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A Financial History to Forget

Considering the subject and the time at which it appears, not to mention its star author, Niall Ferguson's new book is a huge disappointment.

By 3.11.09

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The Ascent of Money: A Financial History of the World
By Niall Ferguson
(The Penguin Press, 432 pages, $29.95)

With the way the world has been turned upside down lately with financial calamity, Niall Ferguson and his publishers at the Penguin Press hit a home run with the release of The Ascent of Money. Ferguson is an accomplished writer and historian, a professor of history at Harvard, and author of The House of Rothschild. His latest effort, however, is a big disappointment.

The book is often disjointed, with a blend of scant overviews and more in-depth portrayals of selective significant events, such as the John Law's ill-fated experiment with inflating France's money supply with bank notes in the early 18th century, and the S&L Crisis of the early 1990s in the United States, as well as the insignificant, such as the workings of modern British loan shark Gerard Law (complete with photo). If the structure has the feel of a book designed around a British television mini-series, that's because it is. http://www.pbs.org/wnet/ascentofmoney/) The presentation is usually fine, factually (except for his brief discussion of Roman Imperial coinage, which is completely wrong). But the writing is not particularly engaging or instructive.

Ferguson does make some good points. For instance, in his discussion of Spain's exploitation of the silver and gold of the New World, he makes clear the distinction between wealth and money. Silver and gold from the New World did not make Spain a wealthy country, as silver and gold do not produce goods and services. What Spain's new store of money achieved was merely some modest inflation in Europe, but not any lasting wealth. The most valuable part of Ferguson's book, however, is the following quote from Chilean economist José Piñera in discussing the rise of the welfare state (out of the concept of insurance):

"What had begun as a system of large-scale insurance had simply become a system of taxation, with today's contributions being used to pay today's benefits, rather than to accumulate a fund for future use. This 'pay as you go' approach had replaced the principle of thrift with the practice of entitlement…[But this approach] is rooted in a false conception of how human beings behave. It destroys, at the individual level, the link between contributions and benefits. In other words, between effort and reward. Wherever that happens on a massive scale and for a long period of time, the final result is disaster."

Unfortunately, we in the United States seem determined not to heed Piñera's warning.

Ferguson finished writing this book in May of 2008 and so it does not discuss the most recent traumatic events in the U.S. and world financial markets. The real lessons, however, as demonstrated in the financial history of the world, are simple: leverage equals risk, and increasing the level of leverage throughout the financial system will eventually lead to collapse as people and institutions inevitably at some point make bad decisions and/or succumb to various frauds. Financial crises are an on-going fact of life, but their severity can be contained through appropriate regulation and governing authorities and central banks working to keep leverage in the system at moderate levels, and stepping in to provide liquidity when necessary to stem financial panic. In the present situation, we saw a failure on all fronts: government allowed greater leverage (which many financial firms injudiciously used), did not regulate the new credit default swap market, and actually mandated poor lending practices to allow more low-income homeowners, while executives and risk managers throughout the industry failed to recognize the abuses in the mortgage markets and the resultant degraded quality of mortgage-backed securities.

Being based on leverage, the financial industry is susceptible to collapse as a result of lost confidence and panic, even if the better part of the participants are in fine shape -- just as a wild fire starting in dry grass can take out huge areas of forests and homes. As Jimmy Stewart explained to his panicked depositors in the Bailey Building and Loan in It's a Wonderful Life, he didn't keep their deposits in a vault, but rather they were loaned out, with only a fraction held in reserve to meet withdrawals. New Deal reforms such as the FDIC were meant to give greater confidence to depositors to reduce future bank runs. But the panic caused by the collapse of Bear Sterns and Lehman Brothers and the exposure of the weakness behind prevalent items on bank balance sheets such as questionable mortgage backed securities (erroneously given high credit ratings by the rating agencies), which were in turn backed by insurance policies (credit default swaps) that were inadequately underwritten and which the issuers (like AIG) had no hopes to make good on in the event of large defaults, was all too much for the existing circuit breakers. The level of truly "toxic" assets in the system is likely significantly less than indicated by current depressed bank stock prices. But the complex nature of these assets makes their valuation hard to discern. Uncertainty breeds fear, and fear destroys the value of credit-based financial assets.

Unlike any other industry, financial services are the foundation on which our economy rests. It might hurt if the auto industry suffers bankruptcies, but a meltdown of the financial system would ravage all sectors of the economy. Fortunately, the Federal Reserve learned the lessons of the 1930s and acted appropriately to stem the panic. The continued reaction of politicians in Washington, however, has been muddled and mangled in both conception and execution. That should come as no surprise.

Ferguson takes us through a journey of bond markets and stock markets and insurance and mortgages. But he barely talks about commercial paper, lines of credit for business working capital, commercial construction lending, and other aspects of the financial services industry that make the modern economy run. Even more stunning, Ferguson wholly neglects the area of consumer credit, and the extension of consumer credit not just from financial institutions, but from merchants themselves, that ignited the industrial revolution in the United States in the 19th century and has been a large driver of economic activity ever since all over the world. These things may be less sexy than stocks and bonds and hedge funds, but by virtually ignoring them, and instead focusing on market bubbles, manipulations, and the trading strategies of George Soros, Ferguson helps to encourage the view held by Senate Finance Committee Chairman Max Baucus that the financial services industry is not part of the "real economy."

To punctuate the uselessness of The Ascent of Money, Ferguson spends his final dozen or so pages talking about understanding financial history in Darwinian evolutionary terms. So he assaults the reader with absurdities like "the financial services sector appears to have passed through a twenty-year Cambrian explosion, with existing species flourishing and new species increasing in number" or "there remains considerable biodiversity" in retail and commercial banking. There is a far better way to explain the history of financial markets and products than through biology. A serious discussion of the subject would be based on micro and macroeconomics.

Unfortunately, few readers of The Ascent of Money will come away with any greater understanding of how the banking system works or the role finance plays in the modern economy. Save your time and money for better uses.

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About the Author
Brandon Crocker is the chief financial officer of a commercial real estate development and management company in San Diego.