13 May 2016

Money Changes Everything by William N. Goetzmann: a whirlwind tour of financial history


Money Changes Everything. How Finance Made Civilization Possible. William N. Goetzmann. Princeton University Press, RPR £24.95

William Goetzmann in his new book takes readers on a whirlwind tour of financial history starting in Mesopotamia 5,000 years ago and leading up to an outlook what a roadmap into the future might look like. A professor at the Yale School of Management might not seem an obvious cicerone of clay chits left behind by ancient Babylonian accountants, but Goetzmann as a veteran of archaeological digs in the region can rightly say “been there, done that.” (One of several hats he wears. Art history is another, and in this book that one too is on display.) Goetzmann has a reason for picking up the trail in Mesopotamia, because right there, at the outset of recorded history, new ways of passing payments triggered changes in society at large by enabling individuals to plan for their future. And when individuals take control of their personal budgets they re-define their dependencies on family, tribe, and whatever other social bonds wrap around them. Seen through Gotzmann’s prism, that is why finance is pivotal for historical change: change in the way money is used is the trigger that makes history happen.

Finance is a means to make cash flow across time and space. Only two tools are needed to do that. The first tool is to document a claim: it may come in different guises, from chits to bits, but that purpose throughout history has been constant. The second tool is where historical change comes in. The reach of purposes to which money can be put has its sole limit set by human ingenuity – and borders were pushed out to how money could be used with every breakthrough in mathematics. The cast list of the history of mathematics and of the history of finance in many cases overlaps; pioneering conceptions how numbers work often have been harbingers of financial innovation. And societal change follows in its wake as a second round effect. The medieval Italian math maven Leonardo Fibonacci penned one of Europe’s first business manuals; probability theorems conceived by the Enlightenment mathematicians de Moivre and Bernoulli enabled diversified investment portfolios and annuity tables.

But if breakthroughs in mathematics often had their applications in finance before they make an impact on any other technology, then, truth be told (and Goetzmann tells it no holds barred), there were times when financial innovations backfired or wrought destruction. Many a hapless Mesopotamian was condemned to slavery on presentation of a debt he could not pay; some of Socrates’ fellow citizens were fleeced by fraudsters who pledged the same security twice; Seneca could take advantage of creative accounting that let wealthy Romans dodge restrictions on financial investment. The pulse of financial innovation began to quicken when Fibonacci’s compatriots in Venice discovered the city could raise money through parcelling out a government loan amongst a multitude of savers. Private borrowers were not far behind, aggregating funds in a vehicle with roots in juristic conceptions of Roman Antiquity, the corporation. Public or private markets for over 800 years have gone from strength to strength in terms of size, but as their dimensions ballooned, so did their scope for malfeasance.

The accelerating pace of innovation in the West from the Enlightenment onward has been a phenomenon credited either to thinkers or to doers. The true heroes, for Goetzmann, were both: individuals with a mind-set for seeing how numbers could point to prospects for gain, combined with a flair for putting theories to the test in practice. Arguably, capitalism in Britain has its founding father not in Adam Smith but in Daniel Defoe whose frame of mind propelled Britain on an upward trajectory of wealth. Defoe embodied the best and the worst of a financial pioneer, a master analyst of social psychology and a visionary promoter of investment schemes. But Defoe’s contemporaries at times found it hard to tell whether he really believed in the schemes he was touting or whether in reality he was taking gullible investors for what they were worth. (not everyone was taken in by Defoe, clearly, he did time in jail and at the time of his death was hotfooting it from his creditors). The same frame of mind showed up in John Law, a cosmopolitan Scot who at the apex of his career was in control of the finances of France. John Law ratcheted up the scale of financial innovation by creating a bubble, however not in a single particular asset, but in something much bigger but less tangible: in money. Of course, debasing coinage was a tried and tested means to increase spending power from times immemorial, but what was new about John Law’s scheme was to do this using paper bills.  Law died in disgrace and penury after his scheme went bust, but that did not preclude his scheme from being copied during the French Revolution with the issuance of so-called assignats that induced the first runaway inflation of modern times.

Financial history the way Goetzmann tells it, in some ways reads like a morality tale. Contemporaneous art illustrated that ambivalent attitudes to financial innovation. Take a close look at David’s famous rendering of Marat assassinated in his bath, and you will spot in the victim’s hand a worthless assignat. Other telling artistic responses to the power of finance were too direct for comfort. For instance, John Law’s Banque Royale commissioned a vast fresco depicting the fruits of commerce, which, alas, did not survive his crash, and New York’s Rockefeller Center commissioned a fresco by the Mexican artist Diego Rivera but had it painted over to avoid piquing the sentiments of visitors passing through the lobby.  But the most influential backlash against financial innovation in the twentieth century emerged in Russia and in China, with outcomes far more pernicious than the ills they were intended to cure.

So the crash of 2008 had precedents. Goetzmann’s review of financial innovation that in 2008 went out with a bang is unequivocal – finding an equilibrium that will satisfy all actors in markets that are irreversibly interdependent will depend as much on an accord what kind of civilization we want to live in as it does on arcana of financial regulation. There is a theme that one would like to see Goetzmann elaborate, however, namely what we can learn from historical precedents for printing money (aka debasing coinage) and what that might have to teach about quantitative easing. Quantitative easers, no doubt, have far better academic credentials than John Law or Jean Paul Marat, moreover, they have models to show that this time is different. But is it ever? No academic discipline has a better handle on models coming unstuck than history, and one would welcome a forecast on this subject by an historian of Goetzmann’s standing. As it is, his silence sounds ominous.

Dr. Benedikt Koehler is a historian and former banker, specialising in early Islamic economics. Koehler delivered the inaugural lecture for the Legatum Institute’s “History of Capitalism” course.