The history of lending, booms, the bust and why the cycle may not be infinite

Paper Promises: Money Debt and the new World Order

GRANDMOTHERS with no interest in algorithms or Wall Street have been telling us for years that profligacy could not last.

There were times when we wondered whether we really should be on that holiday in Miami when we normally went to Quinta Del Largo, or sat in a meeting when unimaginable sums were being committed to and we knew, deep down that we should have been more cautious.

Or, heaven forbid, when we bought the bigger house and overstretched on the assumption that its value would go up. In truth many of us at ground level probably saw it coming, rather hoped it wouldn’t come and lived through a state of benign denial.

At the time of writing, that nice Mrs Merkel is trying to ensure that any of us that have managed to squirrel away any cash will find that it will still be in there in the morning.

Philip Coggan is a well-known financial journalist and was the author of the highly successful book, Money Machine, that explained the intricate workings of the City. He now proves to be an exceptional banking and economic historian.

What is evident is that the human condition must be pre-programmed never to be able to “call it”. Given our past we can predict that, at some date in the future, we will drift into the dreadful cycle of: have-not — have — want more — borrow more — buy more — owe more — show indignation at asset decline — borrow more assuming revival and growth — collapse.

It was Solon the Athenian (not Conan the Barbarian) who, in 600BC resolved the ancient Greek debt crisis. In those days if you could not pay your debts you became a slave. Solon freed them, abolished slavery for defaulters, “cancelled some debts, reduced others, abolished ceilings on interest rates and devalued the coinage by a quarter”.

In 2011 Greece is trying to do something similar under the scrutiny of her European partners. Today Germany wants fiscal union, which basically means that the Germans will dictate tax and spend policy across whole the region, or she will not agree to any more bail outs.

It’s not clear what the penalties are for non-compliance, but the ultimate option is not what Germany does any more. There is no real punishment for default and that’s part of the problem.

Barings collapsed when Nick Leeson traded illicitly and undiscovered in 2005, but the bank was brought to the verge of extinction much earlier in 1890 when the Bank of England had to borrow from France and Russia when there was a run on its reserves.

In 1931 the Austrian Bank Credit Anstalt went bust when it was forced to take over a rival in trouble — not far off what happened when Lloyds took over Halifax/HBOS when the sub-prime crisis was in full swing.

We can see why Germany is reluctant to fall into the same von traps again — by printing money and causing hyperinflation that can wipe out the middle classes and increase the long term burden on the state. Imagine dashing down to the supermarket on the day you receive your wages as they will be worthless one week later. A German called Einstein once said that the definition of insanity was to do the same thing twice and expect a different result, and it looks as if German politicians have decided that they must learn from their own painful history.

Philip Coggan also shows some insight into what people and politicians thought of bankers in previous generations.

It has been a mystery to some that these people have been so revered and achieved such mega stardom, when previously they were thought of as utilitarian — in the same kin as sewage workers and dockside procurement officers.

If a banking system is run properly, surely we want these people to be intensely boring. John Adams, the second president of the United States declared that “I continue to abhor and shall die abhorring … every bank by which interest is to be paid or profit of any kind made by the deponent.”

This seems to be a forerunner of a more recent and damning description of the 3-6-3 profession: that bankers borrow money at 3%, lend it at 6% and are back on the golf course at 3pm. Thomas Jefferson who succeeded John Adams and was his opponent was even less complimentary describing banks as “… an infinity of successive felonious larcenies”.

The banking profession gets a bad press every few years but they have always survived, like rats after the holocaust. And every generation brings a new theory that will temporarily dominate the economic agenda until disaster strikes, which it always will. This book takes you through the big thinkers and what they thought and how they became heroes and villains within their own time.

John Law (1671 – 1729) the Scottish mathematician who killed a man in a duel, fled to France and somehow became a financial guru to Louis XV. He more or less invented quantitative easing by creating a bank with the right to print money without the backing of gold or silver — or anything else for that matter. His view was that “… the lands of France are worth more than all the gold that still lies hid in the hills of Peru.”

John Law went from being admired by Duchesses to dismissal and a horrible death in poverty.

There is no answer to the universe and everything in the final chapter, only the promise that debts will never be paid at their current value and that they may be passed to other governments one day in some form. The key word here is “may”.

If the protracted negotiations in Europe outlast the patience of its population, then the money we will exchange will be worth less than its intrinsic value of paper and ink. Outright default will result in contagion and we could all have to think of a new world order with or without bankers, or banking. On the bright side … well, there isn’t one to be honest.