The Roots of Progress

The time machine

May 20, 2018

I recently finished Money Changes Everything: How Finance Made Civilization Possible, a history of finance by William Goetzmann. I enjoyed reading it and took away a few significant ideas.

First, finance is ancient. The story begins in Sumer. By the time of the earliest writing, they already had loans and compound interest (the concept of which may have come from observing how a herd of livestock grows over generations). In fact, the earliest writing was invented to track this kind of thing: it evolved from financial records. Ancient Greece had maritime loans with variable interest rates depending on the risk of the expedition. Ancient Rome had legal entities with public shareholders.

Another lesson is that there are many different ways to organize corporations and finance ventures: the forms we have today we take for granted, but other models have been tried in the past. For instance, if a modern corporation needs cash, it can issue new debt or equity (in the latter case, diluting existing shareholders). But in 16th century Europe, some corporations would raise cash by issuing a capital call to their existing shareholders; shareholders who couldn’t or wouldn’t pay the required funds would forfeit their equity or be forced to sell it to another investor. Or, in the late 17th century, some corporations issued stock, but allowed investors to buy it on credit. An investor might put down as little as 1% (!) of the value of the stock, and then pay the debt to the company over time (again, losing the equity if they defaulted). Both of these schemes are unheard of today, as far as I know. Maybe they’re not done anymore because they’re bad ideas that had terrible consequences—I’m not advocating bringing any of them back—but it’s a good reminder not to make assumptions about what can and can’t (or should and shouldn’t) be done in finance.

My favorite idea in the book, though, is that of finance as a “time machine”. Finance shifts value forward and backward in time for different parties. If I have money now but don’t need it until later, and you need money now but won’t have it until later, I can give you a loan: boom, we’ve sent my money into the future, in order to bring your future money into the present. Goetzmann claims that:

Finance has stretched the ability of humans to imagine and calculate the future. It has also demanded a deeper understanding and quantification of the past, because history is the fundamental basis for making future predictions. Finance has increasingly made us creatures of time.

Finance is often seen as somewhere between “shady” and “the root of all evil” (indeed, one of the lessons of the book is that social criticism of finance has been around as long as finance). But in fact, finance is an amazing and vastly underappreciated mechanism of social cooperation. It allows the rich to help the poor. It allows the old to help the young (via their accumulated savings). It allows the lucky to help the unlucky (think insurance), thus smoothing out the bumps, jolts and shocks of nature and of life. It allows those with ideas and ambition to pursue them, regardless of their personal funds (otherwise, entrepreneurship would be only for the rich). In general, it accumulates capital from many sources to make it useful, instead of letting it sit idle. In so doing, it allows anyone with any degree of savings to participate in value creation of the economy.

The book covered several other interesting topics, such as: the parallel but different evolution of finance in China (much more centralized and state-controlled, including the first paper money, which amazed and baffled Marco Polo), the Dutch East India Company and the South Sea Bubble of 1720, the breakthroughs in calculation techniques made by Fibonacci, the influence of Keynes in setting up the IMF and World Bank, and even the role in medieval European finance played by the Knights Templar.

All that said, I’m not sure the book lives up to its subtitle. I learned many things but I can’t yet tell the story of “how finance made civilization possible”. That is going to require a lot more study, organization, and essentialization.

Books in this post

Money Changes Everything: How Finance Made Civilization Possible