Author: Niall Ferguson
_Niall Ferguson_
Reading time: 25 minutes
Synopsis
The Blinks for The Ascent of Money (2008) show how different historical events led to today’s financial system. They explain how money and the financial system became the engine of world history and human progress, even though they can cause crises and unfairness.
What’s in it for you: Learn about the origins and how the financial system works.
Today’s financial system often acts without logic. It can easily have crises and is hard to control. It also causes global inequality. But it has always been a good way to create and share money. It has driven world history and helped human progress a lot.
The following Blinks about The Ascent of Money will show you the history. They explain how the modern financial system came to be. You will learn how important the financial system is for society, even though it can have crises.
You will also find out:
- what financial systems and evolution have in common,
- the mistake Spanish conquerors made when they looked for gold and silver, and
- what causes hyperinflation.
Blink 1 – The financial system works like biological evolution.
Charles Darwin discovered that life developed through a process. He called this process natural selection. Life forms that adapted best to their environment grew strong. Those that did not adapt well died out. The financial system works in a similar way.
In most places, natural resources are limited. They only support a certain amount of life. The fight for these resources is tough. Often, failing means death. Life forms that won this fight passed on their genes. They reproduced and grew in number. In the end, they took the place of species that died out.
Evolution never stops. Old species die out, and new ones replace them. Usually, these changes happen in small areas. But sometimes, big events cause many species to die out. For example, 64 million years ago, a meteor killed almost all life on Earth. This included most types of dinosaurs. In such times, new species take over. After the meteor, mammals replaced the dinosaurs.
The financial system changes in a similar way. This is through ‘market selection’, which is like natural selection for money. The financial world is always changing. New methods and ideas drive this change. It is like the constant change in nature.
Companies that can adapt to new situations grow and do well. Other companies then follow their example. But companies that stick to old ways and don’t make enough money are likely to fail.
Some events, like the financial crashes in 1929 or 2008, cause many financial firms and practices to disappear. This is like a ‘mass extinction’. These situations create room for change.
Blink 2 – Only our trust gives money its value.
In the 16th century, Spanish conquerors explored Central and South America. They were looking for gold and silver. They thought that more precious metals meant more coins. They believed this would make them richer. But they did not expect one thing: if they had too many coins, each coin would be worth less. This was true no matter how rare the metal was.
The conquerors did not understand that money’s power and value don’t come from the metal it’s made of. Instead, its value comes from what people are willing to trade for it. Having too many coins always leads to inflation.
What money is made of does not matter. What matters is that society trusts its value. This trust alone decides how much money is worth.
We trust that the money we use will keep its value. We also trust that banks will not print too much of it, unlike the Spanish did long ago. We trust banks to keep our money safe. Banks also trust us to pay back our loans. Without this trust, money is not even worth the paper it is printed on.
Today, physical money itself has little value. Paper and coins made from cheap metals are not worth much on their own. Most money in the world does not even exist as physical cash. It is virtual. You can send it electronically around the world without it ever becoming real money you can touch.
So, in fact, coins that are worth nothing on their own are only valuable because we believe in their value.
Blink 3 – Loans fund the financial system by creating new money.
Loans are one of the most important inventions in human history. Along with new tech and science, loans have greatly helped human progress.
The idea of loans goes back to ancient Mesopotamia. There, lenders received clay tablets for the money they loaned. These tablets were like IOUs, noting the amount owed. This simple system of lending and borrowing changed over time. It led to the credit system we know today.
Banks are the main lenders. The financial system is funded by creating new money through loans.
Creating money means that new money is made when loans are given out. Imagine someone puts 100 Euros in a bank. The bank will likely keep a small part of it. It will then lend the rest, for example 90 Euros, to someone else. This third person might then put that loaned money into another bank. That bank will do the same: keep a small amount and lend the rest, for example 80 Euros, to another person.
This system makes 100 Euros grow to 270 Euros. So, it effectively increases the amount of money available.
This increase in money is very important for funding the financial system. The new money can be used for investing and buying goods. Without this simple link between borrower and lender, the financial system would stop. The amount of money would not grow.
Blink 4 – The modern financial system is built on many linked market types.
The modern financial system mostly grew in Western Europe and North America. In medieval Italy, trade with Arab merchants led to new ways of exchange and good accounting methods.
This led to the first banks. Merchants needed loans to fund their trade. Even then, banks were important in the financial system. They made it easier to get loans and so helped fund the system.
War caused the next financial step: the invention of bonds. These were government loans with a fixed interest rate. This also started in medieval Italy. Italian city-states were always fighting each other. They needed money to pay their soldiers and buy weapons. So, they raised money by selling government bonds.
The next big change in finance first appeared in 17th-century Holland: public companies. Companies got money by selling parts of their ownership, called shares, on the stock market. This new idea became very popular. It quickly spread around the world.
In the 18th century, insurance companies looked at different financial markets. They made portfolio investments to help manage risks. Later, in the 20th century, governments also took a bigger role in this area.
In the early 1820s, the property market grew a lot. This happened because of fewer rules and government help. Politicians wanted this. They aimed to create a stable democracy where many people owned their homes and were independent.
All these linked financial markets and institutions, which depend on each other, make up the modern financial system we know today.
Blink 5 – Loans offer a way out of poverty.
Many stories are told about greedy bankers. They say these bankers harm the poor and those at a disadvantage. People whisper that bankers use others’ weaknesses and lack of knowledge. They do this to get rich at others’ expense. They gather all the wealth at the top of society.
But in reality, the financial system offers the best chance for countries, communities, and people to escape poverty. It helps them build a strong financial future.
People can put their savings in banks. Banks then lend this money to those who need it. If money could not be kept in a bank, it would just sit there without earning interest. It would wait until its owner spent it. But when money is in a bank, others can use it. As a loan, money moves from being still to being active. It changes from a ‘sleeping’ state to a ‘working’ one.
Without access to trusted loans, poor people would have to borrow money from less safe sources. Loan sharks target those who desperately need money but cannot get it from proper financial institutions. They offer loans with very high interest rates. And their penalties for late payments can even include violence.
Access to proper loans allows people to make long-term plans and decisions. Buying land, starting a business, or investing in a company become possible with loans.
One special type of loan that is much talked about is microfinance. This means giving small amounts of money, often to poor women. These women usually have little to no collateral by Western standards. But this money is often enough to buy farm animals or start a small business. It helps people move from relying on others to being independent. So, even a small loan can make a big difference in poor areas.
Blink 6 – If a financial system is weak, it falls prey to stronger ones.
In financial systems that don’t work well, money cannot move freely. Examples are communist planned economies or medieval feudalism. Bureaucrats control money resources. They do this in ways that are not good, often to meet political goals. Or they might keep the wealth for themselves. This makes social differences even bigger. The result is a fixed situation. It gives little reason for new financial developments.
The financial system that grew in Western Europe allows money to flow most freely and efficiently, compared to other systems. Competition is fierce. Financial companies must be profitable and trustworthy. If not, others will replace them.
Societies that adopted the Western financial model early could grow. They did well, sometimes at the expense of less developed economies.
During the time of imperialism, European nations looked for new raw materials. They conquered countries whose economic systems were less efficient. This led to the rise of European empires. Their power came mostly from their financial systems. Because of tough competition, these empires eventually broke apart. Stronger economic powers replaced them. In the 20th century, the Western financial system continued to spread due to globalization.
Here are some examples from history: Between the 18th and 20th centuries, Western nations with strong financial systems took over many Asian countries. These Asian countries had many resources. But they had inefficient and absolute financial systems.
In the 17th century, the Netherlands became free from the much larger Spanish Habsburg Empire. The Netherlands was where the stock market and modern banking began. The Spanish had more gold and silver. But they had little understanding of economics. This allowed the Dutch to defeat their rivals.
Blink 7 – The financial system reflects human nature.
A perfect financial system does not exist. This is because people control financial systems. And all people naturally act without full logic. Several things make human behavior almost impossible to predict.
People tend to move between different moods. They can be very hopeful and happy, or very negative and sad. These mood swings get stronger when money is involved. In these situations, people act even less logically than usual.
People are also like herd animals. They watch what others do, their successes and failures. Then they make their own choices.
We all have different strengths and qualities. Others judge and value these differently. Society does not value everyone equally.
The financial system reflects and increases these illogical behaviors and inequalities. For one, financial gains are not shared equally. People with certain attitudes and skills can gain wealth and power. Others get nothing. Inequality is part of the financial system, just as it is part of our human society.
Just as people have mood swings, the financial market can quickly fall from its highest point. Investors’ trust is very weak. People get very scared about their money. They often overreact if they think their financial situation will be affected.
Investors also watch how other investors act in certain situations. They then copy what others do. The financial market becomes unstable because many people invest or pull out their money too quickly.
Blink 8 – The stock market regularly creates speculative bubbles.
The stock market is like a balloon. When trust is high, share prices go up. The market gets bigger. When trust goes down, investors take their money out. The market shrinks.
Sometimes the market gets so big that prices cannot be kept up. This pressure breaks it, like a balloon that has too much air. The speculative bubble bursts. This leads to a huge fall in prices.
Speculative bubbles happen often. They usually follow the same pattern. But investors are often surprised by them. They don’t see the unsustainable market growth ahead of time. Many lose a lot of money when the bubble bursts.
There are many reasons why bubbles form and why they are hard to predict.
A typical Wall Street CEO’s career lasts 25 years. This is often not long enough to truly understand how unstable the market is. Many believe that good times will last forever. They fail to see the downsides of strong growth.
Unscrupulous leaders use investors’ lack of experience. They give false information about their company’s success and profits. This artificially pushes up share prices. It allows them to earn big bonuses. When such a fraud is found out, share prices fall sharply. Shareholders lose their money.
Speculative bubbles also often happen because people don’t fully understand the financial system. Stories of big profits and amazing growth trick many into getting involved.
All these points lead to market growth that cannot last. The more people invest, the more the market grows. This continues until the speculative bubble bursts. Then investors suffer huge losses.
Blink 9 – Hyperinflation carries great dangers.
Inflation means that money becomes less valuable. Every market expects a small amount of inflation. This is because more money is usually printed over time. But too much inflation, called hyperinflation, can be very dangerous.
Hyperinflation is very risky for those who own government bonds and savings in that currency. These types of assets lose more and more of their value.
Hyperinflation often happens because of bad management of money. It happens when a country prints huge amounts of money and cannot control its debts. So, the central bank or the government is responsible for this problem.
Often, the weakening of money is done on purpose. This can be an effective way for a government to pay off its internal debts. When money loses value, the value of its debts also goes down.
Hyperinflation can also happen because of political instability. Or it can be due to governments failing to solve key economic problems in the long term.
No matter the reason for hyperinflation, it will always have big bad effects on society. It destroys the wealth of local lenders and savers. It also harms everyone who earns a fixed salary. Also, hyperinflation greatly damages the trust in that currency. Foreign investors start to ask for higher interest rates. This is to make up for the risk of unreliable borrowers. This then harms local borrowers.
Hyperinflation shows the power that the state finally has over financial markets. At the same time, it makes clear how dangerous it is to fight against the financial market.
Blink 10 – We choose between private care and the welfare state.
Modern private insurance was invented in Scotland in the 18th century. Two Protestant ministers created it. They wanted to offer financial help to families of priests who had died. They designed an insurance model where paid contributions were gathered. From these pooled funds, money was paid out to members in need.
This new private insurance system gave financial support to those in need. It also lowered their financial risk. The model soon became very popular. So, the insurance system spread quickly in the 19th century.
However, not everyone had insurance protection. There were always people too poor to get insurance. Losing their financial security meant extreme poverty for them. Or it sent them to the workhouse – a prison-like place for those who could no longer support themselves.
Politicians soon realized that protecting weaker members of society helped social stability. It also won them votes. The welfare state aims to lower every citizen’s financial risk. It does this through things like universal healthcare, old-age pensions, and free education.
But these efforts also have downsides. High taxes and universal protection can make people less motivated to work hard and save money. Many welfare states face rising costs for healthcare and pension systems. This is due to an aging population.
Over the past decades, the welfare state has been much discussed. Some governments have tried to reduce parts of the welfare system. They wanted people to take on financial risks again.
To protect ourselves from risks, we must choose. We can pick expensive, uncertain private insurance. Or we can hope that the shrinking welfare state can still take care of us in the future.
Blink 11 – Political decisions were behind the 2008 stock market crash.
Many times in history, political goals have clashed with financial reality. A good example is the changes that happened to the property market in the 20th century.
Especially in English-speaking countries, governments had a policy. They wanted more people to own their homes. The main idea was that homeowners would be more independent and safer than renters.
From a political point of view, this Property-Owning Democracy brought benefits. But the economic effects of this policy were not good.
Think about the 2008 financial crisis. It was the biggest since the Wall Street crash in 1929. We see that removing rules from the US housing market caused banks to fail. It led to government bail-outs and a global debt crisis.
To increase home ownership in the USA, the George W. Bush government strongly supported the ‘subprime’ market in 2003. Here, loans were given to people with a risky low credit rating.
From a political point of view, these loans were a good step. They helped more people own homes. However, from a financial point of view, such subprime loans were not sustainable. They only worked through a kind of ‘financial magic’. The original lenders knew that borrowers would very likely not pay back their loans. So, they repackaged the loans. They sold them to others who could not understand the risk.
The illusion did not last long. As soon as borrowers started missing payments, property prices began to fall. Around the world, institutions like pension funds and city governments were left with worthless debts. The crisis finally took hold of the entire financial system.
In the end, the global financial system collapsed. This happened because the property market was manipulated for political reasons.
Summary
The modern financial system has grown over centuries. It is illogical, unequal, unstable, and hard to control. Even so, it is the most efficient tool to create and share money. Money flowing to areas that need it most drives economic growth and human progress.
Source: https://www.blinkist.com/https://www.blinkist.com/de/books/der-aufstieg-des-geldes-de