Friday, 27 November 2009

Ascent or Descent of Money

Murray Rothbard once said, "Historians don't understand economics and economists are useless historians". As an avid reader of history, it's a common issue that I fully appreciate. One historian who is held in high esteem regarding economics is Niall Ferguson. After reading his recent book, 'The Ascent of Money', I beg to disagree. He may be on TV, he may have a fancy academic post, he may in fact be a highly intelligent person, but clever people can be as fallible as any other person. In Contrast with his other works, 'The Pity of War' or 'Empire: How Britain Made the Modern World', his recent book felt rushed, an attempt to cash in on the unfolding economic events at the time of publication. It was after all published a full year after the credit crunch.

Money, Regulation, Gold Standards, Bubbles and Greenspan are typical topics discussed, but in many of the above, confusion is the only common theme. Professor Ferguson tries to piece together various areas without the pre-requisite economic knowledge. The Achilles heel of historians is once again on display for all to see.

Money. The books title has the word. It dramatically begins with a list of aliases, however the book falls woefully short of explaining what money is, what its context is, how important it is. A passing mention regarding our sovereign monopoly of money doesn't connect the dots. If the required homework had been carried out, Ferguson would have realised that this was the key. Why do we live in seemingly free markets but they periodically crash, overproduce, mal-invest? Its our governments incompetence over money that causes this. There is no mention that money originated from the free market to overcome barter, that kings took over money for personal gain, that inflation has always been a common phenomenon under this type of arrangement. This admission sets the pace for the rest of the book - for non-critical minds a satisfying read, for others, frustrating.

Stating 'Anything can serve as money, clay, silver, paper', it is true many things have served as money but it doesn't mean they have lasted throughout the ages. Metals have generally been used as the de-facto monetary standard. On the other hand, paper, has continuously ended in runaway inflation as there is no limit to expand the supply. Unfortunately this part of history is omitted leading Ferguson to the conclusion that its 'different this time', they can suck out the liquidity, but as Winston Churchill would argue 'All fiat money has ended in inflationary disaster'. Gold Standards are rendered as inflexible, inelastic, incompatible to increase the money supply under times of extreme contraction, however only half the story is told. It is the first part, the initial unwarranted monetary expansion during the boom that causes the bust, not the lack of expansion in money after the crisis. Classic examples such as John Law in France, which lead to hyperinflation because he tried to fix the economic bust by printing more money seems to allude our academic friend. Despite coming to the conclusion that it ended in disaster and no good came from printing more money, Ferguson still believes it to be a good idea. As the quote at the top of this blog states, you either keep expanding indefinitely destroying the currency or you take the medicine.

Despite mentioning the recent great economic powers, Germany, United Kingdom, America, Holland did he ask the question what did all of these have in common during their height? Sound Money. The United Kingdom exported sound money around the world, gold, silver or bimetallic standards, to keep a check on government abuse. All the nations listed went into decline as soon as they abandoned these principles. The Bank of Amsterdam abandoned 100% reserves, Britain abandoned its gold standard in the thirties, Nixon's closing of the Gold Window in '71 in which we have since seen a relative decline in Americas Global dominance.

One pressing issue isn't even mentioned, fractional reserve banking. Its one of the most important issues in banking and one of the reasons finance makes a disproportionate income compared with all other sectors of a modern economy. Despite what is conventional told, you don't need fractional reserve banking to run a successful economy. 100% reserve banking, where the banks can not create money out of thin air would not only give greater stability, but would be fairer for all. Savers are rewarded, peoples purchasing power would increase, all sections of society would gain equally from such a system. One of the reasons society is plagued with great income inequality is that when you inflate the currency based on no supply and demand dynamic, this excess liquidity will inevitably end up in assets such as houses, stocks and so forth. The rich in general posses more assets and when they increase in value caused by the monetary expansion their wealth increases disproportionately. For example, if houses went up 100%, then a person with the previously valued £100,000 house would gain £100,000, however the asset rich person with a £1,000,000 would gain £1,000,000 - ten times the gain, or to put it another way a 1000% more! The rich get richer while the poor get poorer. People with no assets have no such luck.

Fractional reserve banking is an immoral system. It allows the banking community to leverage, i.e. create money at will and profit from something that they can create out of thin air. Can you imagine a factory that could make products out of thin air? A civil engineer making invisible bridges and getting paid for them? This is finance, the rules the government lay down. Allowing our banks to inflate the money supply based on governments targeting their inflation metrics. The better the free market does its job, by lowering the cost of goods and services, the greater the rewards for the banking community as expansive monetary policy is the solution for falling prices. Alas this topic isn't even covered in the book.

Bubbles and Regulation are narrated upon, nevertheless critical analysis is lacking. Ferguson outlines bubbles along with expansive monetary policy but the vital connection is not made. Instead human psychology is used to explain the 'irrationality' of markets, the conventional scapegoat. If our money was sound there wouldn't be the excess money to inflate bubbles and prolong their expansion misleading people to mistake these false price signals. The liquidity would not be available to inflate bubbles as other sectors of the economy would require capital. I recently saw Ferguson interviewed after his book in which he remarks that behind bubbles you will almost always find a central banker, from John Law to Alan Greenspan. It's a shame the book misses this point.

Regulation. We need more regulation? We need to set up a regulatory committee to stop people from poking themselves in the eye, or do we? People are rational to the extent that they make informed decisions. When banks get reckless they get reckless based on the premise that they get bailed out. One of the most heavily regulated industries is banking. I work in the computer software sector and from what I know we don't have any regulation. We don't have codes of conduct in how to make software. Good software companies survive using good business processes and sound coding techniques. They don't need some bureaucrat who visits every so often to inspect the software. The market, that is people, decide what is good or bad quality and cost effective. It should be the same with banks. If a bank is unsound it fails like any other business. When banks used to be allowed to go bust, they took pride in their long history. This in turn attracted people to bank with them as they continually survived during economic crisis. All of this occurred with little or no regulation, people came to that decision on their own accord.

Take for example electronics companies who for example make Computers. Should we have a regulation that states a certain quality of hard drive should be used in order to minimise computer failures, or should we allow people to decide if they wish to pay more for a PC with greater reliability. Of course the market drives up quality. When the Japanese companies started destroying the Western electronics giants they did so not from government regulations but because of market forces, people individually making rational decisions based on build quality and innovation. The books passing comments in relation to regulators maintaining financial stability contradicts the recent economic crisis we are living through.

Described as the best historian of his generation, what premise do I a software developer, have to disagree? Was it not the clerk in a patent office who challenged classical Newtonian mechanics and set off a whole generation of physicists who questioned authority and conventional wisdom? Just because a person has an academic post or a prestigious award doesn't mean he has mastered a particular subject matter. Just as Einstein was brilliant, he was as fallible as us all. Later in his life he couldn't accept quantum mechanics and a host of other new theories, stuck in the past he slipped into insignificance despite being one of the most recognised scientist in modern history. In my opinion one of the greatest economists, Ludwig Von Mises, couldn't even get a paid academic post whilst residing in America.

Critical thinking is rarely conventional wisdom, something Professor Ferguson has forgot. His earlier books such as 'Empire: How Britain Changed the Modern World' challenged the conventional viewpoint that the British empire was inherently bad for the world, on the contrary Ferguson argues well that it was beneficial and ahead of its time. 'The Pity of War' argues that the first world war was not inevitable, people were more apprehensive than conventional wisdom makes belief. It wasn't as black and white with the infamous Archduke assassination that set off a series of chain reaction events that is narrated by many historical texts. Britain held the key, indeed she was the prime cause of the war due to unusual diplomatic moves and indecisiveness.

Ferguson states that finance is the key to modern society. Finance is vitally important but its no more important than the doctors, the engineers, the scientists, the factory workers; everyone plays a key role in society enabling living standards to rise. Finance is the heart of the economy, not the brain. It pumps credit around the economy to the sectors that require it, the brain is the scientists, innovators, entrepreneurs and inventors. These people decide how to do things better and how best to satisfy individuals desires.

Whilst reading the book the title always troubled me. Have we witnessed the 'Ascent of Money'? If that were the case would the story of money not read that people first experimented with common objects such as, shells, clay, beads then we moved to using metals. This became cumbersome so we transitioned onto a more convenient medium which behind it lay the backing of a finite metal such as gold or silver. Then people threw away the governments monopoly and allowed the market to choose what money was. Instead we witnessed the first three steps, but have now instead moved to fiat money, backwards in time to the exception, not the rule. History warns us that fiat systems have always self imploded and we are no more wiser than any previous civilisation that tried to manage paper money. The 'Descent of Money' I feel would have been a more fitting title.


  1. Hello Phill
    I picked up The Ascent of Money in the local bookstore, skimmed through it and felt equally let down by the analysis. It lacked something, but I could not quite explain. Then I realised that the author had also written a history of a certain financial family which although I have not read made me wonder if this book was not a deliberate attempt at historical obfuscation.

    An attempt to confuse, steer the interested reader away from the real issue of money created out of thin air as a debt.

    If you look in your local bookstore do you find copies of Murray Rothbard's Mystery of banking. In fact I cannot remember seeing any book in the store like Rothbard's that explained in simple layman's terms how money works.

    Ask yourself if Ferguson were to bring out a revised second edition that covered some of the topics that Rothbard covered, would it ever be accepted for publication. Would he keep his tenure?

  2. I personally borrowed mine from the local library as I suspected that it would disappoint. I completely agree with your sentiments above, Ferguson couldn't publish the truth, his publishers wouldn't accept it, and it wouldn't sell as well. MurrayRothbard's Mystery of Banking is essential reading for anyone and I personally think it is a great read, like many of his other books. MurrayRothbard had the rare ability to understand economics but also could explain it in the context of history.

    Yes Ferguson has written books about the Rothschild's but I wouldn't read to much into that. I think he just genuinely reads from the same Keynesian page as most other commentators do and consequently gets confused.

    However don't mistake that debt is evil - it is very useful if you spend it wisely for the purposes to increase productive capacity. Its when you spend it on short term consumption that it becomes wasteful and lowers peoples standards of living. Debt should be honest however - not free money that the banks can create at will putting the general public under their control.

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  4. Hello Phill,

    I came across this critique of Professor Ferguson's book. It's a good read.

  5. Thanks,

    It seems to come to the similar conclusion as myself. And you are right - it is an excellent article.