, you will see
how the globalization of finance has, among many other things, blurred the old
distinction between developed and emerging markets, turning China into
America's banker - the Communist creditor to the capitalist debtor, a change of
This theory will require pages of discussion. The remainder of the introduction
describes in general terms but with much detailed financial data, what the
author terms "the ascent of money" - that is the enormous expansion
not only of the quantity of 'money' assets throughout the world but also its
impact on all aspects of society and individual living.
Forbes' annual issue that focuses on the world's billionaires, is an excellent
display of this complete with charts, names and data.
Along the way in his narrative he includes excellent comments such as:
"The financial crisis that struck the Western world in the summer of 2007
provided a timely reminder of one of the perennial truths of financial history.
Sooner or later every bubble bursts, Sooner or later the bearish sellers
outnumber the bullish buyers. Sooner or later greed turns to fear"...
"The proximate cause of the economic uncertainty of 2008 was financial: to
be precise, a spasm in the credit markets caused by mounting defaults on a
species of debt known euphemistically as subprime mortgages".
He was researching and writing in early 2008, before the really disastrous
Another insight he writes: 'I myself have learned a great deal in writing this
book, but three insights in particular stand out.
The first 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". ... "My second great
realization has to do with equality and its absence. If the financial system
has a defect, it is that it reflects and magnifies what we human beings are
like"... "Finally, I have come to understand that few things are
harder to predict accurately than the timing and magnitude of financial crises,
because the financial system is so genuinely complex and so many of the
relationships within it are non-linear, even chaotic".
He concludes his introduction with rather apocalyptic comments about the
potential scenario of the extinction of the world financial system being
similar to the extinctions of species during the Cambrian and Cretaceous
Chapter 1 - Dreams of Avarice
This chapter is a very rapid overview of the development of banks from
Renaissance Italy to the present day. I don't know why the author uses this
chapter title apart from trying to be provacative. As he does throughout the
book he devoted extensive space to 'examples'. In this one he starts with
Pizarro and the taking of the Inca treasure plus finding even more silver,
naturally focusing on the humanity problems of employing miners.
Then he writes: "Money, it is conventional to argue, is a medium of
exchange, which has the advantage of eliminating inefficiencies of barter; a
unit of account, which facilitates valuation and calculation; and a store of
value, which allows economic transaction to be conducted over long periods as
well as geographical distances".
Yes, these are conventional concepts, except that no one has found barter in
use in real societies prior to being replaced by money. And there is
considerable controversy over its use as a unit of account or store of value.
From this remark he jumps to a brief comment about metal coins in classical
Greece and Rome and then to medieval Europe and then to the Crusades and then
back to the problems of Spain after acquiring all that silver.
He is correct in writing: "What the Spaniards had failed to understand is
that the value of precious metal is not absolute. Money is worth only what
someone else is willing to give you for it. An increase in its supply will not
make a society richer, though it may enrich the government that monopolizes the
production of money. Other things being equal, monetary expansion will merely
make prices higher".
All very true, but in the Spanish case he misses a critical factor. Yes, the
government monopolized the production of the silver in Mexico and Peru and its
transport to Europe and China. But first, it lost much of it enroute to British
and Dutch pirates. But much more significantly the crown ONLY put a 20% tax on
the import as the crown share. The other 80% went directly to commercial use,
flowing north to Holland and France or to Italy. So that expansion that
Ferguson notes raised prices while the Spanish crown did not benefit. Adam
Smith noted that silver became so plentiful that people had difficulty getting
rid of it. We know that the Spanish army ( mercenaries not necessarily
Spaniards) fighting in Holland demanded payment in gold rather than
depreciating silver, forcing the Spanish government into debt with Genoese and
other bankers - money traders. And careful research today has shown that prices
actually started rising before the explosion of silver quantities hit northern
Europe and Britain. )See The Great
Then he briefly turns to ancient Mesopotamia for some valid and interesting
thoughts about what money is, before he makes another cogent remark.
"If the basic concept seems familiar to us, it is partly because a modern
banknote does similar things".
Namely, it rapidly expands the quantity of money in circulation.
"Cash in the hands of ordinary Americans accounts for just 11 percent of
the monetary measure known as M2. The intangible character of most money today
is perhaps the best evidence of its true nature. What the conquistadors failed
to understand is that money is a matter of belief, even faith; belief in the
person paying us; blief in the person issuing the money he uses or the
institution that honours his cheques or transfers. Money is not metal, it is
Great point, and so many officials today don't recognize this any more than did
He continues further: "The central relationship that money crystallizes is
between lender and borrower". Again he draws on Mesopotamian practice and
notes the importance of credit even then.
Further: "The remarkable thing is how belatedly and hesitantly the idea of
credit took root in the very part of the world where it has flourished most
spectacularly". It is still misunderstood. (For instance read
Who needs the Fed.
With this somewhat chronologically jumbled introduction he turns to 13th
century Italy and the beginnings of modern banking. Again he devotes much space
to detailed description of some chosen examples, such as Fibonacci, and even
discussing Shakespeare's The Merchant of Venice in relation to Italian banking.
Of course the Medici draw great attention. He shifts to the Dutch banks and
financial power of Amsterdam. And then he shifts to the very important creation
of the Bank of England. For unknown reasons he skips the Fugger's who are
frequently cited as being much more wealthy and politically powerful than the
Very significantly he identifies the three way relationship that developed
between merchants, a stock exchange and a banking system. And he stresses the
innovation of the Bank of England. (See Felix
The third great innovation of the seventeenth century occurred in London with
the creation of the Bank of England in 1694. Designed primarily to assist the
government with war finance (by converting a portion of the government's debt
into shares in the bank) the Bank was endowed with distinctive privileges. From
1709 it was the only bank allowed to operate on a joint-stock basis; and from
1742 it established a partial monopoly on the issue of banknotes, a distinctive
form of promissory note that did not bear interest, designed to facilitate
payments without the need for both parties in a transaction to have current
From this he shifts to how this system led to the 'fractional banking' system
whereby bank credit is multiplied as each deposit becomes the asset behind
creating a new loan (liability) and then each loan becomes another asset as it
is deposited in a bank. This was actually what goldsmiths had been doing for
several centuries in loaning out multiple paper invoices supported by the same
gold held in their vault for depositors.
He writes, however, "Financial innovation had taken the inert silver of
Potosi and turned it into the basis for a modern monetary system, with
relationships between debtors and creditors brokered or 'intermediated' by
increasingly numerous institutions called banks".
Yes to the description of the developing 'fractional banking 'system, but no,
it had nothing to do with silver from Potasi, English money remained gold as
John Locke opined that only gold was real money.
He turns next to the evolution of modern banking.
"Financial historians disagree as to how far the growth of banking after
the seventeenth century can be credited with the acceleration of economic
growth that began in Britain in the late eighteenth century and then spread to
western Europe and Europe's off-shoots of large -scale settlement in North
America and Australia".
Indeed, see McCloskey for instance).
Dr. Ferguson races through the 18th - 19th centuries developments in British
and American banking,. (For details see Felix
Martin and Charles Calorimis. ) After a
brief aside to Lord Keynes he shifts to his visit to Memphis, Tennessee during
which he learned about payday lending, then it is on to some comments about the
expansion of liquidity generating broad money and a graph depicting the huge
increase in the price of gold - or in reverse the decline of the price of the
dollar in terms of gold.
His comment: 'Is it any wonder, then, that money has ceased to hold its value
in the way that it did in the era of the gold standard"? He notes that the
dollar has declined in value by 87 percent just since 1957. Next, he will turn
to what he calls, "the second great pillar of the modern financial system:
the bond market".
Chapter 2 - Of Human Bondage
The chapter is about bonds and financial securities. Again he chooses a
dramatic over hyped up heading. Of course he must repeat the cliche one reads
every where bonds are discussed=, namely James Carville's sarcastic comment
about the 'power' of the bond market. A 'power' that has not been in evidence
for the past 8 years or more.
But he affirms that: "After the creation of credit by banks, the birth of
the bond was the second great revolution in the ascent of money". He gives
a short tutorial on what a bond is and what the bond market does. The result is
the creation of the 'mountain of debt'. He quotes Heraclitus that 'war is the
father of all things". And then the point that "The ability to
finance war through a market for government debt was, like so much else in
financial history, an invention of the Italian Renaissance". He enjoys
digressing into stories for the reader, in this section is about the
condottieri of whom the famous John Hawkwood (or Giovanni Acuto) is
memorialized in Florence. His point is to demonstrate how the increasing cost
of war forced the cities to float more and more bonds at higher and higher
But more broadly, the need to finance war was the cause for creating the
abstract concept of 'the state' itself. Kwasi Kwarteng gets more to the point
in his War and Gold: A 500-year history of
Empires, Adventures, and Debt. And Philip Bobbitt's
Shield of Achilles describes the process. What
Professor Bobbitt demonstrates that Professor Ferguson does not is that the
process led to the 'kingly state' surplanting the 'princely state' due to its
larger scale and greater ability to sustain debt. But there are many books that
explain the connection between the creation and expansion of 'the state' and
the waging of war.
But Ferguson does describe how the increasing debts were handled differently in
Britain and France. He notes, as does Martin, the direct result of the Stuart
'Stop on the Exchequer' and the Glorious Revolution that enabled to founding of
the Bank of England, while the French monarchy continued its profligate ways
without adequate financial methods. This brings him back to another of his fun
stories - a very lengthy discussion of the Rothschild family of bankers -
financiers in the bond markets of Europe and how their financial acumen enabled
to British to defeat Napoleon. From this he jumps to the American Civil War and
again financing, this time the failure of the Confederacy to leverage their
cotton exports into loans from the Rothschilds and others.
Another leap brings the story to the bond market in Latin America and repeated
sovereign defaults on government debts. The author titles this section
"The Euthanasia of the Rentier", a reference to Lord Keynes' desires
and policy program.
First I need to explain what 'rent' in the modern usage means. because it has
nothing to do with renting a house. It comes from the French terms - rentes
heritables and rentes viageres meaning, respectively a revenue
stream that could be inherited by an heir and one that ended at the death of
the purchaser. In other words bonds (securities) issued against debt that were
perpetual generators of interest income and bonds that terminated at the
owner's death. Now, the British created very successful perpetual bond that was
called a 'consol' from consolidated. (And Ferguson describes this process). But
the French term due to its disastrous results was used to name rentiers,
those who lived on the income from their perpetual interest paying government
bonds. And during the Napoleonic wars when British government reached
horrendous massive levels, these rentiers became public ogres despite
the fact that they were mostly very normal bourgeoise including widows and
descendents. Thus the living off of interest income was denounced. And thus it
has continued to today. Keynes especially hated rentiers and sought to
establish economic policy that would create the "Euthanasia of the
Rentier" in the author's words . He cites this demise to the huge
losses that all people living on fixed incomes - bonds - suffered with the
financial collapse of World War One. But Keynes still desired the extermination
of 'rentiers' in the 1930's. Ferguson descries in numerical terms the losses
suffered from World War One and then the continued impact of that process
during the 1920's - 30's.
But he finds more: "If hyperinflation were exclusively associated with the
costs of losing world wars, it would be relatively easy to understand. Yet
there is a puzzle. In more recent times, a number of countries have been driven
to default on their debts - either directly by suspending interest payments, or
indirectly by debasing their currency in which the debts are denominated - as a
result of far less serious disasters". See This Time is Different.
In another fun aside we learn that the former 'bond king', Bill Gross, began as
a blackjack player in Las Vegas. He is no longer the 'king' but is still a
billionaire from using other people's money. Ferguson relates this to Gross's
descriptions of the impact of inflation on bonds. And then the example of
Argentina is described a length.
Then it is back to Keynes and the 'rentier' Keynes' concept was that
inflation again would wipe out the despised 'rentier' class. But this
has not happened. Ferguson notes here that Carville's comment also has not
"That does not mean, however, that the bond market rules the world in the
sense that James Carville meant. Indeed, the kind of discipline he associated
with the bond market in the 1990's has been conspicuous by its absence under
president Clinton's successor, George W. Bush".
And it still absent today despite a vastly greater expansion of debt.
Ferguson's thought: "It is, however, impossible to make sense of this
'conundrum' - as Alan Greenspan called this failure of bond yields to respond
to short-term interest rate rises - by studying the bond market in isolation.
We therefore turn now from the market for government debt to its younger and in
many ways more dynamic sibling: the market for shares in corporate equity,
known colloquially as the stock market".
Chapter 3 - Blowing Bubbles
This is another clever title meant to focus on the repeated manias that push
the prices of stocks up and then bring them down in a rapid crash. The author
begins with another isolated example; the construction of a gas pipeline in
Bolivia. He notes the obvious, that people's opinions about 'value' and the
future vary as much or more as their opinions about anything. The result is a
continual divergence between what he describes as optimistic buyers and
pessimistic sellers. Well, yes, but there are other reasons for buying or
He points out: "In the four hundred years since shares were first bought
and sold, there has been a succession of financial bubbles". (Again see
Reinhart. ) Ferguson describes the process of alternating expansion and
contraction very well. He describes in many pages the creation and success of
the financial markets in Amsterdam and its United East India Company - VOC.
And then he expands at great length on the famous - infamous - John Law and his
creation of the French Banque Generale and the "Company of he West - the
Mississippi company. He states that this was the first 'bubble' by ignoring the
famous 'tulip bubble' in Holland.
In another remarkable jump Ferguson moves to Yale University in 1929 and Irving
Fischer's famous prediction that the stock market was doing fine, just days
before it collapsed, taking Fischer's portfolio along with it. His description
of the Depression follows. He has much to write about the role of the recently
created Federal Reserve System in this. Then follows Ferguson's discussion of
'fat tails' and the markets since World War Two.
In another attempt to create relevance out of separate situations he writes:
"The resemblances between the careers of John Law, perpetrator of the
Mississippi bubble, and Kenneth Lay, chief executive of Enron, are striking, to
say the least". Ferguson devotes pages to describe the Enron fraud.
Well, I disagree. Law was an innovator honestly seeking to help solve the real
financial disaster that was the French monarch's debt and inadequate tax
structure. Lay was a crook from start to finish, a con man who knew exactly how
false his entire pyramid was and he presided over knowingly false financial
accounting. Law was rather defeated in his efforts by the psychological mania
his system unleashed in a public that had no experience or idea about the
Chapter 4 - The Return of Risk
The chapter is about the development of mathematical, statistical, knowledge
about how to evaluate risk. There are many books written on this history,
Ferguson mentions the main individuals. The chapter title is meant to include
the author's description first of the efforts to reduce or eliminate risk that
created the 'welfare state' and second to describe how it has more recently
been found financially insolvent and the result has been increasing risk.
But first, he digresses to a lengthy visit to New Orleans after Hurricane
Katrina. He ties the results he observes to failure of authorities and
individuals adequately to recognize risk and to insurance companies reluctance
to insure against massive risks beyond their financial capacity. The example,
then, serves as an introduction to both aspects - understanding and calculation
of risk, and development of adequate financial instruments to enable insurance
against at least some specific forms of risk.
He begins with an interesting story about the creation of an insuance program
by Scot ministers, after a brief summary of earlier forms of commercial and
life insurance. Mixed in with this is his description of Pascal, Bernoulli, de
Moivre and other leading mathematicians and scientists study of the phenomena
of risk and its statistical properties when seen on the scale of a large
population of incidents.
The fundamental basis for a successful insurance program, he shows, is that the
premiums collected from the actual insurees be actuarially calculated on the
basis of their individual risk profile within the total population insured and
that these premiums be Invested in assets that will generate adequate financial
increases to pay the promised benefits when they come due. A pay-as-you-go
financing scheme will not suffice. Then he accurately points out that the
modern 'welfare state' system was created not out of any concern for the
indigent but by the German Chancellor Bismarck as a political tool and only
later copied by the British government.
As he writes: "If the welfare state was conceived in politics, however, it
grew to maturity in war". It was the growth of government power and
control over society developed as the means for conducting the First World War
that accumusted the public to reliance of governments for more and more
assistance in living.
He continues: "From now on, the welfare state would cover people against
all the vagaries of modern life". But there soon were problems.
"According to British conservatives, what had started out as a system of
national insurance had degenerated into a system of state handouts and
confiscatory taxation which disastrously skewed economic incentives".
"The Big Chill"
The author shifts to discuss Chicago economist Milton Friedman's monetarist
concept about money and then his advise to the Chilean government, after the
overthrow of Salvador Allende, on how to restructure its state pension plan.
Then he jumps to New Orleans after Hurricane Katrina with relation to welfare
systems and insurance.
He makes one comment that I have made repeatedly when I read 'great news' about
new biotechnology that will extend life spans.
"Longer life is good news for individuals, but it is bad news for the
welfare state and the politicians who have to persuade voters to reform it. The
even worse news is that, even as the world's population is growing older, the
world itself may be getting more dangerous".
"The Hedged and the Unheadged"
This section begins with a discussion about terrorism and the ultimate threat
of a nuclear terrorist attack. Then he presents statistics about the likelihood
of various kinds of disasters. This brings him to the discussion of 'hedging'
as a form of insurance against potential losses. He expresses his conclusion:
"The fact nevertheless remains that this financial revolution ahs
effectively divided the world into two: those who are (or can be) hedged, and
those who are not (or cannot be)." And: "As an insurance policy or a
pension plan, however, this strategy has one very obvious flaw. it represents a
one way, totally unhedged bet on one market; the property market".
So on to the next chapter.
Chapter 5 - Safe as Houses
In this chapter Dr. Ferguson is reaching his goal, to focus on the financial
crisis of 2007-8. He notes that no other culture than the English speaking
world focuses so much on home properties - real estate. Indeed, he mentions the
game, Monopoly, which I played avidly while in high school. He digresses into
describing the property owning excesses of the British aristocracy with their
magnificent country mansions. But real estate is not as much of a secure
'security' as people think. He repeats the saying, "An Englishman's home
is his castle". And then he shifts to discuss the American version in
which mortgates play a significant financial role. Another digression brings in
Henry Ford and Diego Rivera, and then Jimmy Stewart in 'It's a Wonderful Life'.
All of this is leading up to his discussion of the property market collapse in
Detroit versus public housing in Great Britain.
"From S&L to Subprime".
In this section he expounds on Danny Faulkner and the massive frauds
perpetrated in theTexas S&L industry. Which, then leads to Lewis Ramiere
and the Salmon Brothers bond trading and on to the mania for investing in home
real states. And then it is back to Detroit and the sub-prime mortgage market.
All of this is the historian's way of creating a hoped for 'fascinating' and
enjoyable read while treating the reader to a painless exposition of the story
building up to its disastrous conclusion when this expanding financial pyramid
of shady financing for home ownership by millions of people who could in
reality not afford the mortgagte loans can crashing down.
Chapter 6 - From Empire to Chimerica
In this chapter Dr. Ferguson moves on to 'chimerica' that is the financial -
economic union of the United States and People's Republic of China. Remember,
this book was written in early 2008. He throws in a wide variety of standard
ideas and misunderstandings about China over the past 3-400 years he has picked
up from popular sources; such as ,"what went wrong in China between the
1700's and the 1970's?" And what enabled Europe and especially Great
Britain to create the "Industrial Revolution"?.
Then, more generally he turns to globalization, various Europeans in China, the
opium wars, the Rothschilds again and such notable figures as Ivan Block,
Norman Angell, Andrew Carnegie, and Gavrilo Princip. And over all this he
inserts the international sock and bond markets. Then he turns to the Bretton
Woods agrement. Following this he discusses the 'economic hit men' and features
the leering countenance of their capo dei capi, one George Soros.
Well, he hits a bulls eye with that one.
George Soros is indeed the poster boy for the hedge fund 'managers' . And
Ferguson describes in some detail how Soros 'broke the Bank of England' while
Ferguson was watchingan opera in London. Now one can read Forbes magazine
annual issues that details the richest 400 in America and another issue that
has the richest individuals world wide. One sees that the great majority of
these folks gained their wealth in 'financials' - that is by manipulating other
Ferguson moves on to the famous Fischer Black and Myron Scholes (they actually
received Nobel Prizes for this) who invented a mathematical formula that they
claim accurately prices options (these are bets on the future price of a
derivative 'asset'. (Except they they don't). He provides their magic formula -
algebraic notation that includes square roots and a logarithm of a ratio. But
that was insufficient, we also have William Sharpe and his Capital Asset
pricing Model and Harry Markowitz with his modern financial theory. All of this
was put into practice by another infamous group in a hedge fund called LTCM.
Risky? Not on your life. It was fool proof as a bunch of big banks and
financial houses were sure. Then everything that could not happen in finance
did happen and all at once. Dr. Ferguson steps in with his diagnosis but no
cure. The autopsy is too gruesome to recount here.
But our historian has one tip. "To put it bluntly, the Nobel prize winners
had known plenty of mathematics, but not enough history".
That reminds me of a recent story in which an economist is reported to have
observed about current analysis to the effect. "Gee, we really should look
back in history about this, clear to 1960".
But Dr. Ferguson has more and worse to note. Again, this is early 2008 speaking
here. Among other statistics he unpleasantly brings up is "Far from
declining in the past ten years hedge funds of every type have exploded in
number and in their volume of assets they manage. In 1990, according to Hedge
Fund Research, there were just over 600 hedge funds managing some $39 billion
in assets. By 2000 there were 3,873 funds with $490 billion in assets."
Now remember also, all these so called assets were someone else's liabilities.
He continues with some selected examples of hedge fund managers such as Soros,
Paulson and Griffin and then provides a simply investment scenario for such a
manager to reap great profits by using leverage.
Now comes his question. "Could an LTCM -style crisis replay itself today,
ten years on - only this time on such a scale, and involving so many such bogus
hedge funds, that it would simply be too big to bailout? Are the banks of the
Western world now even more exposed to hedge fund losses, and related
counterparty risks, than they were in 1998?"
Does the name Lehamn Brothers trigger any memories?
We finally reach the section referenced in the chapter title. This is the
remarkable (historically unique) rapid expansion of the Chinese economy. Dr.
Ferguson descries more clearly than one reads in the usual commentary the
interrelation between American spending for consumer products made in China
paid for with US government and FED created money and the Chinese central bank
taking that money and investing it. But not clearly enough. But he does
highlight some of the inherent problems and risks in this circular financial
movement. He is posting serious warnings just a few months before the Lehman
collapse. But his contemplated crisis-triggering events are not quite what
Afterward - The Descent of Money
Although written before the Lehman collapse, in this chapter Dr. Ferguson mixes
summary references to the themes about money and risk described in the previous
chapters with some meditations ( not predictions exactly) but general warnings,
based on the realities of human nature, about what might happen next.
Some references will follow but see those listed with Ferguson's
The Great Degenration.