Monday, July 2, 2012

History of Money & Banking



This article is made from the books by Niall Ferguson.

Niall Ferguson is a foremost historian in the study of money, wealth and banking

The lust for money started in USA when Spanish Francisco Pizarro came to El Dorado and he with other army went to the money mountains of USA where the mines of gold and silver were common. The portable power was taken by Pizarro. Silver and gold was shipped to Europe and so crown of Spain got rich. But because of excess supply of silver in a short time the value of silver coins got low as compared to products sold so in long run the things did not work out well for Spanish Empire.
Money is not metal or paper but it's the trust and the belief of recipient, you can rely on people to borrow money from you and later pay it back. The borrowing and lending existed since 2nd century against products and their value. Lending is all that made the commerce today to come into being. Fibonacci  was the first mathematician to related maths to business and it helped with calculations of commerce. Computation of interest and book keeping was made by Fibonacci as well . Italian cities were the first business hubs of world ,many money lenders and bankers were established there. Compensation of lender is what we call interest as in old times merchants were given loan and as we cannot predict weather so lenders demanded high interest/compensation. Merchant of Venice tells the story of money lending Jews in Venice .
Niall Ferguson


From Renaissance Italy to modern world ,the money lenders were always villains due to high interest and their demand of anything back when money was not returned. In 15th century Italy the Medici family was top in money dealing and lending, they gained power and you can see in Florence. It was Niccolo Machiavelli who wrote their history and the Medici were the people who paid for Renaissance in Italy . Medici were basically known as tyrants or godfather and those who used to lend money. Now for the first time in 14th century Medici money lenders became founders of the banking. Also Giovanni was the one who made banks across Italy and then began the story of Medici power as banking family in Europe. Medici were the first ones to make banking a powerful profession, they became pioneers of money exchange. 

Leonardo Da Vinci and Michelangelo were among  the few who were paid high by Medici to provide art in Italy. Michelangelo worked for Lorenzo de Medici to give masterpieces. Giovanni di Medicci was a top banker and he extended the banks around Italy. Cosimo de Medici ,son of Giovanni  later worked hard to maintain the power of banking. Cosimo (father of Lorenzo de Medici) was the master of Florence and controlled everything from law to politics to finance. A notable contribution to the profession of accounting by Medici family was the improvement of the general ledger system through the development of the double-entry bookkeeping system for tracking credits and debits. This system was first used by accountants working for the Medici family in Florence.Medici family thus in end of 15th Century was labelled as a family who was ruthless and powerful.

Cosimo de Medici helped banking, trading and industry to develop and made Medici Bank the biggest bank of Europe.

From 1996-2006 there were 1-2 million each year to get bankrupt. While in America we say that many failed in start but made money later on e. g Henry Ford went bust in start and started all over again. The Bond market later turned banking into a casino game ,risk takers went to buy stocks and bonds and made fortunes overnight. Bond market funded wars, it created political powers. In modern time Bond Market  crushed Argentina, fortunes of most of us are linked to Bond market.
In 14th and 15th century many states in Italy were on war ,Sienna ,Tuscany and Pisa etc and all this fight was because of money and goods. Though financing war needs money and so Bond market was invented during Italian Renaissance where wars were done to capture capital, powerful armies used to take goods from weak forces and invested it to make themselves capable to fight with stronger armies. Florence people had a lot of money as there were many bankers were there.
While a war is taking place you as a money lender or bond trader are facing a high risk as you are facing the chance that war may ruin the city but if your clients win you will get a lot in return of the high risk you are facing. So even in old times risk was the actual measure of profit.

 London later became the centre of Europe (or the world) and then in 18th Century the story of Rothschild family started.In 1750 Mayer Amschel Rothschild, worked at the Hanover Bank as a clerk a few years after his father's death. He made a lot of fortune in Germany and also expanded the bank across Europe including England and France, later his son Nathan came and made a giant banking empire.

 Nathan Rothschild was a man of great obsession in banking .He was clever and hard working and he made the first big bank in London. Battle of Waterloo was a war on business ,to pay for war the British sold many Bonds. Nathan later went to get gold and silver from Europe and England's Exchequer while Duke of Wellington was also on march across the Europe to gather gold along with Nathan and while selling gold where the price was high or sending rest in London. So we say that London was premier place for gold exchange and was the market of top metals(gold ,silver etc).Prussian army was beaten as well by Duke of Wellington and later Nathan took a risk to sell gold, he gambled to war of Waterloo and he bought many bonds and wishing that war won would lead Britain bonds to get high price, also while bonds were generated Britain was getting money for war as well. So we say that war/ politics and economy are related to the financial market. By the start of 19th Century Nathan Rothschild acquired control over banking system across Europe including England and France.
Nathan Rothchild

Though the French war made Rothschild family rich and powerful and later they went on to bet American Civil war .Later cotton fields were used for bond market fuel, Rothschild's were always in New York and later Abraham Lincoln was supported by Rothschild for the cotton capture, for a while cotton trade was well off and it made a lot of profit for Rothschild. Rothchild  later had a Machiavellian thinking and chose to be feared rather than loved and even some British started to hate them due to their greed and the political problems due to their lust for money. Cotton from America was sold in Europe and bonds were traded in terms of cotton price(just like gold).Bonds not only effect economy or politics but it effects pensions and inflation which effects everyone. At high inflation bond prices fall, i.e. Argentina is one of example. One Harrods was also in Argentina suggests that it was a rich country and they had a lot of resources(they had a lot of gold and silver but lack of management made it loose all).

16th Century belonged to lending and financial market, while 17th century was about Bond market.

With no foreign loan and no bonds ,the Govt. of Argentina had no option than print new notes and a time came when Argentina was out of paper and printing staff was on strike. Farmers were not bringing or breeding cattle as a price of a cow was equal to 2 pair of shoes or even farmers were in trouble. After the fall of Argentina the Bond market became less famous, price of food got high and many were hungry now, families ran out of cash and they sold goods to buy food. Keynes later came in Britain and described the bond market in his way. Keynes theories rely on a functioning bond market to support  economic of a country. Bond market gained rise again.

Joint stock market came into being in 18th century ,the "stock market" came into being in late 18th century and became top industry in 19th century. Future is always certain ,and stock market is prone to randomness and these can go bust like bubbles. Enron became corporate fraud in history of America (or world).STOCK MARKET BUBBLES CAN CAUSE MASSIVE IMPACT ,even bigger than the bond market or other financial trades.  

John Law was the father of stock market bubble, he was the Scot who owned half of US and he was gambler, financial genius , convicted murderer and a man who indirectly caused French revolution. John Law was famous from Florence to Amsterdam to New York and London, he was the first greatest stock market guy. Law was later charged with murder and was prisoner but he fled to Amsterdam from jail and later went to Paris and also stayed there and made himself a legend.

Stock Market


Later trades were done in Asia where Dutch armies used to get goods like spices and used to sell them in Europe, East India company was first built by Dutch and goods were traded to Europe. People started to invest in East Indi company and made fortunes.
By 1610 THE DUTCH EAST INDIA COMPANY was ready to conquer the world, it was biggest multinational company(also monopoly trading company) of world. With 10,000 soldiers and 70 ships the network was across the world from Java to India. Every good was traded and their own stocks were traded in European company and many got wealthy due to this. John Law was in Amsterdam and was living on gambling and was also involved with Bank of Amsterdam.

In 1760 John Law arrived in Paris, France was in debt due to its wars. It was the perfect opportunity for John Law to change fortune of France, Law was a self taught economist and he suggested to print a lot of money. He later went on to give credit at less interest and also suggested that France should make a monopoly company like East Indi Company. French went to USA and a company was built "Mississippi Company",John Law as its director. Many French merchants and investors were financing the company and this company made men millionaires and John Law was richest of them and later Law said" I am the economy". Law was the most powerful money man in history of France ,he controlled all financing banks, mints, trades and companies. Law later became the Prime Minister of France. John Law's money and stock schemes were Ponzi schemes.

John Law


John Law speculated that most profits will come from the French Colony in USA,LOUISIANA .The trade in this state was best under the management of Mississippi Company. Later share price of Mississippi company began to fell and angry crowd later gathered in Paris in front of Law's bank and started to stone the bank. It was a stock market bubble, Law later stayed in Paris and spent his time writing letters and continued gambling. France was later in loss and nightmare was unbelievable.  Later in 1929 came the stock market crash in Wall Street ,it was the most massive attack in history. Unemployment doubled and inflation rose as well. Technical reasons for such crashes are quite a lot but most relevant is herd behaviour(as described by Nietzsche that herd behaviour of many causes bubbles).According to Bell curve the probability are distributed according to frequency but in stock markets things are different and not follow a proper Bell curve i.e. heights of men are near 5 to 6 feet mostly and dwarves and giants are in tails but in stock markets everything has randomness which is not close to mean or which doesn't make quite a proper Bell curve.

Later Enron became the darling of Wall Street, Sharon Watkins was director of Enron and also many investors invested into Enron and it became one of the largest company in world. Enron launched largest gas pipeline in world, from USA to Brazil and in Argentina. Unlike John Law's system for his French company the system of Enron was fraud. In December 2001 Enron got bankrupt ,they were under 25 Billion debt. Ken Lay and other executives of Enron were charged with fraud and other securities fraud and were jailed .
Finance is much about risk than return, question is are you insured or hedged. Natural disasters also have huge impact on markets e. g Hurricane Katrina. The first insurance company was founded in 1744 in Edinburgh and was under management of Scottish ministers, Robert Wallace was a hard drinker and a math prodigy .He was pioneer of insurance fund and later the fund will become million dollar insurance industry. Robert launched widow fund and later in 18th and 19th century this widow fund expanded due to wars as soldiers were concerned about their sons and husbands. Insurance also contributes to welfare and economy of a country. Japan also was a pioneer in welfare. Nationalizing the risk was the key to welfare system. By late 1970s Japan became top in welfare and also it became the second richest country in world after US. Later in 1980s inflation was rising in London, due to risk.

Milton Friedman later won Nobel Prize and he stated that if money supply went up then so did the price level. Welfare state concept was also practised in Chile but it collapsed. So economics later merged with democracy and state laws.
Futures market later was formed in Chicago, futures contract assured hedging and later "Options" were formed. Future contracts are "Derivatives" and "Options" are smarter version of derivatives. Warren Buffet described derivatives as weapons of destruction of stock markets, one proof is that a big Hedge fund lost  almost all its value in a month. Later became the real estate business as price of land can go up and down. Money was borrowed for land and interest was earned by banks and clients expected the high price in future. But sub-prime borrowers were in this market due to greed of banks for interest(sub-prime borrowers are those who have not much assets but yet get loan as banks believe that rise of price of land will cover interest etc).This all led to sub-prime crisis in 2007 in US, it costed 153 billion to US. Later news were released that while in Sub Prime crisis almost one in two insiders were seen doing fraud.

Wall Street


Now let's come to Wall Street ,while during loans on houses many investors bought securities of A rated firms and so to save their money. Many had no idea what was going on, but they invested to avoid loss in Sub-prime crisis, lenders of Sub-prime mortgage were also investing in securities to save themselves. Those people who were unable to pay for their house were called for bids and were forced to sell houses, this caused loss to both lenders and home owners(loan takers).Next turn of investors was business but this is only limited to people with some capital or assets.
Total market of stocks/derivatives, insurance and bond market of world is 119 trillion dollars ,thanks to globalization and the top Stock Exchanges and their links. Money followed from Government to Government ,two banks such as WORLD BANK AND IMF were made in Washington D.C for stabilization of world economy.IMF and World Bank ensured that borrowed money by countries must be returned in a steady way, like Mexico got bankrupt after taking 30 Billion dollars and IMF took action and recovered money.IMF ensures that politicians are to be responsible to recover money from those countries.

Hedge Funds are funds that put funds for weeks and get massive returns, the master of Hedge fund was George Soros. His Theory of Reflexitivity suggests that financial markets are not perfect and so issues in these markets were read by him and he speculated from these and earned. Later Soros picked UK market and speculated British Treasury and went to speculate on trillion dollars. Soros speculation went right so in one single day he made million of pounds and that he became the world's richest hedge fund manager.

Merton and Scholes 's Long Term Capital Investments made million dollars by their hedging and speculation and later their option in top markets and the models to their speculation were quite accurate and so the risk of going bust was 0.01^20 so zero and later on they were awarded Noble Prize. Quants were predicting too and traders were happy too in all this case due to massive profits and ultimate profits were made. But quants were only using data of last 5 years, so later Long Term Capital crashed later and there came the 2007 crash. The crash that made quants feel like losers. Such crash was blamed for being faulty due to assumption of models of quants. Quants were good in models only for short-term and not for long term, while the one guy that did prove that quant models were wrong was Nassim Nicholas Taleb who warned the Black Swans in 2005-2006 and also suggested that Bell Curve is not to be used in stock or foreign market.

Nassim Nicholas Taleb, the creator of Black Swan Theory

China has many millionaires and also Chinese people are ones who save money for investment ,this makes them better gamblers than American or Europeans. In 2007(after sub-prime crisis) US needed 800 Billion Dollars in a year and China did gave the money so China became a banker to US. Why such a poor country like China will lend money to US? The answer lies in China's buying of dollars in Chinese market (China's business assets and stocks were traded in US dollars)thus raising value of dollar and so having more price in market. Quants are unable to predict Black Swans (as market is more complex these days and randomness is wild ) and human errors and also history of money market is known to few and only few take history into account these days. Thus we can say that crash in markets will keep on occurring unless we have enough knowledge about these issues.



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