The Ascent of Money: A Financial History of the World

Chapter 2 outlines the creation and development of the bond market, what Ferguson calls “the second great revolution in the ascent of money” (65). The bond market increases the credit supply for governments and corporations, and it affects everyone (1) through the investments that pension and retirement plans make in it and (2) by setting long-term interest rates for the overall economy.

“Mountains of Debt”

Again, the northern city-states of Italy played the crucial role in developing the bond market. Constantly at war with each other, they needed ways to fund their wars, and thus devised bonds. Venice and Florence compelled their citizens to loan the government money in exchange for interest (which was not considered usury because the loans were not voluntary). In Venice, these government bonds could then be sold for cash to other investors, and the bond market was born. Northern Europe also played a role in developing this market. Bonds there took the form of annuities (purchasing a series of annual payments for a fee) and lottery loans (investing in the small probability of a large return). Both France and the Netherlands used these methods successfully. When England’s Glorious Revolution of 1688 resulted in William of Orange of the Netherlands becoming King of England, such financial methods spread to Britain as well. By the mid-18th century, bonds had become very popular and successful in London, as the government stabilized and consolidated its debt with the use of bonds (thus they were known as “consols”—short for “consolidated”).

“The Bonaparte of Finance”

This section shows how Napoleon Bonaparte’s reign after the French Revolution affected the financial system of Europe and led to the rise of the Rothschild family, England’s most powerful financiers of the 19th century.

War with Napoleon had caused England’s debt to rise, and because of that, its bonds to decrease in value (for fear the government might default). When the Duke of Wellington led a group of armies in a final showdown with Napoleon, at Waterloo in 1815, the British government called upon banker Nathan Rothschild to buy up gold throughout Europe. This was needed to pay soldiers and purchase material, since English banknotes were not trusted in the various countries involved. A long war was expected, and the government wanted enough gold on hand to finance it. When, however, the Battle of Waterloo resulted in a rapid and decisive defeat of Napoleon, the Rothschilds were left with a pile of gold that would no doubt depreciate in value, since it would no longer be in high demand. Nathan then gambled on the idea that the British government’s bonds would appreciate in value with the war over, as more people bought them without fear of default, and purchased them in great quantities from mid-1815 to late 1817. His hunch was right, and the Rothschilds made many millions in profits as the bond market rose by more than 40%.

“Driving Dixie Down”

The Rothschilds became so powerful in the 1800s that some said they had the power to prevent or wage war. They certainly had the ability to influence it, Ferguson argues, as the US Civil War shows.

When the war began, the Confederate government sold bonds to its own citizens. As the need for funds increased, they then tried selling the bonds in Europe, but there was little interest. At that point, the Confederacy came up with a new kind of bond, backed by cotton, its cash crop. The bonds could thus be converted into cotton at a low, prewar price, making them popular, since the lower supply caused by the war meant the price of cotton rose and investors could sell it for a tidy profit. The Confederacy also stopped selling cotton to the large textile markets in England as a way to pressure that country into supporting it in the war. This caused the price of cotton to soar in England, pushing the value of the cotton bonds even higher. However, New Orleans, the main port from which cotton was exported, fell to the North in early 1862, greatly impacting the value of the bonds. The North blockaded New Orleans, making it all but impossible to get the collateral (i.e., cotton) that made the bonds so valuable. The South had been trying to get the Rothschilds to purchase their bonds, and when they declined to do so, the Confederacy’s financial fate was all but sealed. Indeed, the bonds became worthless by the end of the war three years later.

“The Euthanasia of the Rentier”

On the whole, the bond market was very successful in the 19th century. It was, however, designed at that time to benefit the elite, as only the rich and politically-connected tended to invest in bonds. They were called rentiers, after the French bond known as the rente. It was thus a regressive system, “with taxes imposed on the necessities of the many being used to finance interest payments to the very few” (99). World War I, brought on by the elites themselves, changed this situation.

During the war, the Central Powers (Germany, Austria-Hungary, and Turkey) had no access to the international bond market, so they were limited to their own domestic markets for sales of bonds. When the demand waned, they had to rely on banks for loans, which increased the money supply and thus inflation. After the war, Germany was saddled with enormous debt in the form of reparations imposed by the victors. Adding to the problem was the fact that the German government did not collect enough in taxes (largely due to higher income groups not paying what they owed) to meet their increasing expenses. These large deficits, among other factors, increased reliance on paper money, further boosting inflation. By 1924, Ferguson writes, “prices were on average 1.26 trillion times higher than they had been in 1913” (104). The bond market collapsed, as this hyperinflation wiped out the value of bonds, which are set at fixed interest rates. This mostly affected the upper-middle classes.

Later in the 20th century, events in Argentina highlighted the risk of countries defaulting on their debts. Once among the top ten richest countries in the world, Argentina went from boom to bust after World War II. Inflation and debt each played a role, but both of those had occurred before without dire consequences. Ferguson argues that the country did not have the political will to get these forces under control. In the 1960s and 1970s, frequent coups, along with political and social upheaval, left “no significant group with an interest in price stability” (111). War with Britain over control of the Falkland Islands increased government debt in the early 1980s. The crisis came to a head in 1989, when Argentina’s currency collapsed and the World Bank froze lending to the country. Bond prices fell sharply when word got around that the central bank might run out of money. Domestic debt was wiped out, like in 1920s Germany, having the greatest effect on upper middle classes and those on a fixed income. External debt remained, however, and more than doubled over the next decade, as the government borrowed even more to service existing debt. No attempts at fiscal reform helped, and Argentina eventually defaulted on its debt in 2001.

“The Resurrection of the Rentier”

Since the period of high inflation in the 1970s, inflation rates remained low for thirty years, and the bond market did rather well. Various factors have played a role in this, including the lower costs of consumer goods, but Ferguson argues the greatest impact has been the fact that “the social constituency with an interest in positive real returns on bonds has grown” (116). Increasingly, wealth is invested in pensions and savings institutions that put a large share into the bond market.