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Published by EH.Net (July 2016)

William N. Goetzmann, Money Changes Everything: How Finance Made Civilization Possible.  Princeton: Princeton University Press, 2016. x + 584 pp. $35 (cloth), ISBN: 978-0-691-14378-1.

Reviewed for EH.Net by Larry Neal, Department of Economics, University of Illinois.

Long awaited by other financial historians, myself included, William N. Goetzmann’s book has finally appeared! This, after years of research and teaching during which Goetzmann allowed anyone interested in financial history to view his chapters in progress on-line at: http://viking.som.yale.edu. (The website is well worth visiting in any case for the wide selection of primary source materials he has made readily available there for the rest of us.)  The printed product covers defining episodes in the history of finance from ancient Mesopotamia to the sub-prime crisis of 2008.  The introduction explains the themes that underlie the chest-thumping title despite his modest initial disclaimer that, “This book is a somewhat personal narrative about the people, places, and things that, in my view, shaped the history of finance as a technology of civilization” (p. 3). To motivate the structure of the book chapters that follow Goetzmann summarizes the key elements of finance as:
1. Reallocating economic value through time
2. Reallocating risk
3. Reallocating capital
4. Expanding the access to, and the complexity of, these reallocations

After explaining and extolling the virtues of each financial element, however, he broadens and deepens the implications of financial innovations that have occurred through history under each element.  The first element, the re-allocation of economic value through time, he sees as the fundamental feature that allowed civilizations to arise in the first place, wherever and whenever they occurred. Drawing on earlier work by his father, the late historian William H. Goetzmann, he distinguishes cultures as “structures of interrelated institutions, language, ideas, values, myths and symbols.  They tend to be exclusive, even tribal.  Civilizations, on the other hand, are open to new customs and ideas. They are syncretistic, chaotic, and often confusing societal information systems.  They continue to grow in the richness, variety and complexity of societal experience” (p. 9).

Goetzmann concludes with the optimistic view that: “financial technology allowed for more complex political institutions, enhanced social mobility, and greater economic growth – in short, all the major indicators of complex society we call civilization” (p. 14). Following this upbeat overview, there are four major sections, each with a separate introduction to explain the motivation.  Part 1, “From Cuneiform to Classical Civilization,” starts with Babylon and ends with Roman finance making a transition from informal securities markets in the Republic to central control of the money supply and its uses under the Empire.  Part II, “The Financial Legacy of China,” is a thoughtful diversion about the different routes that financial engineers can take, depending on the nature of political controls and contract enforcement.  Part III, the bulk of the book in two hundred pages, describes in loving detail “The European Crucible,” beginning with sovereign debt in Venice and concluding with American substitutes for sovereign debt, often underwritten by Dutch financiers.   Part IV, “The Emergence of Global Markets,” takes the reader into the maelstrom of the late nineteenth, twentieth, and early twenty-first centuries as global finance made its way among competing political visions in the world, all the while becoming increasingly complex — and disruptive.

Part I, “From Cuneiform to Classical Civilization,” focuses on lasting contributions to the rise of civilizations in the West, starting with writing, then cities, and culminates with a “financial architecture” based on record keeping, contract enforcement, a numerical system that permitted compound interest calculations, and astronomical observations based on a calendar year of 360 days (to make interest calculations easier).  This financial architecture held congeries of cities together in mutually beneficial trade networks, but then also allowed the rise of empires and their disruptive consequences.  Especially poignant is the interpretation of the Muraŝu archive discovered in the ruins of ancient Nippur, which must have been one of the financial centers of the Persian Empire.  Three generations of the Muraŝu family maintained their clay tablets recording outstanding claims on property and business ventures, concluding with their aid to a usurper who overthrew the reigning emperor, Sogdianus.  The Muraŝu family organized the financing of the army of his half-brother, Ochus, who became Darius II.  After which, however, the archive testifies to continuing indebtedness and foreclosures of the various financiers.  Goetzmann concludes, “finance could rapidly and powerfully focus economic assets in one time and place for political gain” (p. 68).

The historical record of finance in the ensuring centuries remains largely to be decoded from the millions of clay tablets now dispersed in museums throughout the world, but the Mesopotamian innovations persisted into Grecian times.  The famed orator, Demosthenes, was often hired to express eloquently and convincingly the case of his client, whether an aggrieved creditor or debtor, before a mass jury of Athenian citizens.  His various speeches demonstrate the sophistication and complexity of Athenian private finance. Goetzmann concludes, “The Athenian state was able to induce investors into the equally risky venture of prospecting and mining through mechanisms for dispute resolution and the means by which the state fairly and transparently allotted property rights” (p. 91).

Roman finance, he argues, laid the basis for later development of corporate enterprises and secondary markets in mortgages as the Roman Republic expanded at the expense of Grecian (and Phoenician) city-states, while adopting their most successful and proven financial techniques, including the use of standardized coins to facilitate impersonal exchanges throughout the unified empire.  Why some forms of private finance, annuities based on rental properties, disappear from the historical record after the rise of the Empire remains a mystery.  The later travails of the Roman Empire with increasingly desperate measures for war finance, moreover, elicit a comparison with the contemporaneous Han Empire in China.

Part II, “The Financial Legacy of China,” basically resolves the so-called “Needham Paradox,” the failure of the technology advances of the Song Dynasty to generate an industrial revolution or further scientific advances that occurred much later in Europe, to the financial divergence between China and Europe. The key factor was the failure of China to develop sovereign debt, whether for its magnificent cities or for the central government.  Only with the opening of China’s treaty ports in the nineteenth century did the Chinese government finally resort to state debt, and even then the first Chinese government bonds were floated on international debt markets rather than in China itself.  But when China did enter global markets of the late nineteenth century, it did so with a vengeance. Shanghai rapidly became one of the great banking centers of the world in the 1920s, but only by discarding the imperial legacy of centuries before.  Goetzmann notes, “There was great debate in the Han over the role of private enterprise versus state ownership [especially regarding salt, iron, and maritime trade] and state ownership won” (p. 174).  Thereafter, the state provided credit to merchants and warlords when it needed to mobilize resources, eventually creating fiat paper money in the Song Dynasty.  Goetzmann concludes, “It is impossible to create fiat money without complete fiat.  Thus, the value of the currency rose and ultimately collapsed with the state” (p. 202).

Part III, “The European Crucible,” develops the logic that led small, competing, and warring city-states scattered across Western Europe to create viable forms of finance that led, with many well-known missteps but also with a few underappreciated financial successes, to modern, global finance.  Goetzmann sees the stages of financial development in Europe as: “first, the emergence of financial institutions; second the development of securities markets; third, the emergence of companies; fourth, the sudden explosion of stock markets; fifth, the quantification of risk; and finally, the spillover of this system to the rest of the world” (p. 203). The next twelve chapters explore both the missteps and the occasional successes that lay the foundations for modern finance.

After 219 pages of fascinating historical episodes, often interleaved with personal accounts of Goetzmann’s encounters with archaeological digs or archival sites, he sums up the lessons of history from the European example.  “Financial technology is redundant, adaptive, and sometimes mercurial.  The institutions we take to be sacrosanct, inevitable, and indispensable are probably not.  Given the random outcome of historical events, another set of institutions might have emerged to solve the same financial problems.  Financial innovation is thus a series of accidents of history — the caprice of time, location, and opportunity” (p. 219).  Consequently, his treatment of the technical advances in probability theory and actuarial science, starting with Fibonacci, Bernoulli and Pascal, contrasts sharply with that of Peter Bernstein’s Against the Gods: The Remarkable Story of Risk (New York: Wiley, 1996).  For Bernstein, the practical application of the Black-Scholes model for pricing options, built on the assumption that past distributions of asset prices could persist over the near future, had created the modern, efficient, global financial market.  For Goetzmann, however, the successes of the early financial markets led to the formalization in mathematical terms of the underlying processes.  He notes with approval the possibilities of non-linearities formalized by his Yale colleague Benoit Mandelbrot and erratic market movements highlighted by another Yale colleague, Robert Shiller.  Both scholars were inspired by observing anomalies in the price discovery processes revealed in the securities markets of the 20th century.

The final success of the European Crucible, according to Goetzmann, however, arose in the American colonies, first with their experiments with land banks (until outlawed by the British Parliament) and then with land companies backed usually by Dutch and British investors.  With all the current fervor surrounding the role played by Alexander Hamilton, thanks to the Broadway musical based on Ronald Chernow’s biography, Goetzmann instead gives Abraham Van Ketwich and a number of other Dutch bankers primary credit for having securitized the early debt of the United States.  True, “Dutch investors made out well when the debt of the United States was reorganized by Alexander Hamilton and the young nation made good on its financial commitments” (p. 386).  So, real credit for America’s success should go to the eighteenth century Dutch investors who developed the financial innovation of closed end mutual funds, which allowed small investors to share the returns from risky assets.

Part IV, “The Emergence of Global Markets,” begins with an interesting discussion of Marx, especially his insights into contemporary finance as demonstrated in his newspaper columns in the New York Daily Tribune in the U.S.  Goetzmann writes, “His prose is terse, witty, and convincing.  When I read these lively columns I can almost forgive him” (p. 411). The Tribune articles by Marx portray a world of “global linkages and geo-political dynamics” and that is what excites Goetzmann about this period of financial history. Especially noteworthy is the amount of information contained in the Investor’s Monthly Manual “quoting thousands of prices for securities from all over the world” (p. 412).  (And it’s available on downloadable pdf files from Goetzmann’s website given above.)  He extols The London Stock Exchange in 1870 as “giant economic lever with the fulcrum planted in the present, balancing past savings and future promises” (p. 413).

There follow fascinating insights into the experiences in pre-revolutionary China (“China’s Financiers”) and pre-World War I and early revolutionary Russia (“The Russian Bear”). Each country attempted to adopt financial innovations and capital from abroad while trying to establish legitimacy for a new government.  Both lapsed into authoritarian regimes espousing Marxian ideology, demonstrating again the historical contingencies under which financial innovations arise or meet their demise.  Chapter 26, “Keynes to the Rescue,” contrasts Keynes’ macro-economic recommendations, familiar to all from his General Theory, with his microeconomic investment strategies in handling the endowments of King’s College at Cambridge University.  At the macro-level, Keynes prescribed governmental spending whenever the animal spirits motivating private investment flagged while at a micro-level he switched from speculating on price movements in equities or foreign exchange (with dismal results) into equity investments in firms with sound management and robust markets.

“The New Financial World” emerged after World War I, not World War II, on Goetzmann’s account.  Highlighting the leadership of the U.S. in finance were skyscraper bonds, which he sees as an application into vertical space of the early American land companies dealing with wide, open horizontal spaces.  Financial architecture mimicked in many ways the new architecture that created a building boom toward the sky.  It is their eventual demise at the end of 1926 that Goetzmann sees as the collapse of a real bubble as “skyscrapers built in Manhattan were … driven by a demand for bonds that backed them rather than by a demand for the amazing new machine to make the land pay” (p. 480). Following the collapse of the urban real estate market in the U.S., returns from applying other new technologies such as radios, autos, and electrical appliances were delayed by a decade of more and equity prices in their companies collapsed, destroying the American public’s craving for investing in the stock markets.

Out of the Great Depression that followed, however, Goetzmann sees the emergence of useful financial innovations, starting with government regulation of the securities markets, implementation of a national Social Security plan, and improvements in mutual fund designs, all leading to post-war developments in financial theories, as well as intense empirical research into the varieties of movements in equity prices.  The challenges of the future, in a global financial system with confidence badly shaken from the 2008 financial crisis, lie in providing assurances to the current working age populations around the world that their future medical expenses and pension benefits can be financed. Attempts to meet these challenges with new financial innovations, whether from private or public initiatives, should be encouraged, as history shows that the consequences of disappointing the public’s expectations have always been disastrous for a civilization.

Larry Neal is the author of A Concise History of International Finance: From Babylon to Bernanke (Cambridge University Press, 2015).

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