Finance and the economy

During the late nineteenth and early twentieth century, Great Britain and Germany were the leading powers in the world, which was as globalized as it is today.

As the economist, John Maynard Keynes, put it:

What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot. But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages. The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep;

He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighboring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable. The projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise, were little more than the amusements of his daily newspaper, and appeared to exercise almost no influence at all on the ordinary course of social and economic life, the internationalization of which was nearly complete in practice.

The era between 1871 and 1914 was referred to as the Belle Époque.

This first modern globalized order came to a halt after World War I which began in 1914.

After the end of World War I came World War II, the Cold War and the division of the world into the First World, the Eastern Bloc and the Third World.

Most countries preferred to stay relatively isolated from each other. Protectionism and nationalism ruled the day.

However, since the 1970s, a new era of globalization has started. This has involved the supreme importance of finance to the world economy. Today, the financial markets in the US, China, Europe etc and intimately tied to each other. The world economy is dependent upon the financial markets of these major players.

Could we in 2017 be living in another Belle Époque? This is the million dollar question and it remains to be seen.

Understanding insurance

As documented in Niall Ferguson’s The Ascent of Money, the origins of insurance lie in seventeenth century Edinburgh, Scotland. This was after the Calvinist reformation.

Widows of the Calvinist ministers needed some form of income protection after the death of the said ministers. So, two clergymen: Robert Wallace and Alexander Webster, who were drinking buddies, came up with the idea of providing some form of insurance to these widows.

Using the mathematical ideas of their fellow Scotsman, Colin Maclaurin, they collected the life expectancy tables of typical Scottish clergymen. Thus, they originated actuarial science.

Their formula was to:

  1. Collect premiums for insurance policies from a large number of ministers so that the total amount collected is quite large
  2. Invest the sum in some way (mostly they used it to give out loans to younger ministers and made money off the interest)
  3. In case of the minister’s demise, the widows would be paid the value of the insurance policy in the form of an annuity

This way, they built up large sums of money collected from the insurance premiums. Wallace and Webster accurately calculated the life expectancies and the growth of the money pool.

The two century-old Scottish Widows company (acquired by Lloyd’s in the 1990s) still maintains the reputation of being very well-trusted by the British public.

Today, insurance companies hold some of the biggest assets in the finance world. They are major institutional investors.

There is another interesting angle to this story which comes in the form of the welfare state. This has its origins in the ideas of the German conservative, Otto Von Bismarck. He figured out that a good way to squelch the noises being made by the socialists of his time was to implement a social insurance scheme, which would mandate a retirement at age 65. In one stroke, he made all his aging socialist enemies retire and provided the people a government program which, he foresaw, would reduce public dissatisfaction with the government.

The program of social insurance and the welfare state was carried out to a great extent earliest by the Japanese, who were prone to facing numerous natural calamities, like earthquakes and tsunamis. The Japanese government also got involved in many wars in the early part of the twentieth century, eventually ending in 1945 with the tragedies at Hiroshima and Nagasaki. Hence the need to provide coverage insured by the state, instead of relying on private insurance providers.

Similar welfare programs arose in the anglospheric West for the first three quarters of the twentieth century until the rise of stagflation (stands for economic stagnation combined with high inflation). This arose as a consequence of excessive government spending and a lack of economic growth. This phenomenon gave the impetus to economists like Milton Friedman to advocate the roll back of the welfare programs.

Today, the United States government is deeply in debt. It seems possible that the programs of social security etc. may not have sufficient funds in the near future to fulfill their promises of insuring the public.

Bubbles

The economic history of the modern world has seen it’s fair share of the phenomenon called bubbles.

One of the early, interesting ones is the one orchestrated by John Law. He was a very influential Scottish financier who gained a lot of favor with the pre-revolution Ancien Régime of France.

He was responsible for the Mississippi Company.

This company was ostensibly set up as a typical 18th century government sponsored monopoly. In comparison to its wildly successful Dutch counterpart (which delivered real economic value to it’s shareholders), the Mississippi Company turned out to be a bubble which was propped up by the manic manipulations of Law, who at one time, controlled the currency issuer, the central bank and the largest corporation in the country.

The initial speculations by the shareholders led to the creation of the first “millionaires” in the world. However the company turned out to be a spectacular failure and Law was exposed. He fled the country, leaving it in financial ruin. But the ground was now prepped for the revolution to occur and eventually bring about historic change.

Modern times have also seen fraudulent companies like Enron prop up bubbles by having large influence with the government, but eventually causing economic disasters.

Understanding credit

The origins of credit lie in the ancient Near East where, for example, the code of Hammurabi laid out the structures and rules around credit.

It originated simply to accommodate traders and merchants. They could have been expecting some money in the near future and could borrow money from a lender to make do in the meantime. The merchant could be expecting a shipment of grain for example. The word credit has it’s etymological root in “credos”, meaning “I trust”. So the creditor was trusting the debtor and providing him with the credit, trusting he will pay it back. Paying interest is one of the ways to compensate the creditor for taking the risk in lending.

The origins of the United States was rooted in encouraging free enterprise and entrepreneurs. So it had the bankruptcy law to support failed businesses to clean their unfulfilled obligations and start again somewhere. This was a way around the debtors’ prisons and debt slavery which was seen in the histories of other countries.

However in recent times, bankruptcy has been used mainly for personal debt by individuals. 97% of bankruptcies are filed by individuals, not businesses. These are mainly caused by hardships and medical debts. This, I think, speaks to the dire state of the healthcare system and the poor knowledge of personal finance in the United States.