Conversations With History: The Ascent of Money

welcome to a conversation with history I'm Harry Kreisler of the Institute of International Studies our guest today is Neil Ferguson who is the Tisch professor of history at Harvard the Ziegler professor of Business Administration at the Harvard Business School our senior research fellow at Jesus College Oxford and a fellow of the Hoover Institution in California his new book is the ascent of money history of global a financial history of the world he'll welcome back to Berkeley it's nice to be back here what was your goal in writing this book well I suppose about 2 and 1/2 years ago I started to sense that a big financial crisis was coming that was at the time when you foreo was reaching its its zenith and people would tell me at conferences that there would never be another recession that a great moderation had been achieved that risk had been perfectly allocated I didn't believe word of that and my suspicion was that there would be a big liquidity crisis so I thought well how is this going to make any sense to people most most people are baffled by the financial world why not try and rise a single volume that gives you the origins of the financial system in one place a sort of one-stop shop for financial history because no such book existed before I also hadn't mind to teach a course at Harvard on financial history and and teaching the course gave me a lot of the materials for the book so the idea was to try to have something in place that would make whatever crisis occurred makes sense in a long-term historical perspective and a 4,000 year perspective and in history is really important to understand things when they unravel my sense is that if you explained the financial system with a flow chart or a series of equations the overwhelming majority of people would be as baffled as when you began but if you explain the financial system in the following terms this is where money came from this is where banks came from this is where the bond market came from the stock market this is why we have insurance this is why the real estate market is the way it is and this is what happens when you put it all together and call it globalization and add-on derivatives then I think it makes much more sense so my strong belief is that we understand things better when we when we know where they came from when we know their story whether it's central banks or paper money or derivatives which of course are in some ways the most intimidating element of all in today's contemporary financial world somehow they they make more sense if you knew if you know where they originated and what about the title the ascent of money what was in your mind was was irony there oh yes and of course iron is a hazardous thing because not everybody detects it when I was a teenager there was a wonderful series on British television the ascent of man presented by Jacob Loski which was essentially a celebration of man's scientific progress when I thought of a title for this financial history I couldn't resist the idea of calling it the ascent of money but it is intended ironic because a whole theme of the book is that the ascent of our financial system it's its evolution is extraordinary bumpy it's a it's a jagged upward move punctuated by really major setbacks now we never go all the way back to ancient Mesopotamia and even the worst financial crisis doesn't in fact take you all the way back as it were to zero you continue to scale the mountain but very very bumpy ride and I think that's one of the the most important points that the book makes there's there's really no period in financial history which hasn't witnessed some kind of crisis or another at one level you're saying that money and Finance gets a bum rap because as you trace this history what you're really saying is it was about greed but it was also about uplifting human welfare and and talk a little about that because I think that's important it's not it's not the way we generally see things especially when things unravel well there's a long tradition in Western civilization of disparaging finance and of regarding bankers money lenders providers of financial services as in some sense parasitical as compared with people who grow corn as compared with people who make things and this skepticism up finance goes back a long way and it goes back well before Shakespeare's Merchant of Venice but I use as a sort of emblematic figure of the of the odious financier actuated by all kinds of antisocial impulses the reality of course is that financial services are just as important as agriculture and manufacturing industry and in fact they're essential for both by by intermediating between savers and borrowers financial institutions have provided for millennia a tremendously important role now the difficulty is that periodically the financial system breaks down for reasons that you alluded to I mean the most obvious being that the human psychology the human appetite for profit periodically leads to to excess we've seen that in recent times we've seen it many many times over over a thousand or more years when these crises happen when when the the bubble bursts that's when the backlash against finance is usually at its most intensive and I think one of the points I try to make in the book is that we have to somehow disentangle the dysfunctional tendency of financial market to blow up from the underlying benefit the financial intermediation gives us look before we talk about you make an analogy to biology and the evolution and it would be a way to talk about the the way different institutions and instruments and vehicles emerged but but I think it's important that we we have to always start and you just tended at this at this duality of of the human psyche on the one hand greed and avarice and so on and on the other fear and panic so a lot of the story is about moving from seeing opportunity leading to greed which it probably in the early stages is a good thing but then becoming something very negative and and then leading to panic and fear well I spent a lot of time in the book trying to explore why bubbles happen going right back to the first stock market bubble which was in France in 17 1920 when John Laws Mississippi company became the object of extraordinary speculation fibra speculation drawing in first time investors from all over france creating an enormous run-up in the price of mississippi company shares followed by a crashing bust which really left france's financial system in in ruins for more than one generation it's a classic story actually because it begins with a kind of displacement it seems as if the opening up of louisiana of france's territory in north america it's going to create a an enormous opportunity for trade and that's the displacement that starts the process going once you start imagining that you're going to make profits beyond the dreams of avarice then people are drawn into speculating in the shares in anticipation of future profits now this is what Hyman Minsky the economists saw as the first phase in the classic bubble that then is the second phase which is euphoria at this point expectations become completely disconnected from reality the price of the shares begins to be run up in a way that bears no relation to any potential future profits that might actually be made and that's the point at which the neophytes the first time investors have drawn in there's quite an interesting interplay in in Minsky's view between the insiders and the outsiders the insiders probably realize at this point that there's something fishy going on but that the newcomers pile in in the anticipation that the price of the shares can only go up then there's disquiet in phase 3 this is a point also brilliantly made by the financial historian Charles Kindleberger that's the point at which the insiders think it's time to take profits and they start to exit the disquiet then of course becomes contagious and turns into full-blown revulsion or panic and that's when the bottom drops out of the market and the bubble bursts now if those events if that sequence sands firmly yeah it's because almost everybody watching this interview has lived through that cycle not once but twice if not more it happened with technology stocks in the 1990s and it's happened again with real estate since the early 2000s and this seems to be a pattern in financial history that repeats itself again and again and again incidentally it seems to happen pretty much regardless of the regulatory framework once people get the idea that there's a one way better at that there's an asset out there that's just going to go up and up and up then the cycle is very very hard to stop and and of course if they don't know history or if there is a generational change then hey they're not even going to remember you know the the tech burst so so we're we're compressing our knowledge of history and it's things change more rapidly a new generation suddenly appears that has no knowledge of this I think one of the biggest problems that we face as a society is our ignorance of financial history it's really not taught in many colleges much less in high schools and therefore great many people whether as as consumers of financial products or in fact as producers of these people working in the industry know remarkably little other than what they've experienced themselves which if you're a genius analyst at Morgan Stanley or Gorman's Sachs may he just be a few years there's an even more serious systemic problem which is the the more mathematical finance became over the last 20 or so years the more reliant people in the industry became modern history but on on models and I sometimes think models deserve and I don't mean supermodels I mean financial models deserve as much of the blame for the recent crisis as any human actors because these models would take usually between three and five years worth of data and spew out a prediction about the probability of losses if things went wrong but this was far too little time this was a sort of sample size absurdly too short and it meant that the models generally speaking left out of account the last crisis and certainly the last really big crisis and even the most experienced people the people who were chief executives of Wall Street banks in 2007 when the crisis began had on average no more than 25 years of experience in the financial world and that meant that their memory did not extend back beyond the early 1980s so they had no first-hand experience of the Great Inflation of the 1970s and absolutely none of the great deflation of the early 1930s so financial history kind of helps here knowing this stuff is a way of protecting yourself because it makes you aware that the bubble will always burst and the greed will always switch into fear at some point and when it does so it'll do so very dramatically this this point about models not the super models but the theoretical and mathematical models raises an interesting point which relates to one of your main themes and that is there's always uncertainty in the financial world and you know measurable risk is one thing but isn't immeasurable is not and so in this context it's interesting to look at the way models emerge but then also that your discussion of the history of insurance which is one of the the main sections in the history of finance really the model for insurance from mathematics plus ministers trying to work out a fund for widows of ministers basically so talk a little about that because that was a problem of risk it was a gathering of ways of thinking about it but then it was implementing it in the strangest of places but in the 17th and 18th century though great advances in the way those people in Europe thought about probability and about risk and and it was in the mid 18th century that these insights began to be implemented in of all places Edinburgh by a small group of clergymen helped by one academic who decided that they needed to improve the way in which the widows and orphans of deceased Scottish clergymen were provided for after the death of their rep winner and the first true Insurance Fund was the Scottish Ministers widows fund that was set up in the mid 1740s with the first properly actuarial calculation about life expectancy now life expectancy is something about which you can say fairly precise things particularly if you have a fairly large group of people that are paying contributions into your fund and so using life tables and thinking probabilistically the people who set up the Scottish Ministers widow's pension fund were able to come up with remarkably accurate forecasts of how much they would have to raise and contributions from ministers while they were alive and how much they would have to pay out to widows and orphans after they they they died and so this was a real breakthrough was the first true Insurance Fund now insurance can be sold for a whole range of eventualities which are remarkably easy to forecast because human beings don't live to be 300 they there's a reasonable probability that that the widow of a Scottish clergyman will not make it past say 70 and it's much earlier of course in the 1740s the trouble is when we get into areas that don't follow that normal distribution that we sometimes refer to as a bell curve in life expectancy like human height people cluster around the median the trouble is but that's not true throughout the financial system and it's particularly not true where stock market fluctuations are concerned if you look at the stock market there are lots of extreme observations many many more than if they were to be distributed on a bell curve and it's these factors if you imagine the curve like that for human height or life expectancy and you contrast it with the curve for stock market movements you have a lot more out here big movements of maybe 10% or more big big declines of 10% or more and that's what makes the trouble really acute if you start assuming that you can ensure somebody against a bank going bust or against a stock going down by 20% as if you were insuring them against their premature demise you're actually taking a much bigger risk then you know because these big fluctuations the so called fat tails the distribution are completely different in financial markets financial markets aren't like as it were human beings or rather they exaggerate I think this is one of my key arguments they exaggerate our human propensity to veer from euphoria to depression and that means that they're just many more extreme events than people tend to expect as you as you've done this sweep of history you you make you conclude with the comparison to a biological analogy and I want to I want you to talk a little about that because we're in a period where clearly money is not as sending but nonetheless the points the evolution are is very important in and what you do and the readers have to look at the book cause it's quite informative looks at the history of the different institutions that emerged so talk about that biological analogy but also you know the different vehicles insurance companies banks and so on that had to emerge well one thing that's worth bearing in mind is that in some ways money is still ascending the stock market may not be ascending but the Federal Reserve and other central banks are pumping money out so that monetary growth is probably as fast as it's ever been at the moment but but the argument I wanted to make was a slightly longer run argument I wanted to suggest that the financial history is a case of evolution in action accelerated evolution with many resemblances to evolution in the natural world now we're all used to people saying casually it's Darwinian out there or it's a case of survival of the fittest that sort of talk is quite commonplace on Wall Street but the people who use that kind of language don't often reflect on how appropriate it is because in fact financial history is rather like Natural History there's lots of innovation or mutation new things have tried new species new financial species come into existence that weren't there before that there's all sorts of biodiversity there's innovation and we've seen that in recent years in the kind of financial instruments that are produced that's to say bonds come along in the in the Italian Renaissance stocks come along in 17th century Holland insurance as really as I said an 18th century invention at least in its its modern form futures pop up in the 19th century and we have this extraordinary flurry of innovation in the late 20th and early 21st century which sees a whole complex of new institutions like hedge funds or private equity partnerships and derivatives like like options suddenly our credit default swaps suddenly proliferating now what makes it like evolution is that periodically there's a shock that will cause some of these new create creations these new species either to reduce drastically a number or to going extinct altogether and that's what it seems to me is helpful about the evolutionary analogy you get what the biologists call punctuated equilibria every now and then something comes along and poet rates the process changes the macroeconomic atmosphere suddenly makes it much much colder if you want to push the a little further and in that sudden chill a whole bunch of creatures die out now I foresaw a great dying when I was researching the book and even wrote an article in late 2007 for the vanishing Financial Times saying we're on the edge of a great dying they're going to be species financial species that go extinct here now even I didn't expect that among those species would be the great investment banks of Wall Street but it happened so I try and tell the story of financial history and right back to 2,000 3,000 years BC in terms of a process of evolution new institutions beginning with the most basic things money itself coins and tokens of payment these innovations constantly happen but periodically there's a check there's an interruption the interesting difference is that whereas an evolution the big interruptions are exogenous they come from outside like the asteroid that hits the earth and suddenly screws the dinosaurs in the financial system their endogenous the crises are actually generated within the system just like the crisis we've seen ourselves and that's a that's an important difference there they're all kinds of different citizen we always need to be careful about pursuing biological analogies particularly Darwinian parallels too far when it comes to understanding human society but I think it's not a bad way of seeing how crises happen and see why it is that periodically a whole series of financial innovations will just stop and only a few will actually survive but before we talk about your book in the context of the present crisis I want to emphasize two other points because you point out that one place we need to look is in the behavioral economics that's emerging for which a Nobel laureate was awarded to Professor Kahneman of Princeton formerly of Berkeley but but but it's a very different view than the the traditional economists view of rational man right well this is a very important revolution that's half in the field of economics as psychology including evolutionary psychology has come in including an experimental kind of psychology so our assumptions about rational Homo economicus the rational calculating economic man have had to be revised because it's clear that most people do not in fact profit maximize they do not make very good calculations about their own financial interests they have very asymmetric views as between gain and loss people very averse to loss you can confront them and this was kanima's great great example you can confront them with essentially identical options in terms of take two financial outcomes but if one of them looks like a loss then people would be much more hesitant about about risking it so I think this asymmetry in the way that human beings think is tremendously important when things go wrong because once people start to lose they in fact tend to overreact once stock markets go down there's a tendency for panic selling to set in and that's a very interesting but only one example of how behavioral finance is really really changing the way that we think and I think it's good for historians because the more we appreciate these quirks of the human psyche the heuristic biases that make us just plain bad calculating our own financial interest the less effective the highly mathematical approach to finance becomes and the more it seems to me historians can can illuminate the the problem because after all there are lots and lots of as it were real time experiments back then in the past we can go back and look at the bubbles of the 18th century and say this looks like a classic case of human behavior in action and not something that can be reduced to a neat mathematical formula you've written a number of books on the relation of the state to finance and you've been on our program before and we've discussed them and I want to bring that into the equation because it's important to look at the role of the state in interfacing with this evolution of the financial institutions because clearly there's a change of direction you mentioned the case of law in France and clearly there his relationship to the monarchy he essentially seemed to be privatizing the financial system and the way you described it really pointed the way to the fall of of the monarchy in France and the Revolution talk a little about that because there is a there is on the one hand an activist state that can create problems on the other hand a passive state that doesn't allow for regulation of financial interest so it can be part of the problem well the state has a perennial problem which is that it tends to spend more money than it can raise in taxation particularly if it fights Wars though there are other reasons in modern times why deficits get run and it tends to turn to financial institutions existing financial institutions to help us with that problem and there are a number of different ways that it can it can actually exploit financial institutions it can monopolize the production of money and then debase it whether by physically adulterating that the the coinage or simply printing more paper to finance its deficit and the history of money is is a story of repeated interventions by the state and and repeated exploitation of monopolies on money creation intents and purposes that is still the case today when most systems are of money creation involves some kind of state monopoly or other and most people are exposed to the depreciation of the currency by state action in the same way states turn to bond markets and indeed in many ways the bond market comes into existence as a new way of financing deficits in the Middle Ages and right through the early modern period into the modern period so it's impossible to imagine the bond market evolving without the state saying gosh there must be a better way of getting money from our citizens than just taxing them I know why don't we get them to lend us the money we'll pay them some interest and that where they'll part with more than if we just ask for it in taxation stock markets don't really come into existence until the 17th century and they do so in large measure as a result of another insight which is I know we can get some money if we grant a monopoly on say trade with the Indies to this corporation this bunch of businessman and they'll pay us something for the privilege and perhaps we can convert some of these rather expensive bonds that we've sold the public into equity in these monopolies trading companies the first corporation the first true cooperation with the Dutch East India Company and it really came into existence as a result of a crisis of Dutch finance same is true in Britain where an East India Company is set up for much the same reason so the history of money the history of Finance is inseparable from the history of the state and much financial history is a series of political expedience really attempts to tap resources that are there as it were in the commercial world awaiting exploitation by politicians and and in if we knew it moving out of the present crisis and in housing it's very interesting in your book you you provide a study of how the notion of a property owning middle class could be a bulwark of democracy and really to understand that we have to go back to the Great Depression and in the innovations adopted by the the New Deal to deal with the collapse of housing talk a little about that because you tell a fascinating story of a historical evolution that leads us up today but but let's go back to the bidding what beginning what happened in the depression well up until the 1930s throughout the world and even in the english-speaking world only a minority of people owned homes most people were tenants who paid rents to landlords and in European countries the ownership of land and buildings on land was privileged for an elite often hereditary aristocratic elite that changes gradually in the 20th century but the big shock really comes in the 30s when among other things the Great Depression produces a a crash in property prices a space of foreclosures all kinds of pain for the people who do own their own homes now in most places the response to the Depression was in a sense socialist that that's to say there was a realization that the private sector wasn't quite doing the job so the public sector should step in and build public housing and then people would pay low rents to live in that public housing let's call that the European continental European solution something different happened here and that is that the Roosevelt administration set out to revive and broaden the mortgage market so that more people would be able to borrow money and own their own homes and institutions to take just one example because there were a whole host of institutions but just just one example like Fannie Mae were created to broaden homeownership to make the market for mortgages a national market and by widening because previously had been pretty local you know it had been the sort of local savings and loan that lent money to people that had been deposited with them by local people it was very much the it's a wonderful life model with the creation of institutions like like Fannie Mae you have the possibility of a nationwide mortgage market and that means that apart from anything else the cost of borrowing goes down the thing becomes much broader and much deeper as a pool of assets so there's a critical turning point and that has a political dimension to it the realization which I think is correct that you will have a more stable society one much less likely to veer to the political left the more people own their own homes if you can facilitate homeownership you will in some sense stabilize let's call it the capitalist order it's a brilliant insight and it worked by the 1950s a clear majority of them Ekans owned their own homes and the mortgage market has become this apparently super stable thing where people have 30-year mortgages with fixed interest rates that are pretty low and that is the basis on which the suburbs that we all know as quintessential America get built so there's a there's an apparent solution to the problem of how do you stabilize democracy at a time of crisis that the answer is make people property owners and we've remained very loyal to that vision right down to the very recent past you could say that the subprime crisis had its origins in yet another push to increase the percentage of American households that owned their own homes bump it up above 70% unfortunately that final push to Kurs into US I suppose a social category of people who really couldn't in fact manage mortgages particularly the kind of mortgages that they were sold because these were not thirty-year fixed interest mortgages these were all sorts of fancy products which turned out to blow up in a crisis so one theme that emerges throughout the book as you go through this history you know all the way back is the realization that when you spread risk over a wider area that that that that essentially works for the financial system and in the case of mortgages in the beginning were local mortgages local banks making the loans and so on and and so as we go through this story of the housing collapse today that's one of the things that's going on because you have instruments that are created and which are then sold and resold globally apparently reducing risk but in fact leading to disaster yeah big and crucial innovation was what's known as securitization where you would take a whole bunch of mortgages from a great number of people and bundle them together and then treat the interest payments that these various people were making as as a single revenue stream and then you would start dividing the revenue stream up so that there would be a kind of top tier that would be regarded as soup safe a middle tier and then a bottom tier which would be where you'd sort of concentrate the risk of default and then instead of selling these as individual mortgages you would in fact sell these as a set back mortgage-backed securities that this innovation which really I suppose got going in the 60s and 70s but exploded in the 80s I mean it's in the 80s that it really takes off had all kinds of apparent benefits in the sense that it made the mortgage market even more liquid and even more flexible than it had been before but the trouble was that the person originating the mortgage who actually does the deal and says here you are here's your home sign here and and and you you become the homeowner and I get the mortgage that person under the system of securitization can then the next day run off and sell the loan to somebody else to an investment bank which then engages in the process I've described and sells the security - who knows and Norwegian Town Council it's a long way from that original point of origin to the final holder of the investment and there's absolutely no social owner or any other connection between the person paying the interest and the distant investor receiving it and it turned out that that did not in fact perfectly spread risk around the world it wasn't that the risk ended up with those best able to bear it it ended up with those least able to understand it and I think that's been one of the most important revelations of the recent crisis that securitisation created all sorts of rather perverse incentives at the point of origin you know you you could give people mortgages without any documentation these were the famous you know no income no job no assets ninja loans and then unload the things sell the thing that the next day to an investment bank which would then pass it on down the line that I think has turned out to be a fundamental flaw in the system and I suspect we will see far less of that kind of securitization in the years ahead and another dimension of this which your again your history makes helps us a lot in understanding is the extent to which insurance swaps began to bet on - apparently guarantee the Securities and people were taking Gamble's but in fact there wasn't credit certification there was nothing basically but but insurance companies and others were putting their name on the line to say this was all a sound investment that's right I mean you you had in addition to the the creation of all sorts of elaborate things like collateralized debt obligations which were fancy mortgage-backed securities on top of that you had the derivatives you had the the so-called credit default swaps saying if by any chance this security that you've just bought goes belly-up and stops paying out we will compensate you an insurance companies including AIG which famously had to be taken over by the American taxpayer became involved in selling that kind of insurance essentially selling derivatives saying don't you worry about this bond we'll pay you if anything goes wrong what a lot went wrong a lot more than anybody expected to go wrong the moment that people started to default on those subprime mortgages in places like Memphis Tennessee and the result was a chain reaction that was fascinating to see this happen in real time because as I was researching and writing this book the crisis was as it were unfolding and I was wandering around Memphis Tennessee and and Detroit which were among the markets the real estate markets to turn down first having a sense that foreclosures were going up in early 2007 and then in August this chain reaction really got going as it became clear that defaults and the subprime mortgages would cause hedge funds and their banks to go bust so while I was writing the book this this crisis that I'd anticipated actually started to happen which was exciting but it meant that was writing history as it was happening a new experience for me and not one I this is why your columnist for The Financial Times his story in a way it's been very helpful to me I wrote a book a few years ago called the cash Nexus which was an attempt to understand that relationship we talked about earlier between the state and finance and at the end of that because really dissatisfied because I felt that what I'd written explained a lot but it didn't really explain the world that we lived in there was a kind of whole set of institutions that I really feel I understood that didn't really have much to do with war finance which had been the driver of so much financial innovation right up to the mid 20th century so part of the point of writing this book was to try and understand the very recent past better and I found myself as it were writing the first draft of history as well as the second draft more or less simultaneously writing articles for the Financial Times which then gave me material for the book I want to talk a little more about the housing and because I want to understand this asteroid that didn't come from outer space but was internal and and there another there are a number of items on the table marine span you comment on the book I didn't want to take the punchbowl away from the party it's very clear now in the story that's emerging that there was a democratic ethos little D in in opening up the you know houses to minorities you've already talked about that and so on there was a recent story in the New York Times on Sisneros and his involvement in all of this so so and I think all of these the legislation in the Congress the Gramm Act which was lobbied for by Robert Rubin and so on all of these things are elements in this interference by political actors and not just you know people who you would concede with the conservative side of the agenda talk a little about that I mean is there any way of theoretically looking at that other than to say well when the party was really going everybody wanted some of the punch and and and Greenspan wanted to keep the ball yeah it's it's very tempting in a crisis to play the blame game and find one scapegoat is much easier than have to carry around in your head the names of 100 so at the moment I guess a lot of the focus is on Alan Greenspan and the claim is repeatedly made that the Federal Reserve under Greenspan was excessively lacs and allowed two bubbles to happen on his watch and I think there is some ground for questioning monetary policy under Greenspan because there was a kind of doctrine in the late 90s which which was that the Fed shouldn't worry about asset prices it should worry about consumer prices and if there was no serious consumer price inflation then it should be relaxed about what happened on the stock market if the stock market crashed it should intervene but it shouldn't really worry about the upside this was the the doctrine that gave rise to the Greenspan poot which essentially was the assumption on Wall Street that if the market went down Greenspan would intervene and the prices would go back up who didn't really need to worry now the moral hazard to use a term economists love that crept in at this point was really quite dangerous it meant that you were kind of insured on the downside if you if you took risk and got it wrong you could rely on the Fed to cut rates and the market would after a little correction recover that mentality became very very widespread in the late 90s and the way the Fed seemed to prove it right in the way that it handled that the dot-com crash and let's not forget the financial shock of 9/11 big injections of liquidity prevented things from going into freefall and I think that gave rise to a certain complacency so we may I think look back and say was it right can the Fed really ignore asset prices and I think the answer is no it can't why should it why should it only look at consumer prices clearly it should be as as interested in the effects of its monetary policy on stock prices or for that matter housing but you're right you can't pin it all on one guy you can't say it's all the fault of the Fed because the politicians in the executive branch and the legislative of both parties were running around not just after 2000 but through the 1990s saying we must do more to widen homeownership and we must do more to bring minorities into the property-owning democracy which means we should be a little bit more relaxed about lending standards and that was a clear signal sent out and not just by the Bush administration though it certainly got louder under Bush and not surprisingly institutions acted on that signal I mean I'm not gonna say we're all guilty because that that's a little trite but it's certainly the case that the property bubble attracted people from all parties and all walks of life and I'm not just talking about people in Washington in many ways this was a magnet that drew us all to some degree the idea that you could simply borrow money and attractively low interest rates and go and buy a house on the assumption that its price could only go up this was terribly attractive this was terribly seductive and people genuinely forgot they forgot altogether the possibility that the price of a house could go down just as deeply as the price of a stock and that was a classic failure to learn from history because it had happened before it had happened before in the 30s it had happened before actually as recently as the early nineties it had happened spectacularly in Japan after 1989 I don't know why we thought property prices could only go up that was a delusion and a really popular delusion at the time especially in in California let's talk about another item that you address in your book and in articles in the Financial Times and in The Washington Post and namely that is the China American relationship which you call Comerica and I want you to explain the implications of that term but but also kind of explicate how in the last 10 15 years this relationship has has totally transformed the global economy and and raised really important questions about the future of that relationship I don't think you can understand the recent past including the crisis without understand what I call chai America and it's a pun of course because it's about China plus America and the question is is it a chimera so a pun that I hope you'll forgive the idea is that although China plus America is a relatively small percentage of the world's land surface and about a quarter of its population it's roughly 1/3 and growing of the world economy and it was responsible for about two-thirds of economic growth in the past six or so years and I came to see that if you could understand that relationship most of what was going on in the realm of globalization would make sense now it's an extraordinary complex symbiotic relationship that has evolved since the 1970s and particularly in the last 10 years the most important components of which are as follows one Chinese labor costs and the low price of Chinese products has dampened down inflation worldwide and particularly in the United States that that's been an important factor in the profitability of corporations to China relies heavily on exports to the US and elsewhere and therefore worries that its currency must stay relatively weak otherwise those exports may no longer be as attractive and therefore three China intervenes systematically in foreign currency markets in order to keep its currency relatively stable and weak against the dollar this intervention has involved the accumulation or more than a trillion dollars worth of dollar denominated securities including interestingly the bonds of Fannie Mae and Freddie Mac but also a whole bunch of US government Treasuries and that accumulation of government debt has had the effects of keeping American interest rates lower than they would otherwise have been in other words to put it really simply for reasons of their own out of self-interest the Chinese and of course other Asian and Middle Eastern economies have financed the u.s. current account deficit have financed American borrowing and when the current account deficit gets up north of six percent of gross domestic product in an economy as big as that of the United States you're talking about a large amounts of borrowing that can be financed from abroad and the reality is that that's what underpinned the great bubble of the early 2000s the real estate bubble was only really possible because there was a wall a glut in Ben Bernanke's phrase of Asian savings available to finance us consumption and u.s. real estate speculation it's an extraordinarily complex story but it does reduce to something as simple as this a marriage China plus America a chai America and like in a lot of marriages one partner was a saver and the other spouse was a spender America was the spendthrift I wouldn't say wife for once have been accused for fear of being accused of sexism but let's say that the spendthrift partner and China was the the frugal saver it seemed like a marriage made in heaven and it certainly propelled the world economy through four or five years of extraordinary growth the trouble was that the spendthrift partner blew the money on real estate speculation and high street shopping more consumption and when the deal went wrong one that the bills fell due and the property prices fell it seemed as if chai America was going to be shattered and I spent a lot of the time since since finishing the book wondering if this crisis really portends the end of Chimerica is it going to turn out to be a chimera an illusory fantasy relationship or will it withstand the shock that's a hugely important question because if it does fall apart if the Chinese say you know we're not going to finance America's borrowing anymore then we will enter a much more dangerous world bad though the crisis seems now it could get a lot worse if we if we don't get that Asian savings glass of flowing into our into our pockets and and the weird thing that you point out in the book is the difference in the the median salary in the United States 40-plus thousand and in China you know something like a couple of thousand basically so would you so a very poor country is subsidizing a very wealthy country to go on a sumption binge well it seems bizarre because we used to think that the economic development involved rich countries lending to poorer countries and that kind of was the model right up from the age of empire through to the 1990s through brilliance of the 97-98 Asian crisis and then there was a kind of paradigm shift in globalization when the Asian economies in particular said borrowing from these guys is too risky that the money suddenly gets pulled out of George Soros doesn't like what we're doing and we get whacked so let's not play that game anymore instead let's finance our growth out of our own savings let's aim to grow through exports let's buy dollars in order to keep our currencies weak and let's let exports do the work now the chai merican Deal was a pretty good one for the Chinese yes they were lending money to the United States and not getting paid terribly much interest on the loans but they were also getting an American consumer who seemed to have a limitless appetite for Chinese manufacturers and as long as exports were growing Chinese employment was growing and the great transition from the countryside to the towns could could carry on so it seemed like a rather a convenient kind of marriage except I think that fatally so much was channeled not just into buying Chinese manufacturers but also into speculating in property and that that turned out to be the fatal turn I think it's just some of the money that Americans borrowed from abroad in the last decade had gone into investment in infrastructure productive investment labs also in in improving education it wouldn't have seemed quite so crazy but the fact that it went into speculation in the prices of houses in states like California that I think will turn out to have been a pretty major mistake you write in the book and and we were sort of coming to the end of the interview but you're right money is a matter of belief even faith belief in the person paying us belief in the person issuing the money he uses or the institution that honors his checks are transfer well clearly we've entered a new world and if China America is a chimera then the question that I know you've thought quite a bit about I've heard you give talks on this is is this the end of America's global dominance insofar it's it's highly dependent on on the financial equation talk a little about that I mean we're still in the middle of all of this but but what is your your gut feeling bringing the history that you've worked on to bear well an analogy that I'm often drawn is between the fate of the British Pound and the future of the American dollar hundred years ago sterling the British currency was the dominant reserve currency of the international system but two world wars an excessive debt level and then slow growth after 1945 ultimately dislodged sterling and it was effectively replaced by the dollar in the mid twentieth century and that's really when the dollars reign as the number one currency begins now the question is does this shock coming on top of all kinds of other geopolitical setbacks portend some kind of similar decline and fall of the dollar and indeed of American financial hegemony a lot of people would like to see that I mean it's interesting how many Europeans including the German Finance Minister peer steinbrück have said this is the end for the American financial superpower I'm a little weary of saying it's happening right here and now because what a perverse consequences of this crisis has been to reveal that for investors all around the world including Americans the United States paradoxically remains a safe haven so that when financial crises break out the default setting is to rush into US government bonds and indeed into dollars into cash so what we saw as the crisis intensified in the last few months of of 2008 as summer turned to fall and everything started to fall it was the it was the dollar that fell least in fact the dollar strengthened on world markets and although the US stock market took a tremendous hit other stock markets fell even further including Brazil Rush's induced china's these were the prick economies that we were supposed to believe we're going to overtake the United States at some point in the decades ahead well the BRICS are dropping like bricks as we speak and a lot of people are taking the view that although this crisis somehow had its epicentre in the United States originated in the United States nevertheless the correct response to the crisis is in fact to increase your exposure to the United States life is so unfair it's so unfair on the rest of the world but it seems to me that that paradoxically this actually gives the United States a better chance of riding out the crisis than to say some European countries have because it means that if the United States has to borrow a trillion dollars to bail out its banking system that's the 700 billion plus the 300 billion that's already been committed funnily enough the rest of the world seems ready to lend that money at a reasonable rate of interest that's the chai American deal alive and well now as long as the rest of the world continues to take that view that it doesn't mind piling up great mountains of American government debt then the us somehow walks away from this pile up relatively unscathed scratched suffering a recession but not going through the Great Depression again not even going through the 1970s again if however foreigners suddenly take the view that enough is enough and that the profligacy of Uncle Sam will no longer be tolerated then we will see something very ugly which is a dollar route higher interest rates at the long end that's to say you'll suddenly see your ten-year Treasury yields zooming up towards five or even six percent and then we will discover the real meaning of financial crisis let's hope it doesn't happen well on that note Neil I I want to weren't able to cover everything but I think we really gave our audience a sense that they want to go out and get this book to be better informed whichever way the financial situation goes forever downward or back up again I think ignorance of financial history has been one of the causes of this crisis and this book is to cure it okay and also there'll be a PBS series that would indeed in early 2009 we will screen the ascent of money in for one hour films on PBS very good so let me show the book one more time and thank you very much for joining us again and we hope to have you back for your next book which I assume will come out in a year or so it'll come out something more like five years time I wanna say thank you very much and thank you very much for joining us for this conversation with history

Channel: University of California Television (UCTV)

Views: 92,576

Rating: 4.8186665 out of 5

Keywords: niall, ferguson, book, ascent, money, financial, history, world

Id: coItaKim-vQ

Length: 56min 9sec (3369 seconds)

Published: Thu Dec 11 2008