A few years ago — around the time that the housing bubble went pop — I was having dinner with a group at a swanky soul food restaurant in San Francisco. Just as we were about to order, in walked the boyfriend of one of the girls at the table. Bleached white grin, total captain of the football team. He was purposefully vague about his work until his girlfriend finally declared that he was an investment banker. “But not one of the bad ones,” she clarified, “he just writes the programs to make everything work better.”
I immediately disliked him. I immediately disliked her. Fortunately, I loved my cornbread and fried chicken. I can’t deal with the shirking of responsibility through abstraction; the claim that a system is so complex that our individual actions carry neither weight nor consequence.
It is one of the reasons that I tend to admire geeks and engineers: social awkwardness aside, they want to know how the world works. Never satisfied with “it’s too complicated,” they instead go to great lengths to explain how most of what surrounds us actually isn’t that complicated at all.
With all the bipolar, extreme ups and downs of the market lost week, it’s not a bad time to take a few hours out of our lives to understand what “the market” actually refers to. For years I’ve been following podcasts like Planet Money and EconTalk, which over time have helped me better understand some of the pieces to the finance puzzle. But I was still missing the historical context. Subprime securitization, credit default swaps, forward contracts, short selling — how did we get here?
Finally I discovered Niall Ferguson’s enlightening six-part documentary video based on his book, The Ascent of Money. The entire four-hour video is available on YouTube.
All of those puzzle pieces finally came together for me. From the use of cowrie shells to the invention of paper money. From the birth of modern credit by Vienna’s Jewish community (able to evade usury laws by lending to non-Jews) to the first government bond issued by England to finance its war against France. Then comes the birth of limited liability companies, stock exchanges, and stock bubbles. The instability of the stock market leads to the rise of the financial insurance market, and the concept of insurance leads to the modern welfare state. Then Chicago’s commodity market leads to speculation, hedging, and the modern futures market, which in turn inspires derivatives, options, securitization, and modern hedge fund operations. Speaking of which, here’s a clip with one of the most successful hedge fund investors over the past 30 years, and the man who is ultimately responsible for my monthly paycheck:
A few patterns stand out in the history of finance. First, financial innovation is almost always rooted in the desperate need to fund wars. Wars also break out in reaction to finance, as private lenders convince governments to send battleships on their behalf. Case in point: the world’s first modern narco-state, Britain, which sent warships to China on behalf of traders during the Opium Wars. We also see that all attempts to protect risk eventually fail, even warships. Over the past two hundred years there have been numerous attempts to socialize investment risk — private insurance, the welfare state, derivatives, and the housing market — but none has been able to match the deadly combination of greed and natural disaster. (Case in point: New Orleans after Katrina.)
Ferguson touches on micro finance and Hernando de Soto’s work on property titling, but surprisingly he says very little about the future of finance.
From cowrie shells to commodity futures, I was impressed by how all “financial innovation” ultimately comes down to three basic activities: 1) bartering, 2) lending, 3) insuring. We are used to bills and coins, but finance is actually built on pure information and trust. Which is why a peer-to-peer system of money seems almost inevitable. The first attempt, Bitcoin, has mostly attracted media attention for its use by online drug dealers, but the theoretical impact of the system seems … theoretically revolutionary. I’m far from a libertarian, and I believe in the regulation of financial markets, but the very fact that Bitcoin is inherently resistant to any kind of regulation is what makes it so intriguing.
While August has been a month of ups and downs for Dow Jones and NASDAQ, it’s been almost all downhill for Bitcoin — with some questioning its survival. Even if Bitcoin does eventually fail, I am fairly certain that a more robust, sustainable peer-to-peer currency will eventually “gain currency,” forcing government regulators to respond, and further blurring the lines between the “information censorship” and “financial regulation.”
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