One of the most extraordinary things about the financial crisis that occurred in 2008 is the fact that most people have no idea that we almost came to the brink of complete collapse.  This ignorance is borne ultimately of a general lack of understanding about the ways in which financial concepts determine the very essence of our existence.  Professor Niall Ferguson makes an important contribution to the improvement of this state of affairs with his book and documentary series – The Ascent of Money: The Financial History of the World. It’s a fascinating account of just how central to our entire existence money really is. Ferguson advances a bold thesis: that the history of finance and money is the central explanatory thread for all of human history.   I think he’s right.  And when you think carefully about the history that he presents, you discover a startling explanation as to why.

Ferguson’s central focus is on the way in which financial concerns were behind some of the most important events in world history. For instance, he relates in one episode how it was that the invention of the government bond market made it possible for governments to fund long and protracted wars – and goes on to explain, as a particular example, the role of the bond market in determining the outcome of the Napoleonic wars. But there is another aspect of Ferguson’s history which I think is even more fascinating – the way that particular forms of life depend on particular ideas and concepts. These concepts are ones that we take for granted and hardly ever think about them. But once you point them out, they truly stand as mind blowing innovations upon which the entire form of our existence and society rests.

If you pay any attention at all to the financial media, you might have heard the term ‘financial innovation’ – and often in the context of defending the role that the various strange and complex financial instruments like “derivatives” and “credit default swaps” played in the financial meltdown. What these people are referencing are the previous instances of financial innovation that really did change the world and make new forms of life (arguably better forms of life) possible. The smart people at JP Morgan who invented credit default swaps back in the nineties really believed that they had hit upon such an innovation. They thought they were changing the world for the better.

To understand this mindset – which to many of us is somewhat astonishing given how much damage credit default swaps caused – you have to understand just how previous innovations changed so much. The very first of these concerns the concept of money itself. Ferguson gives us a great insight into the concept when he compares two clay tablets from ancient Mesopotamia. The first simply recounts a contractual relationship between two parties. One has to pay a certain amount of grain to the other at the harvest date. The second tablet is the one that exemplifies the great innovation that money represents. It introduces the concept of an abstract and anonymous ‘bearer’ into the equation. It states that the such and such a person must pay ‘the bearer’ of the tablet the specified amount of grain.

This ability to abstract from the specific people involved in a contract is an enormous achievement. What it meant was that people could now store wealth in a symbol. And a symbol – like all aspects of meaning and language us – is a public, shared object. It doesn’t exist unless enough people believe in it – or accept its rule of use. This is something that the great philosopher Wittgenstein taught us about meaning. In order for the symbol to gain its power, society had to evolve a trust in itself that simply isn’t possible among more primitive peoples. Hence the introduction of the concept of money – the ability to pay an unspecified, anonymous ‘bearer’ went hand in hand with a different form of life to that which had come previously.

As Ferguson explains, the Incans didn’t have money, and as a result, their society was technologically backward when compared with the marauding Spanish. Money allows for the more complex forms of life needed to produced higher levels of technology. Without it, the technological progress of a society hits a ceiling.

Another absolutely fundamental innovation that really did change the world was the concept of debt. Obviously the concept has been around for a while – but a a number of further innovations allowed it to become perhaps the single most important component of economic growth. By means of debt, capital can be more freely allocated to where its needed – where demand is strong. Without it, capital just sits in giant pools doing nothing. Some person has a great idea that would improve the lives of many, but can’t get access to the capital to make it happen. Debt solves this problem.

The difficulty for the lender is that they take a risk in lending out the money. Many people never end up paying the money back. The concept of interest, which has also been around for a long time, was designed to solve this problem. The debtor paid a premium over and above the amount lent so that the creditor was paid for the risk they took in loaning the money. But there were two problems which had to be overcome before interest could be allowed to solve the problem of freeing up credit for those who needed it.

The first of these was the fact that interest was extremely difficult to calculate in medieval times. This is because medieval Europeans used the roman numeral system for counting. And this made arithmetic extremely tedious. Interest calculations would simply take too long to do using such numbers, and allowed too many errors to occur.

The problem was solved by an Italian mathematician Fibonacci, who imported the arabic numeral system which made arithmetic much easier to perform. Here we get a concrete example of the way mathematics changes the possibilities of our reality – and allows for new forms of life, new processes and practices to rise up and displace the old.

The second problem was that charging interest – or usury – had an extremely bad reputation and had been banned by the major religions (the Jewish had a loophole that allowed them to charge interest to Christians – which is why they were so reviled in medieval times). The reason why usury was so frowned upon was that although it had a great economic benefit, it also led to a large degree of social exploitation. Vulnerable people would end up becoming permanently indebted and unable to claw their way back into the black.

A portrait of Giovanni_di_Bicci_de'_Medici by Cristofano dell'Altissimo

Ferguson explains that it was the famous Medici family who solved this perception problem. By virtue of this achievement they became so powerful and wealthy that Ferguson credits them with virtually funding the renaissance. They started out as a group of small time gangsters but through a loophole in the anti usury laws, discovered by Giovanni de’ Medici, rose to become the center of medieval, Florentine power.

His innovation was to charge a commission on foreign currency conversions. It was effectively an interest charge because money was advanced to a particular trader for various lengths in time in the process of effecting the exchange. The longer the period of time involved, the greater the commission would be. Just as with regulators today, those in charge in medieval Florence weren’t able to understand the true nature of the innovation. The result was the development of the first true bank.

Another crucial development that solved the perception problem involved an astonishing moral argument for the protection of the poor. The argument was (and still is to this day) that poor people should have access to credit in order to improve their lot and social mobility. This is a key plank of the American dream that was advanced by leftist progressives during the time of the great depression. Before the reforms were introduced, poor Americans simply didn’t have access to credit unless they illegally made use of a loan shark that would charge upwards of around fifty percent interest. The Democrats allowed loan sharks to go legit, but insisted that interest rates be set at lower amounts. The overall risk to the loan shark in default vis a vie the lower interest rates were mitigated by their new found legitimacy. This innovation gave rise to what we now call the modern consumer bank.

What is astonishing about this innovation is that it was proposed by the left side of politics (those that believe in protecting the poor and downtrodden) and amounts to simply turning the moral argument against usury on its head. That argument was that usury led to debt slavery of society’s most vulnerable. Now the claim was that by blocking usury to the vulnerable, you entrenched their position at the bottom of society. Certainly the Democrats believed that by forcing a lower rate of interest on the loan sharks, the enslavement would be eradicated. One of course wonders today if that just led to the poor borrowing even more – that either way they were destined to go beyond their limit.

This innovation – a simple inversion of logic – is what ultimately led to the sub prime crisis of 2008 – the event which almost brought society to the brink. If your mind doesn’t boggle at how such a simple chain of thought could have such an effect, then you are missing out on one of the most fascinating aspects of human culture and history. You are missing out on the key features of that history that define your own life on a day to day basis.

I’ve only looked at one of many ideas that Ferguson examines in his history – the nature of debt and the innovations that allowed it to become so central to modern society. I urge you to check out Niall Ferguson’s history of the ascent of money to gain this understanding. He explores a great many more ideas that will truly reward your investment of time and thought.