[Reader-list] “Are we on the brink of a ‘great dying’ in the financial world,”

[Jeebesh]

http://www.nytimes.com/2008/12/02/books/02kaku.html?ref=books

Niall Ferguson's “The Ascent of Money: A Financial History of the  
World,” went to press in May 2008, but it shrewdly anticipates many  
aspects of the current financial crisis, which has toppled banks,  
precipitated gigantic government bailouts and upended global markets.

“Are we on the brink of a ‘great dying’ in the financial world,” Mr.  
Ferguson asks, “one of those mass extinctions of species that have  
occurred periodically, like the end-Cambrian extinction that killed  
off 90 percent of Earth’s species, or the Cretaceous-Tertiary  
catastrophe that wiped out the dinosaurs? It is a scenario that many  
biologists have reason to fear, as man-made climate changewreaks havoc  
with natural habitats around the globe. But a great dying of financial  
institutions is also a scenario that we should worry about, as another  
man-made disaster works its way slowly and painfully through the  
global financial system.”

In the course of this useful if somewhat lumpy volume, Mr. Ferguson  
looks at the roots of the current economic meltdown, examining how, in  
a globalized world that uses increasingly complex financial  
instruments, defaults on subprime mortgages in American cities like  
Detroit and Memphis could unleash a fiscal tsunami that spans the  
planet.

But the book does not focus primarily on speculative manias and  
financial crises; for that, the reader is better off with two old- 
school classics, “Manias, Panics and Crashes” by Charles P.  
Kindleberger and Robert Aliber, and “Extraordinary Popular Delusions  
and the Madness of Crowds” by Charles Mackay. Instead Mr. Ferguson  
discusses such cycles of euphoria and panic within a larger historical  
context: he traces the evolution of credit, debt and the idea of risk  
management over several centuries, and as he did in an earlier book,  
“The Cash Nexus,” he examines the potent links between politics and  
economics.

Mr. Ferguson explains why money went from coinage to paper and the  
advantages and disadvantages of the gold standard. He argues that  
aging societies (like those facing a large baby-boom generation  
entering retirement years) have “a huge and growing need for fixed  
income securities, and for low inflation to ensure that the interest  
they pay retains its purchasing power.”

And he looks at how exotic financial innovations (like collateralized  
debt obligations) and wide support for adjustable rate and subprime  
mortgages (endorsed, he says, by proponents of wider home ownership as  
disparate as Alan Greenspan and President Bush) pushed the snowball of  
the current financial crisis.

Whereas Mr. Ferguson’s recent books “Empire” (2003) and  
“Colossus” (2004) were highly polemical histories promoting the  
virtues of British and American empire, this volume is considerably  
less ideological and less tendentious. No doubt Mr. Ferguson, who  
earlier called for the United States to export democracy and  
capitalism, has been chastened by the continuing war in Iraq and by  
the growing economic difficulties of the United States.

Noting the high savings rate of Chinese households and Chinese  
corporations (in sharp contrast to Americans’ penchant for living on  
credit), he observes that the direction of capital flow is now from  
East to West.

“In 2007 the United States needed to borrow around $800 billion from  
the rest of the world; more than $4 billion every working day,” he  
writes. “China, by contrast, ran a current account surplus of $262  
billion, equivalent to more than a quarter of the U.S. deficit. And a  
remarkably large proportion of that surplus has ended up being lent to  
the United States. In effect, the People’s Republic China has become  
banker to the United States of America.”

Although “The Ascent of Money” is pockmarked by digressions (about  
things like the Black-Scholes model of options pricing) that many lay  
readers will find arcane and difficult to understand, the book as a  
whole is animated by Mr. Ferguson’s narrative gifts, among them his  
ability to discuss complex ideas in user-friendly terms.

He also has a knack for illustrating his larger hypotheses with  
colorful stories about people like Nathan Rothschild (the subject of  
one of his earlier books); the Scottish economist and gambler John Law  
(described as “the man who invented the stock market bubble”); and the  
Nobel Prize-winning economist Milton Friedman and his so-called  
Chicago Boys, who helped bring economic reforms to Pinochet’s Chile.

It is Mr. Ferguson’s belief that “behind each great historical  
phenomenon there lies a financial secret,” and much of this volume  
aims to explicate that argument. He writes, for instance, that the  
Confederacy’s lack of hard cash, as much as its lack of industrial  
capacity or manpower, undercut its cause. And he suggests that the  
Renaissance boom in art and architecture can be traced to Italian  
bankers’ application of Eastern and Arabic mathematics to finance.

“The Dutch Republic prevailed over the Habsburg Empire,” he argues,  
“because having the world’s first modern stock market was financially  
preferable to having the world’s biggest silver mine. 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. It was Nathan  
Rothschild as much as the Duke of Wellington who defeated Napoleon at  
Waterloo. It was financial folly, a self-destructive cycle of defaults  
and devaluations, that turned Argentina from the world’s sixth-richest  
country in the 1880s into the inflation-ridden basket case of the  
1980s.”

Mr. Ferguson is fond of making Darwinian comparisons in the book,  
writing that “financial history is essentially the result of  
institutional mutation and natural selection,” and noting that “as in  
the natural world, the evolutionary process has been subject to big  
disruptions in the form of geopolitical shocks and financial crises.”

Also contributing to “the inherent instability of the financial  
system,” he says, are the vagaries of human behavior: “our innate  
inclination to veer from euphoria to despondency” and “our perennial  
failure to learn from history.”

“Those who put their faith in the ‘wisdom of crowds’ mean no more than  
that a large group of people is more likely to make a correct  
assessment than a small group of supposed experts,” he writes. “But  
that is not saying much. The old joke that ‘Macroeconomists have  
successfully predicted nine of the last five recessions’ is not so  
much a joke as a dispiriting truth about the difficulty of economic  
forecasting. Meanwhile, serious students of human psychology will  
expect as much madness as wisdom from large groups of people. A case  
in point must be the near-universal delusion among investors in the  
first half of 2007 that a major liquidity crisis could not occur.”