Welcome to the world of money,
bread, cash, dosh,
dough, loot, lucre, moolah,
the readies, the wherewithal.
Call it what you like, money can break us or it can make us.
ln the past year, it's certainly broken
more than a few of the biggest names on Wall Street
and in the City of London.
And while former masters of the universe crash and burn,
the rest of us are left worrying if our savings would be safer in a mattress
than in a bank.
The great financiaI crisis that began in the summer of 2007
has most of us utterIy baffIed.
How on earth couId a IittIe IocaI difficuIty
with sub-prime mortgages in the United States
unIeash an economic tsunami big enough
to obIiterate some of WaII Street's most iIIustrious names,
to force nationaIisations of banks on both sides of the AtIantic
and to bring the entire worId economy to the very brink of recession,
if not downright depression?
ShouIdn't this series be caIIed The Descent Of Money?
WeII, I want to expIain to you just how money rose
to pIay such a terrifyingIy dominant roIe in aII our Iives.
What's more, l want to reveal financial history
as the essential back story behind all history.
Banks financed the Renaissance while the bond market decided wars.
Stock markets built empires...
..and monetary meltdowns made revolutions.
From Ancient Mesopotamia right down to present day London,
the ascent of money has been an indispensable part of the ascent of man.
But money's rise has never been a smooth, upward ride.
As we'II see, financiaI history has repeatedIy been interrupted
by gut-wrenching crises of which today's is just the Iatest.
From the fluctuating prices of the homes we own
to the high-speed industrialisation of China,
the power of finance is everywhere we look and it affects all of our lives.
SEAGULLS CRY
But are you in on the secret? Do you know what causes a bank run
or a monetary meItdown or a stock market crash?
Can you teII the difference between a sub-prime Ioan and a prime Ioan?
WeII, I think these financiaI technicaIities onIy reaIIy make sense
once you know where they came from.
And that's why financiaI history is of more than mereIy academic interest.
Not knowing this stuff can seriousIy damage your weaIth.
Crisis or no crisis, the amount of money sloshing around planet finance
still boggles the mind.
By one measure, the US stock of money is now $8, 7 00,000,000,000,
up 1 2% since last year.
And some people are still pocketing a huge share of that cash.
Last year, despite the onset of the biggest financial crisis
since the Depression, his hedge fund paid George Soros a cool $2.4 billion.
That's roughly 41,000 times more than the average American family earned.
As they say on Wall Street, ''Way to gol''.
Now, however, imagine a world with no money.
500 years ago, the most powerful society in South America,
the lnca Empire, had no real concept of money.
The lncas appreciated the aesthetic qualities of rare metals -
gold was the sweat of the sun, silver the tears of the moon -
labour was the unit of value in the lnca Empire,
just as it was later supposed to be in a communist society.
But in 1 532, the lncas ran into a man
whose hunger for money had led him across an ocean.
Francisco Pizarro and his fellow Conquistadores had come from Spain
to what they called Upper Peru inspired by the legend of El Dorado,
the realm of the gold-covered king.
After defeating the lnca army at the Battle of Cajamarca
their quest began in earnest.
At Potosi, in what is now Bolivia,
the Spaniards struck it rich.
They discovered the Cerro Rico, literally the Rich Hill.
Towering nearly 1 6,000 feet above sea level,
it was a money mountain.
In their 250 years of Spanish ruIe, more than two biIIion ounces of siIver
were extracted from mines Iike this one, 1 4,000 feet up in the Andes.
What the Incas couIdn't grasp was why the Europeans had such an insatiabIe Iust
for goId and siIver.
They couIdn't understand that to Pizarro and the Conquistadores,
siIver was much more than just shiny metaI.
It couId be made into money...
..a store of vaIue, a unit of account, portabIe power.
I must say, I find this pIace pretty harrowing.
The Spaniards had a system of forced Iabour
which meant that every abIe-bodied maIe in the native popuIation
had to do a stint down these mines.
And you can see why one in eight of them didn't survive the ordeaI.
Today, 500 years later,
conditions for miners in the Cerro Rico haven't improved much.
But at least they get paid for the work they do.
ln those days, it was a way of making money that verged on genocide.
The silver ore was ground up, refined with mercury
and then shipped to Europe as bars and coins.
Empire, it seemed, had made the Spanish crown rich beyond the dreams of avarice.
And yet, aII the siIver in the mines of Potosi
couIdn't haIt the inexorabIe economic and poIiticaI decIine of Spain's empire.
Why was that, when Pizarro seemed to have struck it so incredibIy rich?
The answer is that the Spaniards had dug up so much siIver
to finance their wars of conquest,
that the metaI itseIf suffered an extraordinary decIine in vaIue.
More siIver coins didn't make Spain richer.
They simpIy made prices higher as an increased quantity of money
chased the same amount of goods.
What the Spaniards didn't get
was that money is onIy worth what other peopIe wiII give in exchange for it.
And, whether money takes the form of silver coins,
seashells, bars of gold or bank notes,
that's been true from ancient times right down to the present day.
Even lumps of clay can work better than silver coins,
if people have enough confidence in them.
In Ancient Mesopotamia, nearIy 4,000 years ago,
peopIe used cIay tabIets Iike these ones
to commit themseIves to particuIar financiaI transactions.
For exampIe, this one, found a IittIe south-west of Baghdad,
specifies that a debtor wiII repay a Iender 330 measures of grain
on the harvest day. But this one's even more fascinating,
because what is says is that a debt of four measures of barIey
shouId be repaid to the bearer of the cIay tabIet
and it's that idea of repayment to the bearer that reaIIy fascinates me.
lf the phrase sounds familiar, then it should.
Just take a look at a Ł20 note.
Bank notes have next to no intrinsic worth.
They're simply promises to pay,
just like the clay tablets of ancient Babylon four millennia ago.
On the back of the $1 0 bill it says, ''ln God We Trust''.
But it's not really God you're trusting in.
By swapping your goods or your Iabour for a fistfuI of these things,
you're trusting the US Treasury Secretary not to repeat Spain's mistake
and produce so many of the damn things that by the time you come to spend them,
they're worth even Iess than the paper they're printed on.
Today we're quite happy with paper money.
Even more amazingly, we're happy with money we can't even see.
Millions of dollars pass through this woman's hands every day...
..or rather, across her computer screen.
She's a foreign exchange dealer,
whose business is literally buying and selling money.
Each day around $3 trillion changes hands
in transactions like these around the world.
And it's all built on trust. lt has to be when you can't even touch the stuff.
That's what the Conquistadores got wrong.
They failed to see that money is about trust - even faith.
Trust in the person paying you the money,
trust in the centraI bank issuing the money,
trust in the commerciaI bank that honours the cheque.
Money isn't metaI. It's trust inscribed.
And it doesn't much matter what it's inscribed on - paper, siIver, cIay,
or a screen - provided the recipient beIieves in it.
There was one huge possibility created
by the emergence of money as a system of mutual trust -
a possibility that would revolutionise world history.
lt was the idea that you could rely on people to borrow money from you
and pay it back at some future date.
That's why the root of ''credit'' is ''credo'', the Latin for ''I beIieve''.
Without the invention of credit,
the entire economic history of our world would have been impossible.
Because we take it for granted,
we tend to underestimate the extent to which our entire civiIisation is based on
the borrowing and Iending of money. No, it doesn't IiteraIIy make the worId go round.
But it does makes vast quantities of peopIe, goods and services
go around the worId from BabyIon to BoIivia.
The puzzle is that the early moneylenders got so little thanks for their services.
On the contrary, they were widely reviled as pariahs.
Why was that?
Welcome to Northern ltaly in the year 1 200AD.
A land divided into multiple feuding city states.
A land where trust was in rather short supply.
Among the many remnants of the defunct Roman Empire was a numerical system
singularly ill-suited to complex mathematical calculation,
let alone the needs of commerce.
Nowhere was this more of a handicap than in Pisa,
where merchants struggled to do business
with seven different forms of coinage in circulation.
Even the simplest transaction could be a headache, requiring the use of an abacus.
By comparison, economic life in the Eastern world -
in the Muslim caliphate or the Sung Chinese Empire - was far more advanced.
To discover modern finance, backward Europe needed to import it.
Enter a young mathematician called Leonardo of Pisa or Fibonacci.
The son of a Pisan customs official based in what is now Algeria,
Fibonacci is best remembered today
for his sequence of numbers that mimic the properties of nature.
But the famous sequence was onIy one of many Eastern mathematicaI ideas
that Fibonacci introduced to Europe with his path-breaking book the Liber Abaci -
The Book of Calculation.
Even more important was his demonstration of the superiority of Arabic numerals
over Roman numerals.
And crucially, nearly all Fibonacci's examples related to business.
Since Roman times,
Europeans had been struggling to do simple arithmetic with these...
The Hindu or Arabic numerals made all kinds of calculation easier.
ln particular, Fibonacci showed how the new methods of calculation
could be applied to commercial bookkeeping, to currency conversions
and, crucially, to the computation of interest.
Just imagine trying to work out percentages in Roman numerals.
Fibonacci's Liber Abaci made it child's play.
This was to be the appIication of mathematics to making money.
The most fertile soil for such financial seeds
proved to be the ltalian city states.
Fibonacci's home town of Pisa was one.
But it was above all Venice -
more exposed than any of the others to Oriental influences -
that became the great money-lending laboratory...
..and the home of literature's most notorious moneylender -
Shylock, in William Shakespeare's The Merchant of Venice.
May you stead me? WiII you pIeasure me?
ShaII I know your answer?
CruciaIIy, ShyIock's onIy prepared to Iend the money if Bassanio's friend,
the merchant Antonio, is providing the security.
Three thousand ducats for three months and Antonio bound.
Your answer to that.
Antonio is a good man.
By ''good'', ShyIock doesn't mean virtuous,
he means ''good'' for the money he's about to Iend Bassanio.
In other words, creditworthy.
Have you heard any imputation to the contrary?
Oh, no, no, no, no. My reason in saying that he's a good man
is to have you understand me that he is sufficient.
(ShyIock) Three thousand ducats. I think I may take his bond.
With any loan, things can go wrong.
Ships can sink. And that is precisely why anyone who lends money to a merchant -
if only for the duration of an ocean voyage - needs to be compensated.
We usually call the compensation ''interest'' -
the amount paid to the lender over and above the sum lent or ''principal''.
Overseas trade of the sort that Venice depended on
couldn't operate without such transactions.
And they remain the foundation of international trade to this day.
But why does Shylock turn out to be such a villain,
demanding literally ''a pound of flesh'' - in effect Antonio's death -
if he can't fulfil his obligations? Why is Shakespeare's moneylender so heartless -
the original of that bloodsucking financier
who recurs time and again in Western literature?
One clue is that Shylock is one of the many Jewish moneylenders in history.
Jews who stayed in Venice for more than two weeks
were supposed to wear a yellow ''O'' on their backs or a yellow hat.
And they were confined to a special area which became known as the Ghetto Nuovo.
This is the entrance to the Jewish ghetto in Venice where Jews were obIiged to Iive
and indeed confined at night. Jews were toIerated in Venice, but for a reason.
The key was that Jews could provide a service that Christian merchants
were forbidden to do - they could charge interest on their loans.
Fibonacci might have figured out the mathematics of lending,
but it took Shylock to do the deal.
This is where the Venetian Jews used to do business.
This buiIding here was the oId Banco Rosso
and it was outside here that they used to sit behind their tabIes - their tavoIe -
on their benches - their banchi, the root of the ItaIian word for banks.
Now, there was good reason why merchants came here to the Jewish ghetto
to borrow money. For Christians, what the Jews were doing,
Iending money at interest, was a sin.
The medieval Church's laws against usury - charging interest on loans -
were a major obstacle to the development of finance in Europe.
After all, what God-fearing Christian merchant
wished to risk the torments of Hell?
This astonishing vision of eternaI damnation
was painted by Giorgio Vasari and Federico Zuccari
on the inside of the great dome of FIorence's CathedraI, the Duomo.
And beIow there's another fresco by Domenico di MicheIino
of FIorence's greatest poet, Dante AIighieri,
hoIding his masterwork, the Divine Comedy.
According to Dante, there was a speciaI part of the seventh circIe of HeII
that was excIusiveIy set aside for usurers.
There the moneylenders were eternally tortured with scorching earth
and freezing snow, their necks weighed down with bulging purses.
Jews, too, weren't supposed to Iend at interest.
But there was a convenient get-out cIause
in the OId Testament book of Deuteronomy, chapter 23,
you weren't supposed to Iend to your brother at interest, but to a stranger?
WeII, that was a different matter. In other words, a Jew couIdn't Iend to a Jew,
but he couId Iend to a Christian.
The price the Jews paid for performing this service was social exclusion.
Hence the ghetto.
And hence the centuries-long association between Jews and finance,
one of the few forms of economic activity from which Jews were not once excluded.
ln the end, of course, Shylock is thwarted.
For although the court recognises his right to a pound of flesh,
the law also prohibits him from shedding Antonio's blood.
And, because he's a Jew, the law also requires the loss of his goods and life
for so much as plotting the death of a Christian.
He only escapes by submitting to baptism.
lt turns out to be a risky business to be a moneylender.
The Merchant of Venice raises profound questions
about both economics and anti-Semitism.
Why don't debtors aIways defauIt on their debts -
especiaIIy when the creditors beIong to unpopuIar ethnic minorities?
Why don't the ShyIocks aIways Iose out?
To get a better idea of how primitive moneyIending works,
you don't need to traveI back in time.
There are pIenty of modern-day ShyIocks remarkabIy cIose to home.
And they don't need to be Jewish to suffer a simiIar fate to ShyIock.
This is ShettIeston in the East End of GIasgow.
It's actuaIIy where my grandmother used to Iive.
And I think with its distinctive steeI shuttering,
it's one of the grimmest pIaces in the whoIe of Western Europe.
In fact, average maIe Iife expectancy here is just 64,
which is sIightIy worse than BangIadesh.
That means that the average ShettIestonian doesn't actuaIIy Iive Iong enough
to coIIect his state pension.
You might think nobody wouId be mad enough
to try and provide financiaI services here. But someone does.
That someone is a loan shark.
You give him your benefit card as security and he gives you a loan.
On the day your benefit arrives, he gives you back the card
and you go to the post office to get your money,
repaying him the interest. lt's a modern version of Shylock's business model.
Usury is alive and well and living in Scotland.
These are some pages from the Ioan book of a GIasgow Ioan shark.
And it's kind of interesting to see how the business modeI works.
You Iend out maybe Ł10 to someone
and you expect to be paid back Ł12.50 at the end of the week.
Now that's 25% a week, but if you work that out at an annuaI rate
it comes to 1 1 miIIion per cent.
So why do people scraping by on just Ł5.90 a day
pay such horrendous interest on loans?
These, surely, are loans you'd be mad not to default on.
But here in Glasgow, defaulting on your loan is highly inadvisable.
You won't literally lose a pound of flesh,
but grievous bodily harm isn't an unknown consequence
of letting down the loan shark.
Quite simply, individual loan sharks have to be rapacious and ruthless
because the costs to them of even a single defaulter are so high.
And that explains why, from Renaissance ltaly to modern Scotland,
the moneylender is so often a hated figure.
He's providing a service, but at a socially unacceptable price.
So how did Ienders Iearn to overcome this fundamentaI probIem?
If they were too generous, they didn't make any money,
but if they were too hard-nosed, borrowers wouId eventuaIIy defauIt.
The answer was to get bigger and more powerfuI. It was time to invent banks.
ln 1 5th century ltaly, the key financial service of providing credit
moved out of the ghetto to become the legitimate preserve of banks.
This transition was symbolised by the rise of one family - the Medici.
With their ascent, credit came of age.
Moneylending ceased to be disreputable.
lt became glorious - and the foundation of a new kind of power.
The dazzling legacy of the Medici family's power
still surrounds you in Florence today.
In the space of 400 years, two Medici became Queens of France,
three became Pope.
AppropriateIy, it was MachiaveIIi, the supreme theorist of power,
who wrote their history.
Perhaps no other family left such an imprint on an age
as the Medici left on the Renaissance.
You might even say that they paid for the Renaissance,
their patronage running the gamut of genius from Michelangelo to Galileo.
And this, in the Uffizi GaIIery, is the Medici's private art coIIection,
one of the most spectacuIar ever assembIed.
What the millions of tourists who flock here generally forget to ask
is how the Medici paid for all this.
The simpIe answer is that they were foreign exchange deaIers,
members of the Arte de Cambio - the money changers' guiId - who made it big.
They were known as banchieri or tavoIieri because, Iike the Jews of Venice,
they IiteraIIy did their business sitting on benches behind tabIes.
Indeed, the originaI Medici bank - or bench -
was Iocated right here in the Via deII'Arte deIIa Lana - WooI GuiId Street.
Prior to the 1 390s, the Medici were Florence's answer to the Sopranos -
a small-time clan notable more for low violence than for high finance.
ln a 1 7-year period, no fewer than five Medici were sentenced to death
by the criminal courts for capital crimes.
Then came Giovanni di Bicci de' Medici.
lt was his aim to make the Medici totally legitimate.
Part of the secret of his success was an ingenious bit of creative accounting
that got the Medici off the hook of the anti-usury laws.
These Iedgers of the Medici bank make it cIear
how important commerciaI biIIs for financing foreign trade were to the bank.
True, the Church prohibited the coIIection of interest on Ioans.
But there was nothing to prevent a shrewd trader
from making money on transactions Iike these, which invoIved muItipIe currencies.
There was no interest, and therefore no sin,
simply a commission deducted for the conversion of one currency into another.
lf money was advanced to a particular trader for any length of time,
the commission was that bit larger.
ln the same way, depositors who put their money in the Medici bank
were given 'discrezione' to compensate them for risking their money.
This was credit, in other words,
but with the interest payments discreetly concealed.
Now, for the first time, moneylending had evolved into banking.
The reaI story of the success of the Medici bank
can be found here in the Libro Segreto - the Secret Book -
of Giovanni di Bicci de' Medici. The key was not so much size as diversification.
EarIier ItaIian banks had been monoIithic
and very vuInerabIe to defauIt by a singIe bad borrower.
But the Medici bank was made up of muItipIe interIocking partnerships,
each in some measure independent of the rest.
It was this decentraIisation that was the key to their astonishing profits.
Under Giovanni's guidance,
the Medici banking network extended from Florence, to Venice, to Rome.
The scale and diversity of the Medici's operations
was the key to reducing the risks of moneylending,
and therefore also the costs to borrowers.
That's the essential difference between loan sharks and banks -
between Shylock and the Medici.
And here's the proof that it worked.
Page after page of Giovanni's assets, decIared for tax purposes
and cuIminating in the grand totaI of 91 ,089 fIorins. In those days
that was serious money.
When Giovanni died in 1 429,
his last words were an exhortation to his heirs
to maintain his standards of financial acumen.
His funeral was attended by 26 men of the name Medici,
all paying homage to the man who had made the business of banking respectable -
and profitable - as it had never been before.
For his son Cosimo, the accumulation of wealth combined seamlessly
with the accumulation of power.
Within 20 years of his father's death,
Cosimo de' Medici was the Florentine State.
As the Pope himself put it - ''Political questions are settled at his house.
''The man he chooses holds office.
''He it is who decides peace and war and controls the laws.
''He is King in everything but name. ''
This BotticeIIi is mainIy famous for the beauty of its young subject.
But it's actuaIIy intended as a tribute to a dead banker, Cosimo de' Medici.
That's him there on the medaIIion,
and you can just make out the inscription Pater Patriae -
the father of his country.
ln 1 50 years, the Medici had transformed themselves from backstreet moneylenders
to the most powerful financial force in Europe.
But it's this painting, BotticeIIi's Adorazione dei Magi,
which more than any other captures the transfiguration of finance
the Medici had achieved.
On cIose inspection, the three wise men are Cosimo de' Medici,
washing the feet of Christ, and his sons Piero and Giovanni.
The young man on the Ieft is Lorenzo.
The painting had been commissioned by the head of the Bankers' GuiId
as a tribute to the famiIy.
Perhaps it shouId reaIIy have been caIIed The Adoration of the Medici.
Having once been damned, bankers were now cIose to divinity.
Nothing could better illustrate the extraordinary ascent of money.
For what the Medici had achieved
was nothing less than the birth of modern banking.
Others had tried before,
but the Medici were the first bankers to hit the poIiticaI big time.
And they did it by Iearning one cruciaI Iesson -
in finance, smaII is seIdom beautifuI.
By making their bank bigger and more diversified,
the Medici had found a way of spreading their risks.
And by focusing on currency trading rather than just Iending,
they'd reduced their exposure to defauIts by borrowers.
For Cosimo and his famiIy, it was a truIy beautifuI business modeI.
Yet not even the Medici were invulnerable.
The bank suffered heavy losses
as a result of over-generous loans to blue-blooded debtors
who felt no compunction about defaulting on their obligations
and telling the bankers to get lost.
Bad debts - money owed by borrowers who go bust -
are the perennial problem that any bank confronts.
Yet for a time, it seemed as if modern bankers had solved this age-old problem.
They really thought they were smarter than the Medici.
Memphis, Tennessee is a long way from Florence.
And the world economy has come a long way since the Renaissance.
A crucial part in that transformation
has been played by the spread of modern banking from its ltalian birthplace
to a country where money has increasingly taken the form of easy credit.
The United States has been built on borrowed money.
But whereas the Medici tended to lend only to the relatively well off,
until the present credit crunch at least, American banks seemed willing to give
just about anyone a loan.
Memphis is famous for blue suede shoes, barbecued ribs and bankruptcies.
You can tell people here are a little... How shall l say it? ..a little sub-prime.
You onIy need to Iook at the shopping maII for the seriousIy poor.
And the ubiquitous no-friIIs eatery.
Then there's a tax advisor who can teII you how to cIaim your Iow-income credits.
A shop where you can borrow money on the equity you own in your car.
And a pIace where they'II give you an advance on next week's pay cheque...
..not to mention a pawn shop the size of a department store.
And finaIIy, when you've no possessions Ieft to pawn or to seII,
there's just one option Ieft.
And that's to head on down to ZLB PIasma
where you can seII your own bIood for $25 doIIars a pop.
TaIk about being ''bIed dry''. It's amazing reaIIy -
an entire economic sector based on peopIe who are broke.
ln some ways, it rather reminds me of the East End of Glasgow.
Yet there's a world of difference between this world
and the world where loan sharks extract their pounds of flesh
from petty defaulters.
Here in sub-prime America, defaulting on your debts is easy.
Well, pretty easy.
This is Richie. He's in the repo business -
snatching cars from under their owners' noses
when they haven't made their payments.
He grabbed that boIt action, he went ''chh'' and I watched the rifIe sheII
go in the barreI and he Iunged it towards me and hit me right here
and aImost knocked me down.
He said, ''Either you drop the truck or I'm dropping you.''
And I said, ''Yes, sir,'' and I dropped the truck.
You know, you make it sound so attractive, maybe I... I shouId switch jobs!
I teII you what, it's interesting.
ln the bankruptcy capital of America, repossessing cars is a routine matter.
BUZZ OF AUCTION ROOM
$16,000...
It's got the Ieather, the top...
Each week, United Auto Recoveries sells 500 repossessed cars.
The cars are auctioned off to the trade, ending up in the same car lots,
to be sold to much the same people
and, when they can't keep up with their monthly payments,
repo'd and recycled once again.
TechnicaIIy the Memphis repo men are simpIy doing what debt coIIectors do
the worId over.
The difference, apart from the sheer mind-boggIing scaIe of the thing,
is the reIative ease with which the bad debts are wound up
and the coIIateraI is soId off. For the debtors,
there's virtuaIIy no sociaI stigma and nobody seems to be getting hurt.
The big mystery is why the worId's most successfuI capitaIist economy
is based on a foundation of more or Iess painIess economic faiIure.
Here in Tennessee, when the house has been stripped bare
and the repo man has taken your car,
you end up in the hands of one of Memphis's bankruptcy lawyers,
along with around 1 3,000 other people
who filed for bankruptcy here in the past year.
Of course that's one thing that's making you... Bumping your payments up so high.
Every week, bankrupts gather here with their lawyers
to hammer out deals with their creditors. There's even a fast track lane.
In this case it's a mortgage and it's a car, or two cars.
I can't see anything eIse in there that they're...they're having to pay off.
- ActuaIIy there are three cars. - Three cars?
The third car is... the neighbourhood titIe Ioans,
has a... has a Iien on the car, they are hoIding the titIe.
(NiaII) So putting this reaIIy simpIy,
what were they supposed to be paying and what are they now paying?
WeII, that payment was reduced from 241 . 1 1 ...
- down to 107. - OK.
Quite an improvement.
Cutting their monthIy obIigations by more than haIf.
From 1 996 to 2006 there were between one and two million bankruptcy cases a year
in the United States, nearly all of them involving individuals
who elected to go bust rather than meet their obligations.
ln medieval ltaly - or in the Glasgow of my youth, for that matter -
bankruptcy was seen as a disaster. But not here.
In fact, this abiIity to waIk away unscathed from unsustainabIe debt
and start again has been a defining characteristic of American capitaIism.
There were no debtors' prisons here in the earIy 1800s,
at a time when EngIish debtors couId Ianguish in jaiI for years. Since 1898,
every American has been entitIed to fiIe for Chapter 7 - Iiquidation,
or Chapter 13 - voIuntary personaI reorganisation.
For rich and poor aIike,
bankruptcy has become as much of an inaIienabIe right
as ''Iife, Iiberty and the pursuit of happiness''.
The theory is that American law exists to encourage entrepreneurship -
to facilitate the creation of new businesses.
And that means giving people a break when things don't work out the first time,
or even the second time.
The born risk-takers don't get wiped out as they learn through trial and error
how to make that first million,
because today's bankrupt might be tomorrow's billionaire.
lt's a theory that seems to work.
Many of America's greatest successes failed in their early endeavours,
including the author Mark Twain,
the comedian Buster Keaton,
and none other than the great industrialist Henry Ford himself.
All of these men eventually flourished
not least because they were given a chance to try, fail and start over.
For their part, the banks simply assume
that a proportion of the loans they make will go bad.
After all, most people going bankrupt owe relatively trivial sums.
A Chapter 1 3 doesn't wipe their debts out, it just reschedules them.
So it's a mistake to think, as Shakespeare's Antonio did,
of moneylenders as mere leeches,
sucking the life's blood out of unfortunate debtors.
Credit and debt are the building blocks of economic development.
But it takes banks to elevate that relationship
beyond the tie between a loan shark and his hapless victim.
It's onIy when borrowers Iike the ones on this GIasgow housing estate
have access to efficient credit markets
that they can escape the cIutches of the ShyIocks and the Ioan sharks.
It's onIy when savers can put their money in dependabIe banks
that it can be channeIIed from the idIe to the industrious.
But wait, l hear you ask, if banks are the answer,
how could so many have collapsed so spectacularly in the past year,
throwing the financial world into turmoil?
To understand why bad debts in places like Memphis
could cause such chaos, you need to understand
how the relationship between banks and borrowers broke down
as loans came to be ''securitised'' and sold on to unwary investors.
Once upon a time, being a banker was reaIIy rather boring.
You Iived by the 3-6-3 ruIe,
which meant you paid 3% on deposits, coIIected 6% on Ioans
and were on the goIf course by 3 o'cIock.
But in our time, banking became reaIIy rather too interesting.
A whoIe series of financiaI innovations
made it possibIe for common or garden Ioans
to poor foIks in pIaces Iike Memphis
to metamorphose into weird and wonderfuI things
with names Iike ''coIIateraIised debt obIigations''.
WeII, this financiaI aIchemy - turning Iead into goId
or toxic waste into giIt-edged securities -
was onIy possibIe because the ascent of banks
was foIIowed by the ascent of the second great piIIar
of the modern financiaI system - the bond market.
HELICOPTER ROTORS THRUM
We may think power resides
with presidents and prime ministers in palaces and parliaments. Not so.
ln today's world, real power lies in the hands of an elite group of unassuming men
in anonymous, open-plan offices...
..the men who control the world's bond market.
Bill Gross is the boss of PlMCO,
the world's biggest bond-trading operation,
which manages a portfolio of bonds worth $7 00 billion.
Gross is widely regarded as the king of the bond market.
Just call him Mr Bond.
Bonds are the magical link between the world of high finance
and the worId of poIiticaI power.
Governments wiII aIways spend more than they raise in taxation -
sometimes shed-Ioads more -
and they make up the difference by seIIing bonds that pay interest.
But - and here's the magic - if you want to get rid of a bond,
the government doesn't have to give you the cash back.
You just take it to a bond market,
Iike the one here at Tokyo Stock Exchange, and seII it.
After the rise of banks,
the birth of the bond market was the next big revolution in the history of finance.
lt created a whole new way for governments to borrow money.
The bond market funded the wars
that plagued northern ltaly 600 years ago.
GUNSHOT ECHOES
lt dictated the outcome
of the Battle of Waterloo
and created the world's greatest financial dynasty.
lt ensured the defeat of the South in the American Civil War.
And in modern times, the bond market
has brought once wealthy nations, like Argentina, crashing to their knees.
Today, governments and companies use bonds to borrow
on an unimaginably vast scale.
All told,
there are bonds out there worth around $85 trillion.
The fortunes of most of us, whether we like it or not,
are directly linked to the bond market.
lf the bond market tanks, then down goes the value of our pensions -
and that's a huge part of our wealth as individuals.
ln the financial crisis that has gripped the world since the summer of 2007,
US government bonds have been seen as a safe haven for investors seeking shelter
from the storm of falling property and share prices.
So if Bill Gross were to lose faith in those bonds,
it would hit the financial world like... well, a thunderball.
That's why this ''Mr Bond''
has become so much more powerful than the Mr Bond created by lan Fleming.
And that's why both kinds of bond have a licence to kill.
TRADERS SHOUT
HORN BLARES
''War, '' declared the ancient Greek philosopher Heraclitus,
''is the father of all things. ''
lt was certainly the father of the bond market.
For much of the 1 4th and 1 5th centuries, the medieval city-states of Tuscany -
Florence, Pisa and Siena - were at war with each other.
This was war waged as much by money as by men.
In Pieter van der Heyden's BattIe Of The Money-Bags And Strong-Boxes,
piggy banks, treasure chests and barreIs fuII of coins
Iay into one another with Iances and swords in a chaotic free-for-aII.
The Dutch verses inscribed at the bottom read,
''It's aII for money and goods, this fighting and quarreIIing.''
But what they might just as easiIy have said
is that war is impossibIe if you don't have the money to pay for it.
BELL TOLLS
And the way to do that -
the ability to finance war through the bond market -
was, like so much else, an invention of the ltalian Renaissance.
Rather than require their own citizens to do the dirty work of fighting,
each city hired military contractors - condottieri -
who raised armies to annex land and loot treasure from the others.
Among the condottieri of the 1 360s and 1 37 0s,
one stood head and shoulders above the others.
This is his portrait in Florence's Duomo - a thank-you from a grateful public.
Unlikely though it may seem, this master mercenary was an Essex boy.
So skilfully did he wage war
that the ltalians called Sir John Hawkwood Giovanni Acuto -
John the Acute.
This castle was one of many pieces of prime real estate
the Florentines gave him as a reward for his services.
But Hawkwood was a mercenary
who was willing to fight for anyone who'd pay him -
Milan, Padua, Pisa or the Pope.
These dazzIing frescoes in FIorence's PaIazzo Vecchio
show the armies of Pisa and FIorence cIashing in 1364.
At that time, Hawkwood was fighting on the side of Pisa.
But 15 years Iater, he'd switched sides.
Why? Because FIorence was where the money was.
The cost of these incessant wars plunged ltaly's city-states into crisis.
Expenditures, even in years of peace, were running
at double or more tax revenues.
To pay the likes of Sir John Hawkwood, Florence was drowning in deficits.
This wonderfuI document in the FIorentine State Archive
shows how the city's debt had expIoded
from around 50,000 fIorins at the beginning of the 1 4th century
to five miIIion by 1 427.
It was quite IiteraIIy a mountain of debt, hence the name - the Monte Commune.
But from whom couId the FIorentines possibIy have borrowed such a vast sum?
The answer is right here - from themseIves.
lt was a revolutionary idea that would change the world of money for ever.
Rather than paying direct tax, citizens were now
effectively obliged to lend money to their own government.
ln return for these forced loans, they received interest.
These debt instruments - simpIe Iines in a Iedger -
were the originaI government bonds.
And the wonderfuI thing about them was that if you needed your money in a hurry,
you couId seII your bonds to other citizens.
They were Iiquid assets.
What this record teIIs us
is how FIorence turned its citizens into its biggest investors.
This wartime expedient marked the birth of the modern bond market.
Everyone was a winner.
Bonds had saved the city-state from bankruptcy.
The citizens were happy earning their interest.
And the bond market let them buy or sell as they saw fit.
lt seemed as if the problem
of public debt had been solved, allowing the citizens of Florence
to turn their minds to higher things.
But there was just one problem with this brilliant idea.
There was a limit to how many more or less unproductive wars could be waged.
The larger the debts of the ltalian cities became, the more bonds they had to issue,
and the more bonds were issued, the less valuable they looked to investors.
And that was exactly the sequence of events in Venice.
By the early 1 6th century,
the city had suffered a series of military reverses,
and the value of Venetian bonds had taken a hammering.
At their nadir between 1509 and 1529,
Venetian Monte Nuovo bonds were trading at just 10% of their face vaIue.
Now, if you buy a bond when war is raging, you're taking a risk -
the risk that the city won't pay you back or pay your interest. On the other hand,
remember that the interest is paid on the face vaIue of the bond,
so if you can buy it at just 10% of its face vaIue,
you're earning a handsome return of maybe 50%.
And that is how the bond market works.
In a sense, you get return for the risk you're prepared to take.
At the same time, it's the bond market
that sets interest rates for the economy as a whoIe.
If the state has in effect to pay 50%, then so do aII the other borrowers.
The bond market had been invented to help pay for ltaly's wars.
But now it was setting interest rates for everyone.
lts rise to power had begun.
Over the next two centuries, bonds would come to rule the world.
This house was built by the financial dynasty
that helped decide the Battle of Waterloo -
the dynasty that produced the man they called the Bonaparte of finance,
the emperor of the 1 9th-century bond market.
''He is master of unbounded wealth,
''he boasts that he is the arbiter of peace and war,
''and that the credit of nations depends upon his nod.
''Ministers of state are in his pay. ''
Those words, spoken in 1 828 by the Radical Member of Parliament Thomas Duncombe,
were describing Nathan Rothschild, bond trader extraordinaire
and founder of the London branch of what became the biggest bank in the world.
The bond market made the Rothschilds stupendously rich -
so rich that they could afford to build 41 stately homes all over Europe.
This is number 29 - Waddesdon Manor in Buckinghamshire,
which has been restored in all its gilded glory
by Jacob Rothschild, Nathan's great-great-great-grandson.
WeII, he was short, fat,
obsessive, extremeIy cIever,
whoIIy focused.
I can't imagine he wouId have been a very pIeasant person to have had deaIings with.
Between around 1 81 0 and 1 836, the five sons of Mayer Amschel Rothschild
rose from the obscurity of the Frankfurt ghetto to attain a position
of unequalled power in international finance.
lt was the third son, Nathan,
who orchestrated this family triumph from London.
Evelyn de Rothschild is Nathan's great-great-grandson.
He recently retired as chairman of Rothschild's -
the bank that Nathan built.
He was very ambitious
and he moved to London.
I think he was determined. I don't think he suffered fooIs IightIy.
Maybe that's a famiIy trait.
This is one of the few surviving Ietters from Nathan RothschiId to his brothers
written, as aIways, in Judendeutsch -
that was German transIiterated into Hebrew characters -
and it gives you an idea of what an extraordinary work ethic the man had
and how he tried to impose it on his poor, Iong-suffering brothers.
Just Iisten to this.
''Dear AmscheI, I am writing you my opinion because it's my damned duty to do so.
''I read your Ietters, not once, but often 100 times,
''because you can weII imagine that after dinner I don't read books,
''I don't pIay cards, I don't go to the theatre.
''My onIy pIeasure is my business.''
PHONES RING
lt was this phenomenal drive, allied with innate financial genius,
that propelled Nathan from obscurity to mastery of the London bond market.
Once again, however,
the opportunity for a financial breakthrough came from war.
On the morning of June 1 8th, 1 81 5, 67,000 British, Dutch and German troops
under the Duke of Wellington's command looked out across the fields of Waterloo,
not far from Brussels, towards an almost equal number of French troops
commanded by the French Emperor, Napoleon Bonaparte.
The BattIe of WaterIoo was the cuImination of more than two decades
of intermittent confIict between Britain and France.
But it was more than just a battIe between two armies.
It was aIso a contest between rivaI financiaI systems.
One, the French, based on pIunder. The other, the British, based on debt.
To pay for the war,
the British government had sold an unprecedented amount of bonds.
According to a long-standing legend,
the Rothschild family made their first millions
by speculating on how the outcome of the Battle of Waterloo
would affect the price of these bonds.
lt was this legend of Jewish profiteering
that, a century later, the Nazis did their best to embroider.
ln 1 940 Josef Goebbels approved the release of this film, Die Rothschilds.
HE SPEAKS GERMAN
Nathan is seen bribing a French general to ensure the Duke of Wellington's victory,
and then deliberately misreporting the outcome of the battle in London.
This triggers panic selling of British bonds,
which Nathan then snaps up at bargain-basement prices.
What happened here in 1 81 5 was altogether different.
Far from making money from WeIIington's defeat of NapoIeon,
the RothschiIds were very nearIy ruined by it.
Their fortune was made not by WaterIoo, but despite it.
This is how it really happened.
Selling bonds to the public had raised plenty of cash for the British government.
But neither bonds nor bank notes were any use to Wellington.
To provision his troops and pay Britain's allies against France
he needed a currency that was universally acceptable.
Nathan Rothschild was given the job of taking the money raised on the bond market
and delivering it to Wellington - as gold.
The success of this operation would determine the fate of the warring empires
and of all Europe.
This Ietter marks a turning point in the history of both the RothschiId famiIy,
and the British government. It's dated the 1 1th of January 181 4,
and it's an order from the ChanceIIor of the Exchequer
to the Commissary-in-Chief teIIing him to appoint Nathan RothschiId -
Mr RothschiId - as a British government agent.
Nathan's job was to gather together as much goId and siIver as he couId find
on the European continent and make sure it got to the Duke of WeIIington and his army
who had just fought their way out of Spain into the South of France.
It was an operation that reIied heaviIy
on the RothschiIds' unique pan-European credit network
and on Nathan's abiIity to mobiIise goId the way WeIIington couId mobiIise troops.
Shifting such vast amounts of gold in the middle of a war was hugely risky.
Yet, from the Rothschilds'point of view,
the hefty commissions they were able to charge more than justified the risks.
The Rothschilds soon became indispensable to the British war effort.
ln the words of the British Commissary-in-Chief...
''Rothschild of this place has executed the various services
''entrusted to him in this line admirably well, and though a Jew,
''we place a good deal of confidence in him. ''
The Rothschilds were so effective as war financiers
because they had a ready-made banking network within the family -
Nathan in London, Amschel in Frankfurt,
James in Paris, Carl in Amsterdam and Salomon roving wherever Nathan saw fit.
lf the price of gold was higher in, say, Paris than in London,
James in Paris would sell - and Nathan in London would buy.
I think their edge over famiIies Iike the Barings, with whom they were competing,
was that they had their brothers in very important financiaI centres in countries.
Now whether that was pre-meditated,
whether they thought that through as they got out of the ghetto,
it's hard to beIieve that they went as far as that.
But that's what happened and once they saw that it was an advantage,
they worked on that advantage.
ln March 1 81 5, Napoleon returned to Paris from exile in Elba
determined to revive his imperial ambitions.
The Rothschilds immediately ramped up their gold operation,
buying up all the bullion and coins they could lay their hands on.
Nathan's reason for buying this huge stock of gold was simple.
He assumed that, as with all Napoleon's wars,
this would be a long one.
His gold would be more and more sought after and it would rise in value.
lt proved to be a near-fatal miscalculation.
Wellington famously called the Battle of Waterloo,
''The nearest-run thing you ever saw in your life. ''
CROWS CAW
After a day of brutal charges, counter charges and heroic defence,
the late arrival of the Prussian Army finally proved decisive.
For Wellington, it was a glorious victory.
But not for the Rothschilds.
No doubt it was gratifying to Nathan RothschiId
to be the first to hear the news of NapoIeon's defeat.
Thanks to the swiftness of the RothschiId couriers,
he heard it fuIIy 48 hours before Major Henry Percy
deIivered WeIIington's officiaI despatch to the British Cabinet.
But, no matter how early he heard it,
the news of Waterloo was anything but good from Nathan's point of view.
He had bargained for something much more protracted.
Now he and his brothers were sitting on top of a piIe of cash that nobody wanted,
to pay for a war that was over.
With the coming of peace,
the great armies that had fought Napoleon could be disbanded.
That meant no more gold for soldiers' wages and it meant the price of gold,
which had soared during the war, would fall.
Nathan was faced with heavy and growing losses.
CAR HORNS HONK
There was only one possible way out.
Nathan could use the Rothschild gold to make a massive and hugely risky bet...
on the bond market.
On July 20, 1 81 5, the evening edition of the London Courier
reported that Nathan had made ''great purchases of stock'',
meaning British government bonds.
Nathan's gamble was that the British victory at Waterloo
would send the price of British bonds soaring upwards.
Nathan bought, and as the price of bonds began to rise, he kept on buying.
Despite his brothers' desperate entreaties to sell, Nathan held his nerve
for another year.
Eventually, in July 1 81 7,
with bond prices up by 40%, he sold his holding.
His profits were worth approximately Ł600 million today.
The Rothschilds had shown
that bonds were more than just a way for governments to fund their wars.
They could be bought and sold in a way that generated serious money.
And with money, came power.
Mayer Amschel Rothschild had repeatedly admonished his five sons,
''lf you can't make yourself loved, make yourself feared. ''
As they bestrode the mid-1 9th century financial world
as masters of the bond market,
the Rothschilds were already more feared than loved.
But now, they had become hated too.
The fact that the Rothschilds were Jewish
gave a new impetus to deep-rooted anti-Semitic prejudice.
(RothschiId) Just a few months ago a colleague of mine in my office,
who coIIects posters, found these...
WeII, this particuIar, rather extraordinary exampIe of anti-Semitism
in a stark form, about the RothschiIds, who were as it were epitomised,
to them and others at times,
the most extreme forms of undesirabIe capitaIism as practised by Jews.
lt was, above all, the Rothschilds' seeming ability to permit or prohibit wars
that aroused the most indignation.
You might have thought that the RothschiIds actuaIIy needed war.
After aII, some of Nathan's biggest deaIs had been produced by war.
If it hadn't been for war, 19th-century states wouIdn't have needed to issue bonds
for the RothschiIds to buy and seII.
But the troubIe with war, and even more so with revoIution,
was that increased the risk that a debtor state might faiI to meet its commitments.
And that hit the price of existing bonds.
By the mid-19th century, the RothschiIds were no Ionger mere traders,
they were fund managers,
carefuIIy tending to a vast portfoIio of their own government bonds.
Now, they stood to Iose much more than to gain from confIict.
The Rothschilds had helped decide the outcome of the Napoleonic Wars
by putting their financial weight behind Britain.
Now they would help decide the outcome of the American Civil War -
by choosing to sit on the sidelines.
GUNSHOTS
Once again, it was the masters of the bond market who would be the arbiters of war.
50 years after the Battle of Waterloo, and on the other side of the world,
another great war would be decided by the power of the bond market.
But this time, it would be the vanquished who made the big bet and lost.
The traditional view is that the key turning point in the American Civil War
came in June 1 863, two years into the conflict.
That was the month when Union forces captured Jackson,
the Mississippi state capital,
and forced a Confederate army to retreat westward to Vicksburg,
their backs to the Mississippi River.
Surrounded, with Union gunboats bombarding their positions from behind,
the Southerners held out for a month before laying down their arms.
After Vicksburg, the Mississippi was firmly in the hands of the North.
The South was literally split in two.
Yet this military setback wasn't the decisive factor
in the South's ultimate defeat. The real turning point came earlier.
And it was financial.
200 miles downstream from Vicksburg,
where the Mississippi joins the Gulf of Mexico, lies the port of New Orleans.
This is Fort Pike,
buiIt after 1812 to protect New OrIeans from a future British attack.
But 50 years Iater, it wasn't abIe to protect the South from a Northern attack
when Captain David Farragut seized New OrIeans on ApriI 28th, 1862.
It was a cruciaI moment in the CiviI War
as New OrIeans was the principaI outIet for the South's most important export...
..cotton.
Without control over the cotton trade the South's cause was doomed -
because cotton had become the essential ingredient
in an ambitious scheme to bring the bond market into the war.
Like the ltalian city states 500 years before,
the Confederate Treasury had initially raised money for the war
by selling bonds to its own citizens.
But there was a finite amount of capital available in the South.
To survive, the Confederacy looked to Europe
in the hope that the world's greatest financial dynasty might help them
beat the North as they had helped Wellington beat Napoleon.
lnitially, the Confederacy had grounds for optimism.
ln New York, the Rothschilds' agent was sympathetic,
having opposed the North's leader, Abraham Lincoln
in the presidential election of 1 860.
But still the Rothschilds hesitated.
Lending to the British government to help defeat Napoleon had been one thing.
But buying bonds from a bunch of breakaway Southern slave states
seemed a risk too far.
The Rothschilds decided to stay out.
Yet despite this setback,
the Confederate government had an ingenious trick up their sleeves.
The trick, like the sleeves themselves, was made of cotton.
The South's idea was to use cotton as collateral to back its bonds.
lnvestors would be comforted to know that if the interest payments dried up
they could still demand their cotton instead.
The South's agents went to work
selling the bonds in the financial centres of Europe.
When the Confederacy tried to market conventional bonds
in European financial centres like Amsterdam's,
investors wouldn't touch them with a bargepole.
But when an obscure French firm named EmiIe ErIanger and Company
offered cotton-backed bonds, it was a compIeteIy different story.
The key to the success of the ErIanger bonds
was that they couId be converted into cotton
at the pre-war price of six pence a pound.
These cotton bonds formed the basis of the South's new financial strategy.
lf they could restrict the supply of cotton, its value,
and the value of the bonds, would increase.
At the same time, the Confederates set out to use cotton
to blackmail the most powerful country in the world -
Britain.
(Tour guide) The routes to the United States of America
provided Liverpool with growing volumes of trade
and new docks opened on the Mersey in quick succession during the 1 800s.
(Narrator) ln 1 860, the Port of Liverpool was the principal gateway
for imports of cotton to the British textile industry,
then the mainstay of the Victorian industriaI economy.
More than 80% of the cotton came from the Southern United States.
Now that gave the Confederate Ieadership hope
that they had the Ieverage to bring in Britain on their side in the CiviI War.
To ratchet up the pressure, they decided to impose an embargo
on aII shipments of cotton to LiverpooI.
For a while, the South's strategy worked brilliantly.
Cotton prices soared. So did the value of the Confederates' cotton-backed bonds.
And the cotton embargo devastated the British economy.
Mills were forced to lay off workers.
Eventually, in late 1 862, production all but ceased.
This cotton miII in StyaI, south of Manchester, empIoyed around 400 workers,
but that was just a fraction of the 500,000 peopIe
empIoyed by King Cotton across Lancashire.
ObviousIy, with no cotton there was nothing for peopIe to do.
By the end of 1862,
haIf the entire workforce of Lancashire had been Iaid off.
A quarter of the popuIation was on poor reIief.
They caIIed it the ''Cotton Famine'', but this reaIIy was a man-made famine.
Britain was in the doldrums.
And the South's cotton bonds were riding high.
Yet the South's ability to manipulate the bond market
depended on one over-riding condition -
that investors could be sure of taking physical possession of the cotton
which underpinned the bonds if the South failed to make its interest payments.
And that's why the fall of New Orleans on April 28, 1 862,
was the real turning point in the American Civil War.
Now that the South's main port was in Union hands,
any investor who wanted to lay his hands on Southern cotton
had to run the Union's formidable naval blockade.
The Confederates had overplayed their hand.
They had turned off the cotton tap, but then lost the ability to turn it back on.
By 1 863, the mills of Lancashire had found new sources of cotton
in China, Egypt, and lndia
and investors were rapidly losing faith in the South's cotton-backed bonds.
The consequences for the Confederate economy were disastrous.
With its domestic bond market exhausted and onIy two paItry foreign Ioans,
the Confederacy reaIIy had no aIternative but to print paper doIIars,
like these ones here in the Louisiana State Museum, to pay for the war.
ln all, 1. 7 billion dollars' worth.
Now, it's true that the North aIso printed paper money,
but by the end of the war its ''greenbacks'' were stiII worth around 50 pre-war cents,
whereas a Southern ''greyback'' was down to just one cent.
What's more, with more and more of this cash chasing fewer and fewer goods,
infIation in the South simpIy expIoded.
By January 1865, the price of some goods was up by a factor of 90.
The South had bet everything on manipulating the bond market
and had lost.
lt would not be the last time in history that an attempt to do so
would end in ruinous inflation.
Today the global market for bonds is still bigger
than the all the world's stock markets put together.
lt's still a market that can make or break governments.
Does it surprise you that its key player
began his money-making career in the casinos of Las Vegas?
I was a bIackjack pIayer.
One of the first professionaI bIackjack pIayers, not to brag,
but in the Iate '60s, I went to Vegas
and appIied a card-counting system to try and beat Vegas.
Now this master of understatement is the King of the Bond Market,
controller of the biggest bond fund in the world.
So what has this got to do with you and me?
Well, when Gross buys or sells bonds,
it doesn't just affect financial markets and government policy,
it affects the value of our pension funds
and the interest rates we pay on our mortgages.
There's only one thing that Mr Bond is afraid of
and it's not Goldfinger.
Rather, it's inflation.
The lethal danger that inflation poses
is that it undermines the value of being paid a fixed rate of interest on a bond.
If infIation goes up to 10%
and the vaIue of a fixed-rate interest is onIy five,
then that means that the bond hoIder is faIIing behind infIation by 5%.
That's why, at the first whiff of higher inflation, bond prices fall,
and in some cases, keep falling.
To see just how bad things can get when the inflationary genie escapes
from the bottle you just have to look at the example of Argentina.
Many Argentines date the steady decline of their economic fortunes
to a day in February, 1 946,
when the newly elected President, General Juan Domingo Peron
came here to the Central Bank in Buenos Aires.
He was astonished at what he saw.
''There is so much gold, '' he marvelled,
''you can hardly walk through the corridors. ''
The very name Argentina suggests wealth and plenty -
it means ''The Land Of Silver''.
The river flowing past the capital is the Rio de la Plata, ''The Silver River''.
Once upon a time, there used to be two Harrods in the world.
One in London, in Knightsbridge, and the other here, in the Avenida Florida,
in the heart of Buenos Aires.
Founded in 1912,
this other Harrods is a reminder that Argentina used to be a rich country.
At one time, its per capita income was 18% Iess than that of the United States.
Investors who fIocked to buy Argentine bonds
hoped that Argentina wouId become the United States of South America.
Well, Argentina's history since then
is a classic illustration that all the resources and talent in the world
can be set at nought by chronic financial mismanagement.
MUTED CONVERSATION
There have been many financial crises in Argentine history.
But the crisis that hit the country in 1 989
was unparalleled.
At the beginning of February,
the country was suffering one of the hottest summers on record.
ln Buenos Aires, the electricity system just couldn't cope.
Five-hour power cuts were commonplace.
But these, as it turned out, were the least of Argentina's problems.
As is almost always the case,
there were several well-trodden steps to monetary hell.
In step one, the government spends more, much more,
than it can raise in taxation.
UsuaIIy, but not aIways, it's because of a war.
In Argentina's case, there were two.
One, a civiI war between GeneraIs and the Left in the 1970s,
the other a foreign war against Britain over the FaIkIand IsIands in 1982.
By 1989, the financiaI system was about ready to bIow.
By February, inflation had already reached 1 0% - per month.
Banks were ordered to close as the government tried to lower interest rates
and stop the currency's exchange rate from collapsing.
lt didn't work.
ln just a month,
the austral fell 1 40% against the dollar.
At the same time, the World Bank froze lending to Argentina,
saying that the government had failed to tackle the root cause of inflation -
a bloated public-sector deficit.
With no cheap Ioans forthcoming from the WorId Bank,
the government tried to finance its deficit by seIIing bonds to the pubIic.
But investors were hardIy IikeIy to buy bonds with the prospect
that their reaI vaIue wouId be wiped out by infIation in just a matter of days.
Nobody was buying.
The government was running out of options.
ln April, furious customers overturned shopping trolleys
after one supermarket announced over the loudspeaker
that prices were being raised by 30% immediately.
Shops emptied of goods as owners weren't making enough money to buy new stock.
Government bond prices plunged
as fears rose that the Central Bank's reserves were running out.
With no foreign Ioans and no-one wiIIing to buy bonds,
there was onIy one thing Ieft for an increasingIy desperate government to do -
get the CentraI Bank IiteraIIy to print more money.
But they couIdn't even get that right.
On Friday April 28th, Argentina literally ran out of money.
''lt's a physical problem, ''
the Central Bank Vice-President told a news conference.
What he meant was that Argentina's mint had run out of paper to print new notes,
and the printers had gone on strike.
''l don't know how we'll do it,
''but the money has got to be there on Monday, '' he declared.
Yet the faster the printing presses rolled, the less the money was worth.
The government was forced to print higher and higher denominations of notes.
ln May, the price of coffee went up by 50% in a week.
Farmers stopped bringing cattle to market as the price for one cow
was now the same as for three pairs of shoes.
By June 1989, infIation in Argentina had reached a monthIy rate of 100%,
an annuaI rate of roughIy 12,000%.
To put that into concrete terms,
if you wanted to go out for dinner in Buenos Aires on a Saturday night,
in May you'd pay 10,000 austraIes.
By June, you'd have to pay 20,000 for the same meaI.
And by the foIIowing month, it wouId take 60,000.
You've heard of a fistfuI of doIIars.
WeII, you needed a drawer fuII of austraIes just to buy a square meaI.
ln June, popular frustration erupted
in two days of intense rioting and looting by hungry mobs.
At least 1 4 people died.
ln a country where a steak and a bottle of wine
were on practically every table every day,
thousands were eating in soup kitchens or going hungry.
CLOCK CHIMES
lt's obvious enough who loses from hyperinflation.
Very rapidly rising prices are bound to wipe out
anybody who's dependent on an income that's fixed in cash terms.
Groups Iike academics and civiI servants on infIexibIe monthIy saIaries,
oId-age pensioners and, particuIarIy,
bondhoIders Iiving off the interest on their investments.
Buenos Aires is absoIuteIy fuII of antique shops Iike this one,
Iaden down with jeweIIery and watches and cutIery,
aII soId off by middIe-cIass famiIies who just ran out of cash.
ln the 1 920s, the great economist John Maynard Keynes had predicted
the euthanasia of the bondholder,
anticipating that inflation would eat up the paper wealth
of financial families like the Rothschilds.
As inflation swept through the world in the 1 97 0s,
Keynes seemed to be proved right.
ln our time, however,
we've seen a miraculous resurrection of the bondholder -
a comeback by Mr Bond... even in Argentina.
The bond market is back,
terrifying American officials as they try to fund a massive financial bailout
by - you guessed it - selling billions of dollars of freshly minted bonds.
The key to Mr Bond's revival
has been a growth in the number of bondholders...
..which brings us back to ltaly,
where the bond market was born 600 years ago.
ltaly is now a country with one of the most rapidly ageing populations in Europe.
ln such a greying society,
there is a growing demand for fixed-income securities like bonds.
But there's also a strong fear of inflation eating up
the real value of pensions and savings.
Central bankers suspected of being soft on inflation
have to answer to the pensioner's friend - the bond market.
And treasuries planning to spend billions to bail out banks that have gone bust
in the current credit crunch have to tread warily, too,
if they expect to raise the money by selling yet more bonds.
In modern Europe, as in Renaissance ItaIy,
an equiIibrium has been struck between poIiticaI power and financiaI exposure.
Today, as much as ever,
it seems it's the bond market, our oId friend Mr Bond,
that reaIIy ruIes the worId.
But what if, rather than lending to governments,
you prefer to use your money to buy a share in a company?
Would that be more or less risky?
More or less profitable?
ln the next episode of the Ascent Of Money,
we'll discover why we find it so hard to learn from financial history,
Some people today say that companies -
and particularly multinational corporations - rule the world.
lt's pretty hard to believe that any kind of human organisation
could tame the vast natural barriers of South America.
But one company believed it could.
By constructing a 1.5 billion dollar gas pipeline from Bolivia
right across the South American continent to the Atlantic coast of Brazil.
By running gas along the longest pipeline in the world
4,000 miles from the tip of Patagonia to the Argentine capital Buenos Aires.
Such schemes exempIify the vauIting ambition of modern capitaIism,
but they're onIy possibIe because of one invention -
the joint stock company.
lf the 1 6th century had seen a revolution in money and credit,
and the 1 7th had witnessed the birth of the bond market,
then the next step in the story of the ascent of money
was the rise of the joint stock limited liability company.
But the ability of the company to transform our lives
would depend on another innovation...
The stock market.
The price that people are prepared to pay for a company's shares in the market
tells you how much money they think it'll make in the future.
But as we have discovered in recent months of financial turmoil,
stock markets can also be shock markets.
The future is aIways uncertain.
But we human beings are prone to over-optimism.
When prices here on the New York Stock Exchange surge upwards in synch,
it's as if investors are gripped by a kind of coIIective euphoria -
what the former chairman of the FederaI Reserve, AIan Greenspan,
once famousIy caIIed ''irrationaI exuberance''.
So stock markets reaIIy can be Iike soap bubbIes.
We never quite know when they're gonna burst.
The exuberance was especially irrational and the burst especially painful
for the company that proposed those vast projects in Latin America.
Enron became the biggest corporate fraud in modern American history.
But Enron was very far from the only corporate scam
since shares were first bought and sold 400 years ago.
And the shady practices it epitomised live on.
lndeed, they've been a key cause of the financial crisis we're living through now.
Cooked books? Stock prices rigged?
Been there. Done that.
For centuries.
Nothing illustrates more clearly than the history of stock market bubbles
how hard human beings find it to learn from history.
STOCK MARKET HUBBUB
Hidden away among the many splendours of Venice
is a small clue to one of the most astonishing tales of adventure
in all financial history.
''To the honour and memory of John Law of Edinburgh,
''most distinguished controIIer of the treasury of the Kings of the French.''
This is the finaI resting pIace of the man who invented the stock market bubbIe.
An ambitious Scot, a convicted murderer,
a compuIsive gambIer and a fIawed financiaI genius,
he not onIy caused the first true boom and bust in asset prices,
he aIso indirectIy caused the French RevoIution.
There was a time when John Law owned a quarter of what is now the United States,
only to lose it all in history's first great crash.
From Edinburgh to Amsterdam to Paris, all the way here to New Orleans,
and finally to Venice, Law's story is a classic tale of boom and bust.
lt's also very much a story for our own times.
Hidden away here in the warehouse of the Louisiana State Museum
is the onIy known painting of John Law.
Here he is.
With that Iean and hungry Iook,
he reaIIy is, for aII the worId, a Scotsman on the make.
The path that led Law ''from obscurity to celebrity, to notoriety'' is a path
that many of the great stock market players have followed since.
Law was born here in Edinburgh in 1 67 1,
the son of a successful goldsmith and heir to the estate of Lauriston.
ln 1 694, while living in London,
Law killed a man in a duel over a woman
and was sentenced to death.
Somehow, Law managed to escape from prison and fled to Amsterdam.
He couldn't have picked a better town to lie low in.
By the 1 690s, Amsterdam was the world capital of financial innovation.
To help finance their war against Spain,
the Dutch had introduced one of the world's first national lotteries.
To protect their merchants from dodgy coinage,
they'd created the world's first central bank.
But the one that had the biggest impact on Law
was the single greatest Dutch invention of them all -
the company.
The story of the company had begun 1 00 years before Law's arrival
as Dutch traders spread out all over the world,
from Manhattan lsland to the Cape of Good Hope.
But it was Asia that became the primary target of Dutch commercial expansion.
Why?
The East Indies were so aIIuring because of these -
spices -
pepper, cIoves, nutmeg, ginger.
Europeans craved them to fIavour their food, but aIso to preserve it.
TraditionaIIy, they'd come overIand by the Spice Road.
But the Dutch pIan was to fetch them the Ionger, but quicker way, by sea.
And that pungent aroma was the smeII of money to be made.
This painting shows the return of one of the first Dutch fleets from the East.
The inscription reads, ''Four ships sailed to go and get the spices towards Bantam
''and also established trading posts.
''And came back richly laden to the poles of Amsterdam.
''Departed 1 st May 1 598.
''Returned 1 9th July 1 599. ''
The Asian spice trade was so profitable
that just one return trip could pay for the construction costs
of a ship like this.
But so prolonged was the journey round the Cape of Good Hope to the East
and so hazardous that merchants had to pool their resources and their risk.
The result was around six fledgling East lndia enterprises.
In 1602, at the instigation of the Dutch government,
these various companies came together
to form the United Dutch East India Chartered Company,
or Vereenigde Oost-Indische Compagnie for short.
And this is its originaI charter,
which speIIs out that the company was to enjoy a monopoIy on aII trade
from the Cape of Good Hope aII the way east to the Straits of MageIIan.
Pretty much haIf the worId.
The structure of the new entity was novel.
The capital of the company was divided unequally
between all the major Dutch cities.
Citizens were invited to participate in the new venture by investing.
lt was the form of this investment that was the real novelty.
This rather wonderfuI painting is of the famiIy of one of the founders
of the Dutch East India Company, Dirck Bas.
For 6,000 guiIders, he and 16 other so-caIIed ''participants'',
became the firm's managing directors, the bewindhebber.
After 1606, however, anyone who put his money into the East India Company
received an ''aktie'' - IiteraIIy an ''action'',
or as we wouId say, ''a piece of the action'' -
a share in the company's future profits.
And here it is, the worId's very first share certificate,
issued by the worId's very first muItinationaI company.
AImost exactIy four centuries ago.
Three years later, Bas and his fellow directors declared
that any shareholders who wanted their cash back could not have it refunded,
but would have to sell their shares to another investor.
Overnight, a market for the company's shares was born -
the worId's first true stock market.
This invention was to change the face of finance for ever,
because it created a mechanism whereby the price of shares was determined
by the laws of supply and demand, sellers and buyers.
And as the renegade Scotsman John Law couldn't help but notice,
the trading of these company stocks
was making the world's first shareholders very rich indeed.
By 1 61 0, the world's first joint stock company, the Dutch East lndia Company,
was ready to conquer the world.
lt had a new charter, new shareholders and a burgeoning trade in these shares.
But it had to fight to survive,
literally.
Having established a string of factories and warehouses across South Asia
from Java to lndia, the company had to struggle to keep the Spaniards
and their English competitors at bay.
With 40 warships and a private army of 1 0,000 soldiers,
the directors of the East lndia Company were the original corporate raiders.
For the Dutch East India Company,
firepower and foreign trade went hand in hand.
But the key to the company's success wasn't just its cannons
Iike these ones aboard The Batavia, the pride of its fIeet.
Like aII big companies, it was abIe to combine economies of scaIe
with reduced transaction costs
and what economists caII ''network externaIities'' -
the abiIity to pooI information between muItipIe empIoyees and agents.
The Batavia was part man-of-war, part muItinationaI corporation.
The big networked company was simply more efficient.
That was why, by the 1 620s,
it had established a virtual monopoly on spice exports from Asia to Europe.
The world's first multinational was making its shareholders enormously wealthy.
I'm Iooking here at the originaI sharehoIders' register
of the Dutch East India Company,
and IiteraIIy every name in here was a winner.
If you'd put 1 ,000 guiIders into the company at its very inception,
by 1 736, your investment wouId have been worth 7,000.
Over its entire Iifetime, the company paid an average annuaI dividend of 16.5%.
VirtuaIIy aII its profits were paid back to the sharehoIders.
Dirck Bas's original shareholding of 6,000 guilders
had been transformed into a 500,000 guilder fortune.
To John Law, lying low in Amsterdam having escaped the gallows in London,
the workings of the Dutch East lndia Company came as a revelation.
Law was living off his winnings at the gambling table.
But he was fascinated by the relationships between the company,
with its splendid offices in the Hoogstraat, the nearby stock exchange,
where dealers busily traded the company shares, and the Bank of Amsterdam.
Yet this Dutch financial system struck Law as not quite complete.
To Law's financiaIIy supercharged mind, the Dutch were missing a trick, or two.
For one thing, it seemed compIeteIy nuts
to restrict the number of East India Company shares
when the markets were so cIearIy enamoured of them.
Law was also puzzled by the conservatism of the Bank of Amsterdam.
lt had created an internal system which allowed merchants to settle their accounts
by direct cashless transfers,
but it hadn't issued any real banknotes to the public.
The idea was aIready taking shape of a breathtaking modification
of the institutions that Law had first encountered here in Amsterdam.
OnIy combine the properties of a monopoIy trading company and a pubIic bank
and the sky reaIIy wouId be the Iimit.
Law was preparing to unIeash a whoIe new system of finance
on an unsuspecting nation.
ln 1 7 1 6, John Law arrived in Paris.
He had identified France as the ideal laboratory
for what would be the biggest experiment in the history of the stock market.
But why did the French give him his chance?
The answer is that France's fiscal problems were exceptionally desperate.
The country was saddled with enormous public debts
as a result of the wars of Louis XlV.
When the Sun King died in 1 7 1 5,
the Duke of Orleans, who was acting as Regent for the under-age king Louis XV,
faced a country on the brink of its third bankruptcy in less than a century.
lt was the perfect opportunity for Law,
the maverick self-taught economist who'd developed his theories
somewhere between the casino and the stock market.
Law's ambition was to revive economic confidence in France
by estabIishing a bank on the Dutch modeI,
but with the difference that this bank wouId issue paper money
Iike this 100 Iivres note.
As money was invested in the bank,
the government's huge debt wouId be consoIidated.
But at the same time, and this was the reaIIy important part of Law's system,
paper money wouId revive French trade, and with it French economic power.
The Royal Government gained doubly.
Consolidation simply meant that its onerous debts
were magically transformed into shares in Law's bank.
At the same time, the monarch gained the ability
to print as much money as he liked.
As Law wrote - ''l maintain that an absolute prince who knows how to govern
''can extend his credit further and find needed funds at a lower interest rate
''than a prince who is limited in his authority.
''ln credit, supreme power must reside in only one person. ''
That absoIute power was in the hands of the Duke of OrIeans
who Iived here in the PaIais RoyaI,
just a short step from Law's apartment in the PIace Vendome.
It was to him that Law now unfoIded his scheme.
The prize was nothing Iess than the revivaI of French power
through financiaI engineering.
But that was onIy haIf of Law's ingenious pIan.
As Law wrote,
''The bank is not the only, nor the grandest of my ideas.
''l will produce a work which will surprise Europe
''by changes more powerful than were produced by the discovery of the lndies. ''
The second part of Law's idea
was that a huge monopoIy trading company shouId be estabIished,
the Compagnie d'Occident, the Company of the West.
As he put it, the whoIe nation wouId become a body of traders
and Law himseIf, named here as the company's chief director,
wouId be at its head.
The focus for this wildly ambitious scheme would be in America,
where the French laid claim to a vast tract of land
either side of the Mississippi - Louisiana.
The Regent gave Law's company, what was to become the Mississippi Company,
a monopoly on trade with the new colony.
Frenchmen, regardless of rank, were encouraged to buy shares in the company.
Law's name headed the list of directors.
In modern parIance, what these documents teII us
is that Law was attempting a refIation. And why not?
France in 1 7 16 was in a depression
and Law's banknotes heIped stimuIate a recovery.
At the same time, what he was doing
was effectiveIy transforming a burdensome and badIy managed pubIic debt
into shares in what was a privatised tax-gathering and trade company.
WeII, what was not to Iike about that?
ln a fever of mass speculation,
the Mississippi Company's share price soared,
from the original price of 500 livres to 5,000 on September 4th.
By December 1 7 1 9, it had reached 1 0,000.
And this is where it aII happened.
This was where Law's share issuing office was Iocated, the Rue Quincampoix.
You can imagine the scenes of frenzy here
as haIf of Paris descended on this narrow aIIeyway
aII desperate for a piece of the action.
The higher the share price went, the more they wanted to buy.
It was a cIassic stock market feedback Ioop.
lt was in these heady times that the word ''millionaire'' was first coined.
Yes, millionaires, like entrepreneurs, were invented in France.
And by January 1 720, John Law was the richest of them all.
Louis XlV had said ''L'etat, c'est moi'' - ''l am the state. ''
Now the renegade Scotsman, John Law, was able to say,
''L'economie, c'est moi'' -
''l am the economy. ''
Ensconced in his paIatiaI suite, here in the PIace Vendome,
that's the Ritz HoteI over there,
Law had achieved a greater concentration of financiaI power in his hands
than any individuaI in aII French history.
As ControIIer-GeneraI of French Finances, he was IiteraIIy in charge of
the coIIection of aII France's indirect taxes,
the entire French nationaI debt,
the 26 mints that produced the country's goId and siIver coinage,
the Company of the Indies - better known as the Mississippi Company -
which had a monopoIy on the import of tobacco,
aII of France's trade with Africa and Asia,
oh, and the Louisiana coIony,
which covered around a quarter of what is today the United States.
ln his own right, Law also owned the Mazarin Palace,
more than a third of the buildings around the Place Vendome,
more than 1 2 country estates,
several plantations in Louisiana,
and a hundred million livres of shares in the Mississippi Company.
Not bad going for a man who, when he'd first come here 12 years before,
had been identified as a joueur - a professionaI gambIer and a possibIe spy.
By January 1 720, Law's triumph seemed complete.
A Scots murderer was, in effect, Prime Minister of France.
Law's problem was that he had no clear idea where to stop.
On the contrary, he had a strong personal interest in printing more money,
which his own bank controlled, to drive up the price of his own company's shares.
FortunateIy for Law, both his bank and his company
were now operating out of the very same buiIding,
the Mazarin PaIace, which he himseIf happened to own.
So aII he had to do in order to drive up the company's share price
was to take a waIk down the corridor from the office where the shares were issued,
to the office where the money was printed.
You couId say that Law had become the uItimate insider trader.
At root, Law's system was what we nowadays call a Ponzi scheme,
after the legendary ltalian-American conman, Charles Ponzi.
To pay out the generous returns it's promised to the first lot of suckers,
a Ponzi scheme needs to take in more money from the next lot of suckers.
ln John Law's scheme, the acquisitions of other companies
and the generous dividends Law paid
were financed not from company profits,
but simply by selling new shares.
Like aII Ponzi schemes, however, the effect of Law's system
was to generate an unsustainabIe bubbIe.
Law had refIated the French economy
with a combination of paper money and pubIic confidence.
Now, unfortunateIy, his bubbIe was about to go pop.
By the beginning of 1 720,
France was in the grip of a mania - the Mississippi Bubble.
But the man responsible, the renegade Scots murderer and gambler, John Law,
who'd risen to become master of the entire French economy,
was about to discover an inviolable law of finance...
Trees don't grow to the sky.
According to Law's PR campaign,
the huge profits he was projecting would come from the French colony of Louisiana,
which he painted as a veritable Garden of Eden,
inhabited by friendly noble savages
willing to exchange a cornucopia of exotic goods.
These would flow to France through a new city
at the mouth of the Mississippi, New Orleans,
named to flatter the always susceptible French Regent, the Duke of Orleans.
All the colony lacked was settlers.
Grasping that Frenchmen were more interested in stock market speculation
than the hard graft of colonisation,
Law launched a recruitment drive in the Franco-German borderlands.
Several thousand bold Germans signed up and set sail to the promised land.
They ended up here.
This was the unfortunate immigrants' first gIimpse of Louisiana,
an insect-infested swamp.
Within a year, 80% of them had died of starvation
or tropicaI diseases Iike yeIIow fever.
SadIy for Law, the Mississippi Company's principaI asset,
its monopoIy on trade with Louisiana, Iooked Iike being more or Iess worthIess.
As the inscription on this Dutch cartoon put it,
''This is the wondrous Mississippi land made famous by her share dealings,
''which through deceit and devious conduct has squandered countless treasures.
''However men regard the shares, it is wind and smoke and nothing more. ''
To Law, economic success was all about confidence.
But this was a confidence trick.
THUNDER RUMBLES
ln Paris, the first rumours began to circulate
that all was not well with Law's system.
The share price of the Mississippi Company began to slide.
ln a desperate bid to avert meltdown, Law called on the Duke of Orleans
to cut the official share price from 9,000 livres to 5,000.
This was when the limits of royal absolutism,
the foundation of Law's system, suddenly became apparent.
Within weeks, the share price was in freefall.
Angry crowds gathered outside Law's bank.
Stones were thrown, windows broken.
By December, the shares had lost more than 90% of their value.
This French map from 1 730 gives an absoIuteIy wonderfuI visuaI representation
of the worId's first stock market bubbIe.
Here at the top is the goddess Fortuna,
pouring down goodies from her horn of pIenty.
Here are the happy investors receiving their shares
in the Mississippi Company from fIying cherubs.
But down beIow, there are some other cherubs chopping up the shares
beside a shattered printing press.
And there are two more cherubs bIowing bubbIes.
To the right, there are four very unhappy Iooking men,
one of whom is preparing to commit suicide by faIIing on his sword.
As if pricked by a sword, the Mississippi Bubble had now burst.
lt was at this moment that Law, vilified by the French people, fled the country.
He never saw his wife and daughter again.
He spent the rest of his life in Venice,
dividing his time between writing long, self-justifying letters
and gambling.
He died in 1 729.
ln France, however, his devastating legacy lived on.
Law's bubbIe and bust fataIIy set back France's financiaI deveIopment,
putting Frenchmen off paper money and stock markets for more than a generation.
The French monarchy's fiscaI crisis went unresoIved
and for the rest of the reign of Louis XV and Louis XVI,
the crown Iived from hand to mouth.
Eventually, France was driven by royal bankruptcy to revolution.
The Mississippi Bubble of 1 7 1 9 was the first stock market bubble in history.
But it's been by no means the largest.
When we think of stock market bubbles, we think of this.
The nightmare that haunts the world of finance,
which has returned to haunt us in the last few months,
is that there could ever be a bust to match the Great Wall Street Crash,
which began on October 24th 1 929, Black Thursday.
Over the next three years, the US stock market declined a staggering 86%,
reaching its nadir in June 1 932.
What was worse, this asset price deflation
was accompanied by the worst depression in all history.
ln the United States, output collapsed by nearly a third.
Unemployment reached a quarter of the civilian labour force.
Why did the 1 929 crash happen?
Why, indeed, does any crash happen?
This remains one of the most hotly debated questions in financial history.
There are all kinds of technical explanations for stock market crashes.
But at root, it's all about herd psychology.
ln a bull market, that's when share prices are rising,
even the smartest investors can succumb
to what the former chairman of the American Federal Reserve,
Alan Greenspan, famously called ''irrational exuberance''.
But when the herd changes direction,
sometimes in reaction to nothing more than a change in the wind,
their mood can also change from euphoria to gloom.
The herd stampedes.
One cow gets scared,
and that fear just transIates to the whoIe herd and they aII take off.
And the rest of them don't know why they're scared.
They just feeI that fear and they run.
Fear overwheIms aII rationaI thinking.
UntiI it's over.
ln market jargon, the buyers have turned into sellers, the bulls into bears.
Despite the zooIogicaI imagery,
the point is that markets are mirrors of the human psyche.
Like homo sapiens, they are prone to mood swings,
from greed to fear.
They can suffer from depression.
And sometimes they can experience compIete breakdowns.
That happens rather more often
than some financiaI theories wouId Iead you to expect,
but not so often that we're ever quite ready for the next breakdown.
lf movements in financial markets
were statistically distributed like human heights,
there would hardly be any crashes.
Most months would be clustered around the average,
with only a tiny number witnessing extreme ups or downs.
Let's face it, not many of us are below four feet in height or above eight feet.
This is the cIassic beII-shaped curve,
where things are distributed according to their frequency -
the most commonIy occurring cIustered here around the middIe
and the reIativeIy rare dwarves and giants out here at the extremes.
That's why it's quite a steep curve,
because most human heights are quite cIose to the average.
But if you do the same thing for financiaI markets,
for daiIy moves in the stock market,
you end up with something that Iooks more Iike this,
with reIativeIy fewer smaII movements
and reIativeIy more big movements down or up.
And these are what the statisticians mean when they taIk about Iong or fat taiIs.
lf stock market movements were distributed like human heights,
a drop of 1 0% would happen only once every 500 years.
And stock market crashes of 20% in a year would be unheard of,
rather like people just six inches tall.
Whereas in fact, there have been seven such crashes in the past century.
As it turned out, those who feared that the brief panic of October 1 987
would turn into the next great crash were proved wrong.
The market had one really bad month, then rallied.
But that bubble provided a golden opportunity for corporate crookery.
What John Law's Mississippi Company had been to the bubbIe
that Iaunched the 18th century,
so another company wouId be to the bubbIe that ended the 20th.
It was a company that promised its investors
weaIth beyond the dreams of avarice.
It was a company that cIaimed to have reinvented the entire financiaI system.
And it was a company that used its impeccabIe poIiticaI connections
to ride aII the way to the top of the buII market.
Named by Fortune Magazine as ''America's Most lnnovative Company''
for six consecutive years, that company was...
Enron.
Seven years after its collapse,
most of us have consigned Enron to the dustbin of financial history.
Yet it pioneered many of the dubious business practices
that continue to plague us today.
ln the three years up to August 2000,
shares of the Houston energy company had gone through the roof.
Once a small-time gas company in Nebraska,
Enron was now the fifth largest company in the United States,
with stated revenues of 1 1 1 billion dollars.
Enron was the darling of Wall Street.
Yet a little historical knowledge might have made Enron's investors think twice.
lndeed, the story of Enron was like a re-run of the Mississippi Bubble
280 years before.
John Law's plan had been to revolutionise French government finance.
Ken Lay, the chairman of Enron,
planned to revolutionise the global energy business.
For years, the industry had been dominated by huge utility companies,
which both produced the energy, pumped the gas and generated the electricity,
and sold it on to consumers.
Lay's big idea was to create a kind of energy bank,
which would act as the intermediary between suppliers and consumers.
His dream was to make Enron the greatest energy company in the world.
Caught up in the heady spirit of the times
was senior Enron executive, Sherron Watkins.
It was very eIectric.
You feIt Iike you couId... If you came up with a good idea,
Enron wouId give you the money and you couId go for it at a very young age.
Like John Law, Ken Lay had friends in high places.
He contributed generously to George HWBush's presidential campaign.
As President, Bush duly pushed through legislation
that deregulated the energy industry.
Riding a global wave of energy privatisation,
Enron snapped up assets all over the world.
ln Latin America alone, the company had interests in Colombia, Ecuador,
Peru and Bolivia, where they laid a huge pipeline across the continent to Brazil.
And thanks to the intervention of Ken Lay's personaI friend, George W Bush,
Enron was abIe to acquire a controIIing stake
in the Iargest naturaI gas pipeIine network in the worId,
here in Argentina.
Above all, however, Enron traded.
Not only in energy, but in virtually all the ancient elements
of earth, water, fire and air.
lt even traded in internet bandwidth.
Enron led a Wall Street surge unnervingly reminiscent of the Mississippi Bubble.
Despite his half-hearted warnings against ''irrational exuberance'',
this bull market was propelled upward
by the chairman of the US Federal Reserve, Alan Greenspan.
As in John Law's time, a stock market bubble could only happen
if money was abundant.
And by raising interest rates only once between February 1 995 and June 1 990,
Greenspan made sure that it was.
The rewards for investors were immense,
and aIso for the managers here at the company's Houston headquarters,
who were generousIy incentivised with share options.
In the space of just three years after 1997,
the Enron stock price rose by a factor of very nearIy five,
from beIow 20 doIIars a share to above 90.
It was the Mississippi Company aII over again.
Even a city used to extravagant oil-fired living had seen nothing like it.
This is where Ken Lay and his Enron executives used to live,
in River Oaks, Houston's most exclusive neighbourhood.
ln the final year of its existence, Enron paid its top 1 40 executives
an average of 5.3 million dollars each.
Luxury car sales went through the roof.
(Sherron Watkins) You got muItipIes of your annuaI base pay.
You were reaIIy Iess thought of if you got a percentage,
even if it was 75% of your annuaI base pay.
Oh, you were getting a percentage. You wanted muItipIes.
You wanted two times your annuaI base pay,
three times, four times your annuaI base pay, as a bonus.
And Lay, the pillar of society,
espoused the highest moral standards for his company.
(Ken Lay) Enron is a company that deaIs with everyone with absoIute integrity.
We pIay by aII of the ruIes, we stand by our word,
we mean what we say, we say what we mean.
The only problem was that, like John Law's system,
the Enron system was an elaborate fraud.
PHONE RINGS
ln this tape, an Enron trader
is discussing with the El Paso Electric Company
how to hold California's consumers to ransom
by closing power stations to restrict the supply of electricity.
OK.
The results were not only the higher prices Enron wanted,
but also, despite there being plenty of power available,
repeated blackouts for consumers.
Enron's money was stolen in more ways than one.
The company's stated assets were vastly inflated.
But its key financial innovation was to remove its debts from the balance sheet
and hide them in so-called ''special purpose entities'',
dubious names like Chewco and Raptor.
Each quarter, the company's executives had to use more smoke and more mirrors
to make actual losses look like bumper profits.
lt couldn't last.
When you cook the books and then you try to hide it,
you're toast.
When they sensed the game would soon be up,
Lay and his cronies started to unload
hundreds of millions of dollars worth of shares,
while at the same time reassuring the public
that the share price would continue to soar.
Like John Law's desperate attempts
to stem the freefall of Mississippi Company shares,
all Ken Lay's reassurances were in vain.
On November 1 5th 2001, Alan Greenspan, head of the US Federal Reserve,
received the Enron Prize for Distinguished Public Service,
adding his name to a roll of honour
that included Mikhail Gorbachev and Nelson Mandela.
Greenspan deserved it, because without his monetary policies in the late '90s,
the Enron bubble, and the dotcom bubble that coincided with it,
would surely have been impossible.
Just two weeks after the award ceremony, Enron filed for bankruptcy.
The company owed billions.
But just how many billions?
When Enron decIared bankruptcy, December 2001 ,
they met with their creditors to say,
''Erm, guys, I know on our baIance sheet,
''we have reported 13 biIIion doIIars of Iong-term debt.
''Our true Iong-term debt picture is 38 biIIion doIIars.
''There's 25 biIIion doIIars in off-baIance-sheet debt''.
(NiaII Ferguson) Did those numbers come as a shock to you?
You knew there were probIems, but not on that scaIe.
Yes, I mean, I think we were aII fIabbergasted.
The day before 4,500 employees at Enron's HQ were given their marching orders,
a final round of bonus cheques were issued to grateful executives.
ln May 2006, Ken Lay was convicted on all six counts of securities and wire fraud.
His sidekick, Jeffrey Skilling, was sentenced to 24 years in prison.
Lay died before sentencing, while on holiday in Aspen, Colorado.
Yet the fraudulent practices that propelled Enron's rise and fall
didn't die with Ken Lay.
On the contrary, the habit of hiding debt off-balance-sheet
that Enron pioneered subsequently spread throughout the Western financial system.
The unravelling of this dodgy accounting
has been a key component of the current crisis.
In many respects, I think the Enron probIem was in a Petri dish
and the germ has spread throughout the financiaI markets.
Some of which comes from Enron traders and finance foIks
that are gainfuIIy empIoyed at banks and energy trading houses.
So that rot is everywhere in the financiaI markets.
The joint stock Iimited IiabiIity company truIy is a miracuIous institution.
And yet throughout financiaI history,
there have aIways been a few crooked companies,
just as there have occasionaIIy been irrationaI markets.
Indeed, the two go hand in hand,
because it's preciseIy when the buIIs are stampeding most enthusiasticaIIy
that peopIe are most IikeIy to get taken for the proverbiaI ride.
THUNDER RUMBLES
As we've seen in the past year,
the path of financial markets can never be as smooth as we would like.
Since the current credit crunch began,
some stock markets around the world have fallen by as much as 50%.
So long as human expectations of the future veer
from the over-optimistic to the over-pessimistic, from greed to fear,
stock prices will tend to trace a line
not unlike the jagged and irregular peaks of the Andes.
As an investor, you just have to hope
that when you have to come down from the summit of euphoria,
it'll be on a nice, smooth ski-slope, and not over a sheer cliff.
But is there nothing we can do to protect ourselves
from real and metaphorical falls?
As we'll see in the next episode of The Ascent Of Money,
finance is as much about risk as it is about return.
And the big question is,
are you insured?
THUNDER RUMBLES
The most basic financial impulse of all
is to save for a rainy day.
Because, as we've been painfully reminded by the recent months of financial turmoil,
the future is so unpredictable.
The world really can be a dangerous place.
Not many of us get through life without a little bad luck.
Some of us get a lot.
lt's all about being in the wrong place at the wrong time,
like New Orleans when Hurricane Katrina hit.
The question is, how shouId we deaI with the risks and uncertainties of the future?
ShouId the onus be on the individuaI to insure against disaster?
ShouId we be abIe to reIy on the voIuntary charity of our feIIow human beings
when caIamity strikes?
Or shouId we be abIe to count on the state -
in other words, the compuIsory contributions of our feIIow taxpayers -
to baiI us out when the fIood comes?
THUNDER RUMBLES
That's a long way of asking a simple question -
are you insured?
The British certainly think they are.
GULLS CRY
Today, we pay a larger proportion of our income on insurance
than any other people in the world.
lt's rather odd, because Britain is one of the safest countries on Earth.
The struggle to overcome risk has been a constant theme of the history of money,
from the invention of life insurance by two hard-drinking Scots clergymen,
to the rise and fall of the welfare state,
to the explosive growth of hedge funds and their multi-billionaire owners.
At the core of our struggle with risk is an insoluble conflict -
we want to be financially secure, and so we yearn for a predictable world.
But the future always seems to come up with new and unpleasant ways
to take us by surprise.
We want calculable risk.
We're stuck with random uncertainty.
When Hurricane Katrina hit New Orleans in the last week of August 2005,
it caused death and destruction.
Yet it's not a natural catastrophe that now threatens the survival of the city.
The real lesson of the disaster is about money.
How the risk management system we call insurance
simply failed when faced with a calamity on this scale.
The hurricane didn't hit New Orleans directly.
The main force of the storm passed to the north-east of the city.
But just as the residents breathed a sigh of relief,
the real catastrophe began.
This IndustriaI CanaI Iinks Lake Pontchartrain to the Mississippi.
After the hurricane, the huge storm surge
raised the water IeveI in the canaI so high
that it broke the Ievee,
pouring umpteen gaIIons of the Iake over here, into the Ninth Ward of New OrIeans.
Just to the east of the Ninth Ward is St Bernard,
a blue-collar community of homeowners
all, on paper at least, covered by private insurance.
Councillor Joey DiFatta refused advice to leave the city,
staying put during the storm.
Eventually, he was forced to retreat to the roof of the town hall
as the waters kept rising.
..And as you can see,
- this is the water Iine. - That's the water Iine.
(Joey DiFatta) Where it came up to.
The water came in this buiIding in, er...
- 1 4 feet of water in 15 minutes. - Wow.
From the second fIoor of this buiIding,
I couId see, coming down Judge Perez, a waII of water.
In that waII of water was debris - cars, vehicIes, pieces of roofs.
And this waII of water, you know, you guestimate,
had to be maybe 15 to 20 feet taII.
- And moving fast. - Moving quickIy.
Just coming down this bouIevard street, and taking everything with it as it came.
The whole of St Bernard Parish was inundated in just 1 5 minutes.
Only five houses out of 26,000 weren't flooded.
More than 2,000 peopIe were kiIIed in Hurricane Katrina
and the subsequent fIooding.
Here in St Bernard Parish, 1 48 peopIe Iost their Iives,
mostIy because they became trapped in their houses
as the fIood waters rose.
The painted signs on these abandoned houses
say whether dead bodies were found after the fIood waters receded.
A IittIe bit Iike medievaI London in the time of pIague.
Yet three years later,
it's not flooding or plague that's killing New Orleans.
A harsh financial reality has emerged.
People can't live here any more
because they can't insure their homes.
One man made it his mission
to show the limits of private insurance
when it comes to a really big crisis.
He's former navy pilot Richard F Scruggs,
one of those lawyers that only America seems to produce.
Dickie Scruggs took $50 million off the asbestos industry,
then $248 billion off tobacco companies
for failing to warn smokers of the danger of lung cancer.
This kind of work has its rewards.
Scruggs's share in fees on the tobacco case was $1.4 billion.
Scruggs's latest target has been America's insurance companies.
His clients, hundreds of homeowners whose houses were destroyed by Katrina,
argued that the companies were refusing to pay up on genuine claims -
a view the insurers disputed.
There was a house there?
There was a house here, a house next to it,
where you see the traiIer.
Scruggs had a dog of his own in this fight.
His own home on Pascagoula's Beach Boulevard, here on the Mississippi coast,
was so badly damaged by Katrina
that it had to be demolished.
- This is the... - The front door?
This is the front door, right here.
The edge of the sIab, if you wiII.
- You were sIabbed. - We were sIabbed.
If you couId fix the system...
But I'm fortunate enough that I have the means to...
- To Iose a house and buiId it. - Most peopIe here don't.
If you had the power to change the system so that peopIe really were insured,
how wouId you do that?
Is there a way of making insurance work again?
There is, and it's discIosure of what...what you're buying.
Er, so that, you know...
Iike...Iike a drug.
There's a bIack box warning on there.
''This is what it does, this is what you shouId watch out for.''
As opposed to this device, which is caIIed a modern insurance poIicy,
which no-one can interpret or understand.
lt seemed as if the insurance companies had been well and truly ''Scrugged''.
One of America's biggest insurers settled hundreds of cases brought by Scruggs
on behalf of clients whose claims had been turned down.
THUNDER RUMBLES
But in this bitter, high-stakes battle,
the insurance companies had the last laugh.
After winning the case, Scruggs was convicted and sentenced to five years
for attempting to bribe a judge and influence the distribution of legal fees.
And the big insurance companies responded to the weight of post-Katrina claims
by, in effect, declaring parts of the Gulf Coast a no-home-insurance zone.
Today, as Councillor Joey DiFatta has found out,
insuring a house in this part of New Orleans is virtually impossible.
- They can't get a mortgage either? - (Joey DiFatta) That is correct.
They have to make a choice. Do I buiId a house here?
Or do I reIocate to an area where insurance may be a IittIe cheaper
and I can afford it?
That is hurting our community, it's taking our peopIe away,
the nucIeus of this parish, and puIIing them away.
SHIP HORN
Three years after disaster struck,
St Bernard Parish has only a third of its pre-Katrina population.
THUNDER RUMBLES
Of course, life has always been dangerous.
The real lesson of Katrina, or any big disaster,
is that even when we think we're protected against risk,
sometimes it turns out we're not.
Even making quite modest insurance claims
can seem more trouble than it's worth.
lt leaves you wondering why we bother
spending so much on insurance policies every year.
Where did this strange habit come from?
Saving up for the proverbiaI rainy day is the first principIe of insurance,
but the trick is knowing what to do with your savings
so that, unIike in New OrIeans after Katrina,
they're in the kitty when you reaIIy need them.
But to do that, you need to be more than usuaIIy canny,
and that gives us a vaIuabIe cIue
as to where the history of modern insurance has its origins.
Where eIse but in bonny, canny ScotIand?
BELL TOLLS
They say the Scots are a pessimistic people.
Maybe it's the weather - all those hundreds of rainy days.
Maybe it's the endless years of sporting disappointment.
Or maybe it was the Calvinism we picked up at the time of the Reformation.
Certainly, it's two Church of Scotland ministers
who deserve the credit for inventing the first true insurance fund,
back in 1 7 44,
and fathering a multi-billion-pound industry.
The Kirkyard of Greyfriars is best known for the grave-robbers,
the Resurrection Men, who came here in the late 1 8th century
to supply the Medical School at Edinburgh University
with corpses for dissection.
But Greyfriars' lasting importance
comes from the work of the minister here, Robert Wallace,
and his friend, Alexander Webster.
It's somehow appropriate that it was Scottish ministers
who invented modern insurance.
After aII, we tend to think of them as the embodiment of prudence and thrift,
weighed down with an anticipation of impending divine retribution
for every tiny transgression.
But, in fact, Robert WaIIace was a hard drinker,
as weII as a mathematicaI prodigy,
who Iiked nothing better than knocking back magnums of cIaret
with his bibuIous buddies.
Wallace and Webster were unhappy
at the way the widows and children of their fellow clergymen
were treated when the Grim Reaper struck.
They often found themselves homeless and penniless.
The plan Wallace and Webster came up with was ingenious -
the first true insurance fund in history.
These are some of the voIuminous caIcuIations that Robert WaIIace did,
now housed at the NationaI Archives Of ScotIand.
You can see how he ran the numbers over and over again,
making very carefuI assumptions about the maximum number
of widows and orphans that wouId have to be provided for.
The key point was that, from now on, ministers wouIdn't just pay money in
that wouId be paid out when one of their number died.
Rather, they wouId pay premiums that wouId be used to create a fund,
and the fund wouId then be invested for profitabIe purposes.
The widows and orphans, henceforth, wouId be paid out of the returns on that money,
Ieaving the premiums to accumuIate.
All that was required for the scheme to work
was an accurate projection of how many widows and orphans
there would likely be in the future.
A calculation which Wallace and Webster made with extraordinary precision.
The creation of the Scottish Ministers' Widows' Fund
was a milestone in financial history,
for it provided a model not just for Scottish clergymen,
but for everyone who aspired to provide for life's eventualities.
By 1815, the principIe of insurance was sufficientIy widespread
to be adopted for the widows of men who Iost their Iives
fighting against NapoIeon.
At the BattIe of WaterIoo, your chances of getting kiIIed were up to one in four,
but at Ieast if you'd taken out insurance,
you had the consoIation of knowing your wife and chiIdren
wouIdn't be thrown out onto the street.
Gives a whoIe new meaning to the phrase ''take cover''.
The Scottish ministers' fund grew into the world-famous Scottish Widows.
Even novelists, not renowned for their financial prudence,
could join.
Walter Scott took out a policy in 1 826,
to reassure his creditors they'd be paid in the event of his death.
By the mid-1 9th century, being insured was as much a badge of respectability
as going to church on Sunday.
BELL TOLLS
What no-one anticipated back in 1 7 44
was that the careful calculations of two Scottish ministers
would grow into today's huge insurance industry.
As Robert WaIIace understood 250 years ago,
size matters in insurance,
because the more peopIe are paying into a fund
the easier it becomes, by the Iaw of averages,
to predict how much wiII have to be paid out each year.
AIthough no individuaI's date of death can be known in advance,
actuaries can caIcuIate the IikeIy Iife expectancy of a Iarge group of individuaIs
with quite astonishing precision.
ln other words, insurance is all about
trying to cope with the risks of the future.
lf, that is, you're insured in the first place.
No matter how many private funds like Scottish Widows were set up,
there were always going to be people beyond the reach of insurance,
who were either too poor or too feckless to save for that rainy day.
The Iot of the poor was once a pretty harsh one -
either dependence on private charity,
or the harsh regime of the workhouse,
Iike this typicaIIy austere one here in the heart of Edinburgh.
Yet by the 1880s,
peopIe began to feeI that Iife's Iosers somehow deserved better.
The seed was pIanted of an entireIy new approach to risk,
a seed that wouId uItimateIy sprout into the modern weIfare state.
The state system of insurance was designed to expIoit the uItimate economy of scaIe,
by covering IiteraIIy every citizen from the cradIe to the grave.
Yet while we tend to think of the welfare state as a British invention,
in fact, the world's first welfare superpower
was Japan.
Disaster just kept striking Japan in the first half of the 20th century.
ln 1 923, a huge earthquake devastated Tokyo.
As in New Orleans,
private insurance policies turned out to be worth little more
than the paper they were printed on.
A new idea began to emerge in Japan - that the state should take care of risk.
But this was to be state protection allied with imperial ambition.
The Japanese set up a welfare state.
And they did it to promote warfare.
lt was the mid-20th-century state's insatiable appetite
for able-bodied young soldiers and workers,
not some kind of bleeding-heart altruism,
that inspired the rise of welfare.
State healthcare would ensure a fitter populace
and a steady supply of able-bodied recruits to the Emperor's armed forces,
and deliver him an empire.
ENGINE REVS
The wartime slogan ''All people are soldiers''
was adapted to become ''All people should have insurance''.
The only problem was that Japan had gone to war
with the world's economic colossus -
the United States.
Japan's warfare state proved to be a massive mistake.
Quite apart from the nearly three million lives lost
in Japan's doomed bid for empire,
by 1 945, the value of Japan's entire capital stock
seemed to have been reduced to zero
by American bombers.
Cities built largely out of wood were incinerated.
Nearly a third of the urban population lost their homes.
Practically the only city to survive intact
was Kyoto, the former imperial capital.
1 945 may have seen the end of the Japanese warfare state,
but it wasn't the end of the Japanese experiment with state-sponsored welfare.
In Japan, as in most competent countries, the Iesson was cIear -
the worId was just too dangerous a pIace
for private insurance markets to cope with.
With the best wiII in the worId,
peopIe couIdn't be expected to insure themseIves against the US Air Force.
The answer, practicaIIy everywhere, was the same -
for government to step in.
In effect, to nationaIise risk.
Perhaps the most familiar sub-system of welfare from the cradle to the grave,
also born in the ruins of war,
was devised by the British economist, William Beverage.
When the Japanese came up with their own comprehensive weIfare system
in October 1947,
their advisory committee in sociaI security recommended
what amounted to ''Bebariji no Nihon-ban'',
''Beverage for the Japanese''.
And yet, they went even further than Beverage had intended,
as this copy of their report,
here in the Iibrary of the Japanese NationaI ParIiament, makes cIear.
It caIIed on the government to provide against every cause of poverty.
Sickness and injury, disabiIity, death,
chiIdbirth, Iarge famiIies, oId age and unempIoyment.
Whatever the reason, the needy wouId be guaranteed the minimum standard of Iiving
by nationaI assistance.
MONKS PERFORM INCANTATIONS
The Japanese wouId no Ionger have to reIy on the benevoIence of a feudaI Iord
or the Iuck of the gods -
the weIfare state wouId cover them
against aII the vagaries and vicissitudes of the modern worId.
lf they couldn't afford education,
the state would pay.
lf they couldn't find work,
the state would pay.
lf they were too ill to work, the state would pay.
When they retired, the state would pay.
And when they finally died, the state would pay their dependents.
So what happened after the war in Japan
was merely the extension of the warfare welfare state.
The slogan now became ''All people should have pensions''.
The Japanese welfare state seemed to be a miracle of effectiveness.
ln public health and education, Japan led the world.
By the late 1 97 0s,
the Japanese could boast that their country had become
the welfare superpower.
Run Iike this, the weIfare state seemed to make so much sense.
Japan had achieved security for aII,
the eIimination of risk,
whiIe at the same time growing so rapidIy that by 1968
it had the second-Iargest economy in the worId.
One US economist even predicted that Japan's per-capita income
would overtake America's by the year 2000.
WeIfare was working where warfare had faiIed -
to make Japan top nation.
The key turned out to be not a foreign empire,
but a domestic safety net.
And yet, there was a catch,
a fataI fIaw in the design of the post-war weIfare state.
Just what was it that caused those predictions of Japan's uItimate triumph
to faiI to come true?
The welfare state looked to be working smoothly enough in 1 97 0s Japan.
But elsewhere, there were signs that all was not well.
ln Britain and throughout the western world,
the welfare state, it seemed, had removed the incentives
without which a capitalist economy simply cannot function -
the carrot of serious money for those who strive,
the stick of hardship for those who are idle.
The result was stagflation -
low growth and high inflation.
What was to be done?
One man and his pupils thought they knew the answer.
Thanks in large measure to their influence,
one of the great economic trends of the past 25 years
has been for the welfare state to be dismantled -
reintroducing people with a sharp shock
to the unpredictable monster they thought they had escaped from...
Risk.
ln 1 97 6, a diminutive professor called Milton Friedman,
working here at the University of Chicago,
won the Nobel Prize in Economics.
MiIton Friedman won his pIace in the economic haII of fame
by restating this simpIe equation.
MV = PQ,
where M is the money suppIy,
V is the veIocity at which it circuIates,
P is the price IeveI
and Q is the quantity of expenditures.
Friedman's observation was simpIe -
if the money suppIy went up, then so did the price IeveI.
Hence, the Quantity Theory of Money.
But you needed much more than a piece of chaIk and a bIackboard
to answer the second cruciaI question of MiIton Friedman's career -
what had gone wrong with the weIfare state?
ln Chile, he found the perfect laboratory to test his theories.
ln September 1 97 3, tanks had rolled through Santiago
to overthrow the government
of Chile's Marxist president, Salvador Allende,
whose attempt to turn the country into a communist state
had ended in total economic chaos
and a call by the Chilean Parliament for a military coup.
Up there on the baIcony of the Carrera HoteI,
opponents of the AIIende regime ceIebrated with champagne
as air force jets fIew overhead to bomb the Moneda PaIace.
WHISTLING, EXPLOSION
Here in the paIace, AIIende prepared to make a desperate Iast stand,
armed with an AK-47 presented to him by his Cuban roIe modeI, FideI Castro.
Looking out the paIace window and seeing the tanks IiteraIIy roIIing in,
AIIende reaIised that it was aII over for his dream of a Marxist ChiIe.
Cornered here in what was Ieft of the presidentiaI quarters,
he took the decision to shoot himseIf.
MILITARY BAND PLAYS
35 years later, you can still see the bullet holes
in some of the buildings around the square.
What happened here in September 1973
in many ways epitomised a worIdwide crisis of the weIfare state,
and posed a stark choice between aIternative economic systems.
With output coIIapsing and infIation rampant,
ChiIe's system of universaI benefits was effectiveIy bankrupt.
For AIIende, the onIy soIution
was fuII-bIown, Soviet-styIe takeover of the entire economy.
The generaIs and their supporters knew they didn't want that,
but what did they actuaIIy want,
given that the status quo was unsustainabIe?
Enter MiIton Friedman.
ln March 1 97 5,
Friedman flew from Chicago to Chile to answer that question.
SOLDIER SHOUTS ORDERS
ln addition to giving lectures and seminars,
Friedman came here, to the Moneda Palace,
for a meeting with the new Chilean president, General Augusto Pinochet.
Friedman spent three-quarters of an hour with Pinochet,
urging him to reduce the government deficit that he'd identified
as the main cause of Chile's sky-high inflation -
then running at an annual rate of 900%.
A month after Friedman's visit,
the Chilean junta announced that inflation would be stopped at any cost.
The regime cut government spending by 27%.
''This problem of inflation is not of recent origin.
''lt arises from trends towards socialism that started 40 years ago,
''and reached their logical and terrible climax in the Allende regime. ''
For tendering this advice, Friedman found himself denounced
for acting as a consultant to a military dictator
responsible for the executions of more than 2,000 real and suspected communists,
and the torture of nearly 30,000 more.
Chicago's roIe in ChiIe's new regime
consisted of more than just a visit by MiIton Friedman, however.
Since the 1950s, there'd been a steady stream of bright, young economists
going from this pIace, the CathoIic University in Santiago,
to study in Chicago,
and they'd come back convinced of the need to baIance the budget,
tighten the money suppIy, and IiberaIise trade.
These were the Chicago Boys, Friedman's foot soIdiers.
And yet the most radicaI of their ideas
went beyond what Friedman had recommended to Pinochet.
It amounted to a fuII-scaIe roIIing back of the weIfare state.
The conservative economic revoIution didn't begin in Thatcher's Britain,
or Reagan's America.
It began right here in ChiIe.
The mastermind behind this wholesale dismantling of the welfare state
was a young economist called Jose Pinera.
ChiIe's economy was destroyed. We have had 50 years of protectionism,
state intervention - Iike sociaIism, if you want -
and that was exacerbated during the AIIende government.
We had created a sort of weIfare state,
and that, of course, was going bankrupt in ChiIe.
Between 1979 and 1981 ,
Pinera and his coIIeagues erected a radicaIIy new pension system for ChiIe,
giving every worker the chance to opt out of the oId pay-as-you-go state system.
Instead of a payroII tax,
each worker now couId put 10% of his wages aside
into an individuaI personaI retirement account,
to be managed by private competing companies.
There was aIso a smaII premium for disabiIity and Iife insurance.
The idea was to give each worker a sense
that the money being put aside was his own property,
his own capitaI.
GUITAR PLAYING, MAN SINGING
Pinera gambled. He gave workers a choice -
stick with the old system of pay as you go,
or opt for the new personal retirement accounts.
lt paid off.
Convinced by Pinera's argument,
80% made the switch to a private pension plan.
But was it worth it? Was it worth the huge moraI compromise
that the Chicago Boys and the Harvard man made
when they got into bed with a torturing, murderous dictatorship?
The answer to that question very much depends on whether you think their reform
has heIped pave a peacefuI way back to a sustainabIe democracy in ChiIe.
And I think they did.
ln 1 980, Pinochet conceded a new constitution
that prescribed a ten-year transition back to democracy.
Ten years later, he stepped down as president.
Democracy was restored,
and by that time, the economic miracle was under way
that helped to ensure its survival.
For the pension reform not only created a new class of property owners,
each with his own retirement nest egg,
it also gave the Chilean economy a massive shot in the arm.
These brokers at the Banco de ChiIe
are investing ChiIean workers' pension contributions into the stock market.
And they've been doing a pretty good job of it.
Average returns on the personaI retirement accounts has been over 10%,
refIecting the fact that in the 20 years after 1987,
the ChiIean stock market has gone up by a factor of 18.
There is a downside to the system, to be sure.
Since not everyone in the economy has a regular full-time job,
not everyone ends up participating in the system.
Which leaves a substantial chunk of the population
with no pension coverage at all.
I'm standing in front of the Communist Party headquarters
here in La Victoria, a suburb of Santiago,
which was once one of the hotbeds of opposition to the Pinochet regime.
Because most peopIe here are either unempIoyed
or work in the informaI sector,
they don't, or can't, pay into the pension system
which means they don't get anything out of it.
This is the kind of neighbourhood where Che Guevara is stiII the IocaI hero,
not Jose Pinera.
The poor of Chile may not have a private pension plan,
and may have to make do with a meagre government handout in their old age...
..but even they've benefited from Chile's rapidly growing economy.
(Jose Pinera) Growth makes a difference in the Iife of every citizen.
The poverty rate in ChiIe has gone down from about 50%
to 13%.
So this has been reaIIy a huge success
and the pension reform has been a criticaI eIement in this.
The improvement in ChiIe's economic performance
since the Chicago Boys' reforms is reaIIy very hard to argue with.
In the 15 years before MiIton Friedman's visit,
the growth rate here was a measIy 0. 1 7% a year.
In the subsequent 15 years,
it increased by a factor of nearIy 20.
The poverty rate here's down to 15%,
compared to 40% in the rest of Latin America.
And when you Iook down at Santiago's shiny new financiaI district,
you can see why the ChiIean pension reform
has been imitated right across the region and, indeed, around the worId.
For Britain's Margaret Thatcher, the general from Chile
and the professor from Chicago were heroes,
who demonstrated that only by rolling back the welfare state
could governments revive economic growth.
Yet one country where this recipe has not been tried
is the country that's come to need it most.
Japan.
So successful was the Japanese welfare superpower
that by the 1 97 0s, life expectancy was the longest in the world.
The problem was
that Japan's welfare state was too successful.
Today, the programmes run here at Japan's Ministry of WeIfare
reIy on an ever-smaIIer number of active workers
to support an ever-rising popuIation of retirees.
Back in 1960, there were something Iike 1 1 active workers
for every one retired person.
But by 2025,
that number couId sink as Iow as two.
In other words, there'II be one oId-age pensioner
for every two bureaucrats working here at the Ministry.
In just 30 years, the cost of sociaI security benefits
has risen in reIation to Japan's nationaI income
by a factor of four.
Today, virtually all Japan's health insurance societies
are in deficit.
And the pension funds are nearly out of money too.
Japan's once so-super welfare state
is threatening to bankrupt the nation.
lnsurance. lt seemed such a brilliant idea
in the calculations of those Scottish ministers,
and even more brilliant in Japan's all-encompassing welfare state.
But as we've seen, the best-laid schemes can be thrown into disarray
by an unexpected turn of events.
So is there any better way of managing risk in an uncertain world?
Disasters Iike 9/1 1 and Katrina
expose the Iimits of both traditionaI insurance
and the weIfare state.
But insurance and weIfare aren't the onIy ways
to buy yourseIf protection against future shocks.
These days, the smart way of doing it is by being hedged.
Now, everybody's heard of hedge funds,
but what exactIy does ''hedging'' mean and where did it come from?
To most of us, hedge funds are a mystery.
But the one thing we do know
is that they can make you stupendously rich.
One hugely successful hedge fund manager paid $60 million for this Cezanne.
And he owns this Degas too.
Not to mention a Jasper Johns he paid $80 million for.
He's also given hundreds of millions of dollars to charity.
Ken Griffin is the founder of the Citadel lnvestment Group,
one of the world's biggest hedge funds.
Last year, he navigated his way through the credit crunch so successfully
he was able to pay himself more than a billion dollars.
To most of us, risk is scary,
but all of Griffin's vast wealth has come because he's found a way of managing risk,
with a mixture of mathematical precision and brilliant intuition.
(Ken Griffin) Nothing is constant. Nothing is the way it's aIways been.
So what I find is that peopIe who are reaIIy good at this
have great intuition, great instinct.
Their gut actuaIIy teIIs them something.
The mathematics are important
because they demonstrate you understand the probIem.
But uItimateIy, the decision about whether or not to take a given risk
I think is reaIIy a human judgement caII in every sense of the word.
The origins of hedging, appropriateIy enough, are agricuIturaI.
For a farmer, nothing is more important than the future price of his crop
after it's been harvested and brought to market.
But that can be higher, or much Iower, than he expects.
A futures contract aIIows him to protect himseIf
by committing a merchant to buy the crop when it's brought to market
at a price agreed when the seeds are being pIanted.
The farmer gets a floor below which the price can't sink.
The merchant gets a ceiling above which it can't rise.
By signing a futures contract,
both the farmer and the merchant have hedged their bets.
(Ken Griffin) Both parties are better off,
and because of that, the worId as a whoIe is much better off.
It encourages capitaI formation,
it encourages investment,
it encourages peopIe to do what is needed to be done
to make the worId a better pIace.
With the development of a standardised futures contract,
agreed rules, and an effective clearing house,
the first true futures market was born.
And its birthplace was here in the Windy City.
Chicago.
After the city's futures exchange was established in 1 87 4,
hedging commodities became standard practice.
The next step was for a conditional kind of future to evolve.
The option.
Some of this really is the financial equivalent of rocket science,
but the underlying principle is simple.
Because they're derived from underIying assets,
aII futures contracts are known as ''derivatives''.
But an even smarter kind of derivative is an ''option''.
The buyer of a caII option
has the right, say, to buy a barreI of oiI for $120
in a year's time.
Now, if the price of oiI rises to $150 a barreI,
then the option is in the money
and the smart guy makes a profit of $30.
But if that doesn't happen, if the price of oiI stays the same,
or actuaIIy decIines,
he's under no obIigation to carry through the deaI.
AII he does is to write off the cost of the option itseIf.
WeII, it's by buying and seIIing compIex smart derivatives Iike options
that Ken Griffin has become a biIIionaire.
TRADERS SHOUTING
ln theory, derivatives offer a new way to hedge against an uncertain future.
A much smarter way than boring old insurance.
And much more profitable.
ln the past decade, derivatives have seemed to take over the world of finance.
By the end of 2007, the notional value of all derivatives contracts
reached a staggering $596 trillion.
That's 43 times the size of the American economy.
There are tremendous economic benefits for peopIe that work here.
$20 biIIion in the hands of 1 ,000 peopIe
is reaIIy a 21st century phenomenon.
This never happened 50 years ago.
Yet there are downsides to hedging too.
When biIIionaire investor Warren Buffet
described derivatives as ''financiaI weapons of mass destruction'',
he aII but prophesised the downfaII of American insurance giant AIG.
Their European headquarters are there behind me.
Brought Iow not by seIIing insurance poIicies,
but by seIIing derivatives that bIew up in its face.
Our basic human urge to protect ourselves against risk
has proved frustratingly difficult to satisfy.
lnsurance companies let us down.
Welfare states sink into insolvency.
And derivatives turn out to be a double-edged weapon too.
GUNSHOT
And so for many families,
providing for the future now takes one very simple form -
an investment in a house,
the value of which is supposed to keep going up
until the day the breadwinners need to retire.
lf the pension plan falls short, never mind.
There's always home, sweet home.
As a pension or an insurance poIicy,
this strategy has one very obvious fIaw -
it represents a one-way, totaIIy unhedged bet
on a singIe market, the property market.
But as we'II see in the next episode of The Ascent Of Money,
a bet on bricks and mortar,
or good oId Japanese wood,
lt's the English-speaking world's favourite game...property.
And today the stakes in the game are higher than ever.
The original property game we know today as Monopoly was actually
invented back in 1 903 to expose the unfairness of a social system
where a small minority of landlords screwed the majority of tenants.
30 years later, an unemployed plumber named Charles Darrow
patented a new version of the game, with the board based on
the streets here in Atlantic City.
lt was Darrow who introduced the little houses and hotels.
What the game of Monopoly tells us, contrary to its inventor's intentions.
is that it's smart to own property.
And if it's smart to own property, it's even smarter
to Iend money to the peopIe who own property.
That's because the phrase, ''Safe as houses''
has a rather speciaI meaning in the worId of finance. What it means
is there's nothing safer than to Iend money to peopIe who own reaI estate.
Why? WeII, because if they defauIt on the Ioan,
you can aIways repossess the property.
Even if they run away, the house can't.
What's more, the English-speaking world's obsession with property
has been the foundation for a unique economic and political experiment -
the property-owning democracy.
Some say it's a model the whole world should adopt.
The growth of property ownership
gave rise to a new era in the history of finance.
On the back of property, literally trillions of dollars
have been borrowed, some of it by so-called sub-prime borrowers -
people who'd previously been content to rent rather than own their homes.
So it's come as rather a shock to millions of people that real estate
is fundamentally no different from any other financial asset.
lts price can go down as well as up.
lt turns out that no amount of financial alchemy
can turn little suburban boxes into treasure chests with roofs.
Which raises the question, is property really as safe as houses?
Or couId it be that we've Iet our Iove affair with reaI estate
get compIeteIy out of proportion?
Property ownership was once the preserve of an aristocratic elite.
Estates were passed down from father to son, along with titles
and political privileges.
Everyone else was a mere tenant, paying rent to their landlord.
Even the right to vote in elections
was originally a function of property ownership.
In one respect, not much has changed in Britain since those days.
Of 60 miIIion acres of British Iand, around 40 miIIion
are owned by just 189,000 famiIies.
The difference is that they no Ionger monopoIise the poIiticaI system.
Indeed, thanks to reform of the House of Lords,
the hereditary peerage is being phased out of ParIiament.
Now, you can expIain the decIine of the aristocracy in many ways.
But, as far as I'm concerned, the main driver was finance.
Until the 1 830s, fortune smiled on the British land-owning elite -
the 30 or so families with gross annual income from their lands
above Ł60,000 a year -
roughly Ł 1 50 million pounds today.
With such vast property assets backing them
and income from agriculture booming,
it was hard to see how the aristocracy could fail to flourish.
Yet, by ignoring a fundamental truth about property,
they ensured their own decline.
GUNSHOT
CROWS CAW
Like many of us today, the great magnates saw the value
of their property as a cash cow and used it to borrow to the hilt...
..often more than the property was worth.
What they'd failed to understand is that property is only a security
to the person who lends you money.
As a borrower, you still have to earn the money to pay back the loan.
And for the great landowners
of Victorian Britain, that suddenly became a very difficult thing to do.
Nowhere was the pain more acute than here in the heart of rural Buckinghamshire.
There's something undeniabIy magnificent about this huge,
neocIassicaI paIace -
Stowe House - arguabIy the greatest private residence
buiIt in EngIand in the 18th century.
Just Iook at these extraordinary scagIioIa piIIars
or the stunning eIIipticaI pIaster ceiIing.
And yet there seems to be something missing.
Or rather many things.
Because once in each of these aIcoves there was a Roman statue.
The exquisite Georgian firepIaces have been ripped out
and repIaced by bog-standard ones Iike this.
Why?
How did this most stately of stately homes become a mere shell of its former self?
The answer is that this house beIonged to the principaI victim
of the first modern property crash -
Richard PIantagenet TempIe-Nugent-Brydges-Chandos-GrenviIIe,
2nd Duke of Buckingham.
Stowe was only part of the Duke's vast empire of real estate.
ln all, he owned around 67,000 acres in England, lreland and Jamaica.
These immense properties seemed more than adequate
to back his extravagant lifestyle.
And he spent money as if it might go out of fashion
on mistresses, on illegitimate children,
on anything that he felt was compatible with his standing as a Duke of the Realm.
PEACOCK CRIES
By 1 845, the jig was up.
Grain prices had begun their long slide downwards,
and so had the income from agricultural land.
Rural property prices plummeted.
Suddenly, the aristocracy found that their borrowings
had outrun the value of their estates.
The Duke was spending far more than his income
and most of that was being absorbed by interest payments.
But there was to be one final bout of conspicuous consumption.
In preparation for a visit by Queen Victoria and Prince AIbert,
the Duke decided to spIash out and refurbish Stowe House from top to bottom.
15 saIoons were stuffed fuII of the most expensive furniture
that money couId buy.
The fIoorboards were groaning under the weight of Genoa veIvet,
embroidered satin and goId brocade.
When the Queen saw the resuIts, she commented rather waspishIy,
''I am sure I have no such spIendid apartments in either of my paIaces. ''
SadIy, the cost of this mega-makeover proved to be the finaI straw
for the ducaI finances.
ln August 1 848, to the Duke's horror,
his son had the entire contents of Stowe House auctioned off.
Now, his ancestral stately home was thrown open
for throngs of bargain-hunters to bid for the silver, the wine, the china.
Today, Stowe is a private boarding school.
lt's a poignant symbol of the transience of landed wealth.
ln the modern world, it turned out,
a regular job and a steady income mattered more than an inherited title -
no matter how many acres you owned.
Divorced by his Iong-suffering and much-betrayed Scottish wife,
whose entire wardrobe had been seized by Sheriffs Officers in London,
the Duke was finaIIy forced to reIinquish Stowe
and move into rented accommodation.
He eked out his days at his cIub, the CarIton,
writing a succession of highIy unreIiabIe memoirs
and incorrigibIy chasing actresses and other men's wives.
The fall of the Duke of Buckingham was a kind of harbinger
for a new democratic age in which every adult would be given the vote
whether they owned a stately home or paid rent for a humble flat.
As aristocratic fortunes from agriculture declined,
so the franchise was widened.
Yet the advent of universaI suffrage didn't mean that property ownership
had become universaI.
On the contrary, as recentIy as 1938,
Iess than a third of the UK housing stock was in the hands of owner-occupiers.
It was on the other side of the AtIantic
that the first true property-owning democracy wouId emerge.
And it wouId emerge from the biggest financiaI crisis ever seen.
An EngIishman's home is his castIe
and Americans know that there's no pIace Iike home too,
even if aII the homes are rather simiIar.
Today we take the universal right to own our own home for granted.
But before the 1 930s,
no more than two-fifths of American households were owner-occupiers.
lf the old class system,
based on elite property-ownership was distinctively British,
the revolution that created a new property-owning democracy
was born out of a great American financial crisis.
When the Depression struck in 1 929, the US economy nose-dived.
The minority of people who did own their own homes
couldn't afford the mortgage payments.
Tenants too struggled to pay the rent when all they had coming in was the dole.
Nowhere were the effects of the Depression more painful than in Detroit.
Soon the automobile industry here
employed only half the number of workers it had in 1 929,
and at half the wages.
By 1 932, the dispossessed of Detroit had had enough.
On March 7th, 5,000 workers laid off by the Ford Motor Company
marched to the factory to demand unemployment relief.
What followed would force Americans to completely rethink
their attitude to property ownership.
As the unarmed crowd reached Gate 4
of the company's River Rouge plant in Dearborn,
scuffles broke out.
Suddenly, the factory gates opened
and a phalanx of police and security men rushed out
and fired into the crowd.
GUNSHOTS
Five workers were killed.
Days later, 60,000 people sang The lnternationale at their funeral.
The Communist Party newspaper accused Edsel Ford,
son of the firm's founder, Henry, of allowing a massacre.
Could anything be done
to defuse what was beginning to seem like a revolutionary situation,
pitting the seriously propertied Fords against their property-less ex-employees?
ln a remarkable gesture of conciliation,
Edsel Ford turned to a Mexican artist named Diego Rivera.
He invited him to paint a mural that would show Detroit's economy
as a site of cooperation, not class conflict.
Diego Rivera was a IifeIong Communist.
His ideaI was of a society in which there wouId be no private property,
in which the means of production wouId be commonIy owned.
In his eyes, Ford's River Rouge pIant was the very opposite,
a capitaIist society in which the workers worked
and the property owners, who reaped the rewards of their efforts,
mereIy watched.
When the murals were unveiled in 1 933, the city's dignitaries were appalled.
They saw them as Communist propaganda, ''a travesty on the spirit of Detroit''.
The power of art is a wonderful thing.
But it was clearly going to take something rather more powerful than art
to heal a society so deeply split by the Depression.
Other countries turned to the extremes of totaIitarianism.
But in the United States the answer was the New DeaI.
And that incIuded a New DeaI on housing.
In radicaIIy increasing the number of Americans
who couId hope to own their own homes,
the RooseveIt administration pioneered the idea of a property-owning democracy.
It proved to be the perfect antidote to Red revoIution.
ln effect, the government would rig the housing market
to incentivise Americans to become property owners.
Customers at local mortgage lenders, known as savings and loans,
the equivalent of British building societies,
would have their deposits guaranteed by the Government
even if a bank went bust.
Crucially, a new Federal Housing Administration was set up
to offer larger, longer and lower-interest loans.
After the 1 930s, most mortgages in the United States were fixed
for 20 or 30 years.
A new Federal National Mortgage Association, nicknamed Fannie Mae,
was set up to create a nationwide market for home loans.
(TV REPORTER) This coupIe is going through a modeI house now.
The husband, apparentIy, isn't very keen about it aII,
but his wife is entranced by such convenient features
as the sturdy buiIt-in ironing board.
By reducing the monthly cost of a mortgage,
these reforms made home-ownership possible
for many more Americans than ever before.
(TV REPORTER) They both wouId Iike to have this pIace for their very own.
Too bad they can't afford it.
Ah! But maybe they can.
For according to this sign, they can buy this house
with monthIy payments that are Iess than they now spend for rent!
lt's not too much to say that the modern United States,
with its seductively samey suburbs, was born out of these New Deal reforms.
From the 1930s then, the US Government effectiveIy underwrote
the mortgage market, bringing borrowers and Ienders together.
And that was the reason for the big expIosion in property ownership
and mortgage debt in the decades after WorId War II.
There was just one catch -
not everyone in American society had an invitation to the property-owning party.
When these houses were built in Detroit back in 1 941,
whether you got the money or not for a mortgage
depended on which side of this divide you lived.
It was a reaI estate deveIoper who buiIt this six-foot high waII
right through the middIe of Detroit's 8 MiIe district.
He had to buiId it in order to quaIify for Ioans
from the FederaI Housing Administration.
The Ioans were to be given for construction on that side of the waII,
which was a predominantIy white neighbourhood.
On this side, on the bIack side, there was to be no federaI credit,
because African Americans were regarded as fundamentaIIy uncreditworthy.
lt was part of a system that divided the whole city -
in theory by credit-rating,
in practice by colour.
Segregation, in other words, wasn't accidental,
but a direct consequence of federal policy.
This map by the FederaI Home Loan Board
shows the predominantIy bIack areas of Detroit, the Iower east side
and so-caIIed coIonies Iike the one we're in now in Birwood-Griggs,
marked with a Ietter D and coIoured red.
You can see why the practice
of giving whoIe neighbourhoods a negative credit rating
came to be known as ''red-Iining''.
The resuIt was that when peopIe from round here needed mortgages,
they had to pay significantIy higher interest rates
than the foIks in the white part of town.
Half a century later, the two categories of borrowers
would come to be known euphemistically as prime and sub-prime.
But in the 1 960s, this divide was the hidden financial dimension
of the Civil Rights struggle.
Blacks were to be excluded from the new property-owning society.
There would be a heavy price to pay for this exclusion.
On July 23rd 1 967, property in Detroit literally went up in flames.
(TV) Four days of rioting, Iooting and arson rocked the city of Detroit
in the worst outbreak of urban raciaI vioIence this year.
Anger at economic discrimination spilled over into five days of rioting
that left 43 people dead.
Significantly, most of the violence was directed not against people,
but against property.
Nearly 3,000 buildings were looted or burned.
The real lesson for policy makers was that excluding ethnic minorities
from the property-owning democracy was a fast track to trouble.
To make people feel like stakeholders in the social status quo,
you had to make them property owners.
lndeed, widening home ownership might even turn the malcontents
into conservatives.
This was a lesson that Margaret Thatcher was quick to learn.
Here in Britain, the idea of the property-owning democracy
became a keystone of 1 980s Conservatism.
By selling off council housing at bargain-basement prices,
Thatcher ensured that more and more British couples had a home of their own.
That also meant that more people than ever had mortgages.
Up untiI the 1980s, government incentives to borrow money and buy a house
made pretty good sense for the average British famiIy.
Interest rates were reIativeIy Iow in the '60s and '70s,
and the infIation rate tended to creep up,
so that the reaI vaIue of mortgage debt tended to faII.
But there was a sting in the taiI.
The very same governments that professed their faith
in the property-owning democracy were aIso committed to fighting infIation,
and that meant raising interest rates.
The British and American policy of encouraging people
to take out mortgages and then cranking up interest rates led in the late '80s
to one of the most spectacular booms and busts in the property market's history.
lt was to the '80s what the sub-prime meltdown has been in our own time -
the first, but not the last time that America's mortgage market
has gone stark raving mad.
To many of us, it's come as a shock
that a crash in the American property market
could trigger a major financial crisis.
ln fact, as so often in the ascent of money, it's happened before.
ln March 1 984, American government regulators received a copy
of a video showing mile after mile of half-built houses and condominiums
along lnterstate 30, just outside Dallas in Texas.
You can still see the empty slabs today.
The investigation triggered by these un-buiIt homes wouId expose
one of the biggest financiaI scandaIs of aII time -
a scam that wouId make a mockery of the idea
of property as a safe form of investment.
This isn't a story about reaI estate -
more Iike surreal estate.
Savings and loan associations - America's building societies -
were not only central to Roosevelt's New Deal on housing.
By the 1 97 0s, they were the foundation of America's property-owning democracy.
Then, in the 1970s, the savings and Ioan industry was hit
first by doubIe-digit infIation and then by higher interest rates.
lt was a lethal double punch for institutions that were forbidden by law
to raise the rates they paid to savers,
and which were receiving interest payments from local mortgage borrowers
that had been fixed decades before.
The response in Washington was to remove nearly all these restrictions.
When deregulation was enacted in 1 982,
President Reagan was cock-a-hoop.
AII in aII, I think we hit the jackpot.
Well, some people certainly did.
Liberated from the old constraints, the people running savings and loans
suddenly saw a chance to make some serious money
from the once boring business of mortgage lending.
By raising savings rates, they could attract much more money from depositors.
Then they could use these deposits
as the basis for as many loans as they liked.
Crucially, though, one thing didn't change.
Savers' deposits were still insured by the government.
lt was an invitation to a gigantic free lunch for financial cowboys.
This is the Wise Circle Grill just outside Dallas,
filled every lunchtime with local citizens of unblemished integrity.
Twenty years ago, the clientele was rather different.
The city of DaIIas had more than its fair share of frauduIent savings and Ioans,
and this was where the DaIIas property cowboys came to hang out.
The Wise CircIe GriII was the pIace to have brunch
when they weren't whooping it up on their Southfork-styIe ranches.
It was aII very, very 1980s.
To one group of DaIIas deveIopers, the Empire Savings and Loan Association
offered the perfect opportunity to make money out of thin air...
or rather, out of fIat, Texan Iand.
The surreal saga of Empire Savings and Loans began
when chairman Spencer Blain teamed up
with a flamboyant high-school dropout turned property developer
named Danny Faulkner, whose speciality was extravagant generosity...
with other people's money.
COINS CASCADE
The money in question came in the form of deposit accounts
on which Empire paid alluringly high interest rates.
This is FauIkner Point, one of the very first deveIopments
that Danny FauIkner ever buiIt, and it spawned a veritabIe empire
of FauIkner Crest, FauIkner Creek, FauIkner Crescent,
FauIkner Fountains, FauIkner Oaks.
Danny FauIkner's favourite trick was ''the fIip''.
He'd buy some parceI of Iand for peanuts, and then seII it on to naive investors
who got the money Ient to them by -
you've guessed it - Empire Savings and Loans.
Danny FauIkner may have cIaimed that he was iIIiterate,
but he certainIy wasn't innumerate.
Many investors never even got a chance to view their properties close up.
Faulkner would simply fly them over in his helicopter without landing.
By 1 984, property development in Texas was out of control,
paid for by government-guaranteed deposits
that were effectively going straight into the pockets of the developers.
On paper at least, the assets of Empire had grown
from $1 2 million to $257 million in just over two years.
The troubIe was that the demand for condos by Interstate 30
couId never possibIy have kept up with the vast suppIy
that was being generated by FauIkner, BIain and their cronies.
When the reguIators finaIIy bIew the whistIe in 1984,
that reaIity couId no Ionger be escaped,
and hundreds of the buiIdings that they erected
ended up being buIIdozed or burnt to the ground.
Today, 24 years on,
it's stiII a Texan wasteIand.
ln 1 991, Faulkner and Blain were both convicted and jailed for fraud.
One investigator called Empire ''one of the most reckless
''and fraudulent land investment schemes in American history. ''
ln all, nearly 500 savings and loans collapsed.
According to one official estimate,
nearly half had seen ''criminal conduct by insiders''.
The full cost of the crisis was $1 53 billion,
making it one of the most expensive financial crises in American history.
And the federal government which had deregulated
the savings and loans in the first place
had to pick up the bill, which is another way of saying that taxpayers forked out.
It was the first cIear sign that there might be a downside
to the idea of the property-owning democracy.
Yet the savings and loans crisis was a mere tremor
compared with the property earthquake
that would strike the US market 20 years later.
Savings and loans was an all-American crisis.
But the sub-prime quake
would shake the entire world of finance to its very foundations.
When this wall was built
to divide white homeowners from black renters in the 1 940s,
black families found it virtually impossible to get mortgages.
Sixty years later, that had all changed.
''We want everybody in America to own their own home, ''
President George WBush declared in October 2002, challenging lenders
to create 5.5 million new minority homeowners
by the end of the decade.
Positively encouraged by the federal government to relax lending standards,
mortgage companies swarmed into areas like this one,
offering all kinds of alluring deals.
Because so many of the new borrowers had patchy credit histories,
these loans came to be known as ''sub-prime''.
That made you a perfect candidate for a NlNJ A loan.
The problem was that behind low introductory payments,
these new mortgage loans were very different from the old,
30-year fixed-rate repayment loans of the past.
Since the 1980s,
the housing game has radicaIIy changed throughout the EngIish-speaking worId.
Mortgages are for shorter and shorter durations
and more and more borrowers are opting for interest-onIy mortgages.
That makes househoIds far more sensitive than they were to interest-rate hikes.
So how come the lenders didn't worry that these sub-prime borrowers
were almost certain to default if interest rates rose?
The answer to that question
and the key to the sub-prime crisis was another ''S'' word...
Instead of putting their own money at risk,
sub-prime Ienders immediateIy soId the Ioans on
to banks here, in and around WaII Street.
And the banks then securitized the Ioans,
which means they bundIed them together and then sIiced and diced them
so that at Ieast the top tier
couId be cIassified as tripIe-A-rated, ''investment grade'' securities.
And the banks then soId these securities to investors 1 ,000 miIes away from Detroit
who were happy to pay
for just a few extra hundredths of a percentage point in interest.
The key to securitization was the distance
between the mortgage borrowers in, say, Detroit,
and the people who ended up receiving their interest payments.
By the time small towns in Norway bought these securities,
they had no idea what was really behind their investment.
FinanciaI aIchemy?
WeII, it was a business modeI that worked beautifuIIy
as Iong as interest rates stayed Iow, peopIe kept their jobs,
and reaI-estate prices continued to rise.
Unfortunately, none of these things happened in Detroit.
ln 2006 alone,
sub-prime lenders injected more than a billion dollars
into those areas of the city where home values were already falling
and unemployment and mortgage rates were already rising.
Where Detroit led, other cities soon followed.
MEN READ OUT ADDRESSES
It's Thursday at noon and I'm witnessing a twice-daiIy rituaI
here on the steps of the Memphis Courthouse.
About 30 homes are about to be auctioned off here, and the reason is
that the mortgage Ienders have forecIosed on the homeowners
for faiIing to keep up with their interest payments.
2926 South Radford Avenue...
Memphis is reaIIy becoming ForecIosure City these days.
In the past five years, something Iike one in four househoIds
has received a notice threatening them with forecIosure.
Since the sub-prime mortgage market began to turn sour
in the early summer of 2007, shockwaves have been spreading
through all the world's financial markets,
wiping out hedge funds, obliterating venerable investment banks
and costing the survivors hundreds of billions of dollars.
Remember that pillar of the 1 930s New Deal mortgage market,
Fannie Mae?
With its younger brother, Freddie Mac, it grew to own or guarantee
around half of all American home loans.
ln September 2008, Fannie and Freddie
were effectively nationalised
to avoid a complete collapse of the mortgage market.
Established Wall Street names like Bear Stearns, Lehman Brothers
and Merrill Lynch have vanished.
Unlike savings and loans, this crisis extends right around the world.
The four Norwegian municipalities of Rana, Hemnes, Hattfjelldal and Narvik,
which had invested their citizens' taxes in sub-prime backed securities,
are now sitting on an investment worth roughly 1 5% of what they paid for it -
a loss of $1 00 million.
In the EngIish-speaking worId,
we tend to think of property as a one-way bet.
The simpIest way of getting rich is to pIay the property market.
In fact, you'd be a mug to invest your money in anything eIse.
But the remarkable thing about this supposed ''truth''
is how often reality gives it the lie.
For like stock markets, property can soar in value
only to crash in the most spectacular way.
ln Britain, between 1 989 and 1 995,
the average house price fell by 1 8%.
But that was nothing compared with what happened here in Japan.
The view's good.
Very Austin Powers decor. I'm Ioving that.
Oh, that's the boiIer.
OK, weII, Iet's cut to the chase.
How much is this pIace going to cost if I put the money down now?
SPEAKS JAPANESE
So that wouId be cIose to $2 miIIion.
OK, that's Iike a miIIion...
a miIIion pounds buys me this bijou apartment in Tokyo.
But this is a smart neighbourhood, right?
That may sound like a lot, but in recent Japanese history, it's a real bargain.
Between 1 985 and 1 990,
property prices in Japan rose by a factor of roughly three.
Banks fell over themselves to ride this wave.
But it wasn't a wave. lt was a bubble.
And in 1 990 it burst.
Prices here in Tokyo fell...
..by 7 5%, wiping out all the previous gains.
This costs Ł1 miIIion now.
How much did it cost back in 1990, at the peak of the property bubbIe?
- So roughIy three times the vaIue. - Three times?
So cIose to...possibIy $6 miIIion.
Ł3 miIIion. Wow!
We think we've had a property crash in the West, but this is a reaI property crash.
So no, property isn't a uniqueIy safe investment.
House prices can go down as weII as up.
And as assets go, houses are pretty iIIiquid,
which means you can't unIoad them in a hurry if you get into a financiaI jam.
And that, pretty much, is the downside
of the idea of a property-owning democracy.
The question now is whether we EngIish-speakers
have any business trying to export our modeI to the rest of the worId.
The real flaw in the property-owning democracy, as recent events have proved,
is that the housing market, like any asset market, is prone to booms and busts.
But maybe there's another way of looking at property -
as a means of unlocking new wealth
by providing collateral for aspiring entrepreneurs.
Could property ownership be the answer to the problems
of the world's poorest countries?
You've heard of sub-prime borrowers. Well, welcome to a sub-prime country...
..Argentina, where economic underachievement
has been a way of life for a century.
These slums on the outskirts of Buenos Aires seem a million miles
from the elegant boulevards of the Argentine capital's centre.
But are people here really as poor as they look?
One man didn't believe so.
Peruvian economist Hernando de Soto saw the shabby residences like these
in developing countries all over the world as representing
literally trillions of dollars of unrealised wealth.
The probIem is that the peopIe who Iive here,
and in countIess shanty towns around the worId,
don't have secure IegaI titIe to their homes.
That's bad, because without a IegaI titIe to property,
you can't use it as coIIateraI to borrow money.
And if you can't borrow money,
then you can't possibIy raise the capitaI you need to start a business.
Part of the trouble is that in poor countries, it's a bureaucratic nightmare
to establish secure legal title to property.
lt can take months - sometimes years - longer than in the English-speaking world.
For Hernando de Soto,
breathing financiaI Iife into aII this dead capitaI
is the key to providing the poor with a more prosperous future.
The shanty town of Quilmes, on the southern outskirts of Buenos Aires,
provides a natural experiment to test De Soto's theory.
On one side of the town, there are some of the most squalid slums l've ever seen.
But just a few miles away, it's a very different story.
It was in the earIy 1980s that a group of squatters here
Iobbied the government for secure IegaI titIe to their homes.
They were successfuI, and those wiIIing to pay a nominaI rent were granted Ieases
which, after 20 years, converted into fuII ownership.
You can teII they're owner-occupied by the fact that there's a fence,
the waIIs are painted, there's even a rather excitabIe guard dog.
After aII, owners tend to Iook after properties better than tenants.
And some of the owners here
are even reaIising the vaIue of their properties by putting them up for saIe.
Yet there seems to be a flaw in the theory, for owning their own homes
hasn't made it significantly easier for people here to borrow money.
Just 4% of them have managed to secure a mortgage.
The reaIity is that owning property doesn't give you security -
it just gives your creditors security.
ReaI security comes from having an income,
as the Duke of Buckingham discovered in the 1840s,
as Detroit homeowners are discovering today,
and as I suspect the peopIe of QuiImes wouId probabIy agree.
For that reason, it probabIy isn't necessary
for every entrepreneur in the deveIoping worId to take out a mortgage on his home
or, for that matter, on her home.
In fact, property ownership may not be the key to weaIth-generation at aII.
This is Betty Flores.
She runs a small coffee shop in El Alto,
a poor suburb of the Bolivian capital, La Paz.
Betty is one of an increasingly large number of women around the world
who have borrowed money with no security at all.
She's the personification
of an extraordinary new financial movement known as microfinance.
Did you borrow the money to set up this coffee stand?
COMPANION TRANSLATES
SHE REPLIES IN SPANISH
Yes, to make the...the stand. She borrowed money to make the stand.
Has she paid it aII back?
- She's paid it off a Iong time ago. - Oh, I see.
Stories Iike Betty's point to one of the great reveIations
of the microfinance movement in a country Iike BoIivia.
It turns out that women are actuaIIy a better credit risk than men,
with or without a home as security for the Ioan.
It aII rather fIies in the face of the conventionaI image
of the spendthrift femaIe.
These women are hardly what you would call good financial risks.
They probably have just a few dollars between them.
Yet with no security, they are being lent money. Here in Bolivia,
lenders have come to realise
that creditworthiness may in fact be a female trait.
Carmen Velasco set up Pro Mujer
to provide finance to poor but enterprising women.
Because the loans are unsecured by property,
the challenge is to get the women to pay them back...but they do.
From day one, they have to know that they have to repay on time,
that they have interest rates and they have to save.
So it's a process of Iearning, and at the beginning it's very difficuIt,
because they are not used to handIing a Ioan.
But IittIe by IittIe, they get used to it, and they feeI so proud when they repay.
I must say, I'm hugeIy impressed by what I'm seeing here at Pro Mujer.
You can sense in this hive of activity
the transformation that microfinance has brought into these women's Iives.
And behind me you can see the bottom Iine...
women Iining up to repay their Ioans punctuaIIy.
Maybe it's time to change that oId catch phrase from ''as safe as houses''
to ''as safe as housewives''.
Of course, it would be a mistake to assume that microfinance
is some kind of economic magic bullet.
Just giving out loans won't necessarily consign poverty to the museums.
But then, betting everything on the house won't do that, either.
Financial illiteracy may be rampant,
but somehow we were all experts on one branch of economics -
the property market.
We all knew that property was a one-way bet.
Except that it wasn't.
All over the world, it seems, property prices are falling...
..from Memphis to Santiago,
from London to La Paz.
Encouraging home ownership may weII create
a poIiticaI constituency for capitaIism.
But it aIso distorts the capitaI market by persuading peopIe to bet the house on...
weII, the house.
PeopIe need to borrow money, of course,
to start up businesses or to buy expensive assets.
But it seems dangerous to Iure them into staking everything
on the far from risk-free property market.
From Buckinghamshire to BoIivia to bonny ScotIand,
the key is to strike the right baIance between debt and income.
And next week I'II be suggesting that the entire worId economy
ln our time, we've witnessed the zenith of global finance.
ln 2006, the world's total economic output was worth around $47 trillion -
that's 47 followed by 1 2 zeroes.
The total value of stock and bond markets
was roughly $1 1 9 trillion - more than twice the size.
And the amount outstanding of the strange new financial life form
known as derivatives was $47 3 trillion - ten times larger.
By the summer of 2007, it seemed as if the Earth had turned into Planet Finance.
As never before, the world was interconnected,
but not just by cabIes, container ships and jet pIanes.
By 24/7 deaIing rooms and internationaI investment banks.
ln this series, we've seen how the markets for credit, bonds, stocks,
insurance and real estate all evolved in Europe and North America.
Well, now it's time to tell the story
of how those financial innovations conquered the world.
This is the story of financial globalisation.
Globalisation is something we take for granted today.
And yet for all the advantages of an interconnected world,
perfectIy exempIified by Hong Kong's astonishing humming container port,
there's a downside to gIobaIisation, and that is its vuInerabiIity -
its vuInerabiIity to financiaI shocks, because finance isn't an exact science,
and its vuInerabiIity to poIiticaI forces beyond the controI of the bankers.
The ascent of money has seldom been smooth.
Time and again, it's been punctuated by big and painful crises.
Just ten years ago, it seemed that these crises
were more likely to blow up in emerging markets, like Asia.
Yet today, it's the West that's caught up in a full-blown credit crunch,
while Asia seems scarcely to have noticed.
lndeed, a new phenomenon has come to define the world economy.
American borrowers have come to rely on Chinese savers -
a symbiotic relationship between China and America that l call ''Chimerica''.
But can we be sure that Chimerica will save
this era of financial globalisation?
The chiIIing reaIity is that a hundred years ago,
another age of financiaI gIobaIisation ended not with a whimper, but with a bang.
And there's no reason why that shouIdn't happen again in our time.
lt used to be said that ''emerging markets''
were places where they have emergencies.
lnvesting in faraway places can make you rich,
but when things go wrong, it's often been a fast track to financial ruin.
That's why many of today's apparently unstoppable emerging markets
are really re-emerging markets.
These days, of course, the uItimate re-emerging market is China.
To taIk to some peopIe,
there's simpIy no Iimit to the amount of money to be made here.
And it's certainIy true that over the past 20 years,
the mainIand has foIIowed the exampIe set here in Hong Kong, and boomed.
And yet this isn't the first time that foreign investors have piIed into China,
aiming to make megabucks from the worId's most popuIous nation.
And the Iast time,
those foreign investors Iost aImost as many shirts
as the IocaI taiIors here can stitch together in a week.
The key problem with overseas investment, then as now,
is that it's hard for an investor in London or New York
to see what a foreign government or company is up to
when they're an ocean or more apart.
lf the foreign borrower decides to default on its debts,
what's an investor to do?
The answer before 1 91 4 was brutally simple but effective.
Get your government to send in the navy.
By guaranteeing European political control,
gunboat diplomacy provided reassurance for British investors
even at the remotest extremities of the world economy.
The Royal Navy provided the firepower
that underwrote the first age of globalisation...
..and its pioneers,
like William Jardine... and James Matheson.
Jardine and Matheson were buccaneering Scots
who'd set up a trading company in the southern Chinese port of Canton in 1 832.
Not to put too fine a point on it,
their most profitable line of business was drug dealing.
They shipped opium produced under British Government control in lndia
to China's population of addicts -
a trade that China's Emperor had banned.
On March 1 0th, 1 839, an imperial official named Lin Zexu
arrived in Canton under orders from the Emperor to stamp out the trade.
He besieged the British opium warehouses,
blocking any further imports.
20,000 chests of opium valued at Ł2 million
were confiscated and literally thrown in the sea.
Faced with catastrophic losses, Jardine hurried to London
to lobby the British Government to send a gunboat.
WeII, Jardine got his wish granted.
On August 23rd, 1840, British gunships Ianded here on Hong Kong IsIand.
The Qing Empire was about to feeI the fuII force
of history's most successfuI narco-state.
As Jardine had predicted,
the Royal Navy made short work of the Chinese defences.
With south-western China under British control,
the opium trade was given free rein.
Drug addiction exploded.
Large tracts of the country slid into rebellion and anarchy.
But for Jardine Matheson, with their head office now established in Hong Kong,
the glory days of Victorian globalisation had arrived.
By1 900, the firm had diversified into more respectable lines of business.
lt had its own breweries, its own cotton mills,
its own insurance company,
and its own railways, like the one they built from Kowloon to Canton.
Back in 1913, an investor in London had an extraordinary range
of foreign opportunities,
and nothing iIIustrates that better than the Iedgers of N M RothschiId & Sons.
Just a singIe page from 1913
Iists no fewer than 20 different foreign securities,
incIuding bonds issues by ChiIe, Egypt, Germany, Hungary, ItaIy,
not forgetting 1 1 different raiIway companies,
incIuding four from Argentina, two from Canada and, down here,
the good oId KowIoon to Canton raiIway Iine.
For the first time in history, the world economy was truly united
by a combination of low trade and high finance.
Yet this first era of financial globalisation
was to be brought to a violent halt by the world's first truly global conflict.
On June 28th, 1 91 4, the heir to the Austrian throne,
the Archduke Franz Ferdinand,
was assassinated in the Bosnian capital, Sarajevo.
lnitially, financial markets shrugged off the news
as just another bout of Balkan bloodshed.
ln reality, the assassination
had sparked off a chain reaction in the world's financial markets.
As investors belatedly grasped the likelihood of a full-scale European war,
liquidity - the ability to borrow money or sell assets -
was sucked out of the world economy as if the bottom had dropped out of a bath.
The resulting disruption to international finance
shattered globalisation.
It's absoIuteIy fascinating to foIIow the outbreak of the First WorId War
through the financiaI pages of the London Times.
It wasn't untiI JuIy 22nd, 191 4, that anybody appreciated
that the assassination of the Archduke Franz Ferdinand in Sarajevo,
three weeks before, might have some financiaI repercussions.
Just ten days Iater, on August 1st, 191 4,
the Times had to report the cIosure of the Stock Exchange,
and cIosed it remained untiI January 4th, 1915.
Why were investors so seemingIy obIivious to Armageddon
just days before the outbreak of worId war?
WeII, the answer is that a combination of financiaI innovation
and gIobaI integration had made the worId seem reassuringIy safe.
The lights in financial markets were flashing green, not red,
until the very eve of destruction.
There may be a lesson here for our time, too.
Financial globalisation mark one took a generation to engineer.
But it was blown apart in a matter of days.
And it would take more than a generation to repair the damage done
by the guns of August 1 91 4.
The First World War had put an end to the first age of globalisation.
Until the late 1 960s, international finance slumbered.
Some even considered it dead.
ln 1 944, the soon-to-be-victorious Allies
gathered to devise a new financial architecture for the world.
Trade wouId be free,
but capitaI movements wouId be subject to tight reguIation.
When money did fIow across nationaI borders,
it wouId go from government to government.
This new financial order was to have two guardian sisters,
established here in Washington DC -
the lnternational Monetary Fund
and the lnternational Bank for Reconstruction and Development,
later known as the World Bank.
By the 1 97 0s, however, vast sums of money were being accumulated
by the oil exporters of the Middle East.
With Western bankers desperate to reinvest the money as loans,
the guardian sisters relaxed their grip.
Financial globalisation was reborn.
The region where the bankers chose to lend the petrodollars
seemed to promise the best returns.
Not for the first time in financial history,
it also posed the biggest risks.
ln seven years, Latin America quadrupled its borrowings from foreigners
to more than $31 5 billion.
Then, in 1 982,
Mexico declared that it would no longer be able to service its debt.
Soon, the entire continent teetered on the verge of bankruptcy.
But the days had gone when investors could confidently expect their governments
to send a gunboat to get their money back when foreign borrowers misbehaved.
Now responsibility for such debt crises fell on the lMF and the World Bank.
They didn't have gunboats.
But in return for new loans,
they could insist that Latin American governments
adopt painful ''structural adjustment programmes'' -
impose fiscal discipline.
To American economists, these programmes all made perfect sense.
But not everyone agreed.
To the increasingly vocal critics of global finance,
the two guardian sisters of the post-war order
were being transformed into economic hit men.
They were holding a financial gun to the heads of Third World governments...
..propping up dictators and furthering the interests of Yankee imperialism.
And woe betide those who resisted the hit men.
Conspiracy theories flourished in the anti-globalisation movement.
According to one popular theory, two Latin American leaders -
Jaime Roldos of Ecuador and Omar Torrijos of Panama -
were actually assassinated for resisting the demands of American imperialism.
And yet there's something about this story of a WorId Bank-IMF pIot
against Third WorId Ieaders that doesn't quite add up.
After aII, it's not as if the United States had Ient that much money
to Ecuador and Panama.
In the 1970s, they accounted for just 0.4% of totaI US grants and Ioans.
Nor were they particuIarIy big customers for the United States.
Again, Iess than 0.4% of totaI US exports.
Now, those just don't strike me as figures worth kiIIing for.
To say the least,
the idea of lMF-sponsored assassinations is a stretch.
Nevertheless, this new phase in the story of globalisation
did see the emergence of a new and more plausible kind of economic hit man,
armed with a financially lethal weapon - the hedge fund.
The men who ran the hedge funds were far more intimidating
precisely because they didn't even need to threaten violence to get their way.
And their distinctive contribution to globalisation was to speed it up.
Whereas the World Bank lends money to countries for periods of years,
hedge funds are more likely to put their money in for just weeks,
or even days.
The grandmaster of the new economic hit men
was George Soros.
A Hungarian Jew by birth, but educated in London and based in New York,
Soros brought to global finance a brand-new theory of economic behaviour
that underlined the fallibility of human nature
and the instability of financial markets.
Your actions wiII have unintended consequences,
so the outcome wiII not correspond to your expectations.
And that is the way human affairs generaIIy work.
According to Soros's Theory of Reflexivity,
financial markets can't possibly be perfectly efficient,
much less rational,
for the simpIe reason
that prices are just the refIection of the ignorance and the biases,
mostIy compIeteIy irrationaI, of miIIions of investors.
In Soros's eyes, markets are bound to go through cycIes of boom and bust,
as sureIy as the human temperament
is prone to bouts of euphoria and despondency.
Soros's Quantum Fund had made millions from short selling,
a type of dealing which borrows stocks or currencies
and sells them for future delivery
on the calculation that they'll go down in value.
His biggest coups came from being right about losers, not winners.
And the greatest of these was among the most momentous speculative hits
in all financial history.
On September 1 6th, 1 992, with the British pound in big trouble,
l watched as Soros put out a contract on the Bank of England.
I became convinced that specuIators Iike Soros were bound to win
if it came to a straight showdown with the British Government.
It was a matter of simpIe arithmetic -
a triIIion doIIars of currency traded every day on foreign exchange markets
against the meagre hard currency reserves of the UK Treasury.
At that time, the British pound was tightly linked to the German mark
through the ERM - the European Exchange Rate Mechanism.
As German interest rates rose
in the wake of that country's hugely expensive reunification,
Britain's rates had to rise too,
hurting home-owners and businesses.
Soros calculated that the British Chancellor, Norman Lamont,
would be forced to withdraw from the ERM and devalue the pound.
lt was the biggest bet of Soros's life.
So sure was he that the pound would drop that he bet $1 0 billion -
more than the entire capital of his fund.
The risk-reward was disproportionate.
And therefore it seemed Iike a good specuIation,
or investment, if you Iike, shorting the pound.
l was equally convinced that sterling would have to be be devalued,
though all l had to bet was my credibility.
That evening, I headed to the opera to see Verdi's The Force Of Destiny.
It proved exceedingIy appropriate.
At the intervaI, they announced that ChanceIIor Norman Lamont
had appeared in there, in the Treasury courtyard,
to say that Britain was withdrawing from the ERM.
How we aII cheered.
Today has been an extremeIy difficuIt and turbuIent day.
Massive specuIative fIows have continued to disrupt
the functioning of the Exchange Rate Mechanism.
Soros made a billion dollars that day,
and that was only 40% of his fund's annual profits.
(NiaII) Do you feeI... or did you feeI a sense of triumph
when your prophecy came true and the bet paid off hugeIy?
Of course. It was Iike when you're betting and you win,
naturaIIy, you have that satisfaction and aIso the profit.
COWS MOO
Soros owed his success to a kind of gut instinct
about the way the ''electronic herd'' would move.
But even his instincts are sometimes wrong.
So what if instinct couId somehow be repIaced by mathematics?
What if you couId write an aIgebraic formuIa
that guaranteed doubIe-digit returns?
WeII, on the other side of the financiaI gaIaxy,
such a formuIa had just been devised.
As the new era of globalisation increased trade and growth,
it also increased the world economy's vulnerability to financial shocks
that could spread rapidly to the four corners of the Earth.
But what if we inhabited another completely different kind of planet?
A planet without all the complicating frictions caused by subjective,
sometimes irrational human beings.
One where the inhabitants instantly absorbed all new information
and used it to maximise profits,
where amid the turbulence of everyday life
all was calm and predictable.
ln such a perfectly observed, efficiently interconnected world,
an unpredicted catastrophic stock market crash would be about as common
as an adult shorter than one-and-a-half feet in our own world.
lt would happen only once in four million years of trading.
This was the planet imagined
by some of the most brilliant financial economists of modern times.
And this is what their planet looked like.
ln 1 993, two mathematical geniuses came to Greenwich, Connecticut,
with a big idea.
Stanford University's Myron Scholes
had invented a revolutionary new theory of pricing things called ''options''.
He and Harvard's Robert Merton were the original ''quants'' -
a new breed of speculators using quantitative mathematics
to make money.
From this nondescript office they plotted a global financial revolution.
Merton and SchoIes's idea was based on the simpIe option contract.
Take the case of a stock that's worth $100 today.
Now, suppose I think that stock's going to be worth 200 in a year's time.
WouIdn't it be nice to have the option to buy it at today's price in a year's time?
If I'm right, I make a tidy profit of $100.
But if I'm wrong, weII, who cares? It was onIy an option.
The onIy cost to me is the price of the option itseIf.
The big question is, what shouId that price be?
$5? $1 0?
The answer was to be found in a magic formula.
''Quants'' sometimes refer to this formula as a ''black box''.
Well, let's look inside the box.
The challenge Merton and Scholes faced was how to price an option
to buy a particular stock on a particular date in the future,
taking into account the unpredictable movement of the price of the stock
in the intervening period.
Work that option price out accurately, rather than just relying on guesswork,
and you truly deserve the title ''rocket scientist''.
With wonderful mathematical wizardry,
the quants reduced the price of the option to this formula.
FeeIing a IittIe bit baffIed? Finding the aIgebra rather tricky to foIIow?
WeII, that was just fine by the quants.
In order to make money from this kind of thing,
they needed markets to be fuII of peopIe who had no idea how to price options.
ln its first two years, Merton and Scholes's company,
Long Term Capital Management, made megabucks by selling options
that were never exercised because the buyers had guessed wrong
and Long Term had got it right.
They also made a killing by buying up all kinds of different securities
that the rocket scientists thought were mispriced.
Greenwich's luxury car dealers had never had it so good.
Admittedly, to generate these huge returns, Long Term had to borrow.
This additional ''leverage'',
or gearing, allowed them to bet more than just their own money.
By August 1 997, the fund's capital was just under $7 billion,
but the assets funded by borrowing amounted to 1 26 billion.
You might have thought that a coupIe of academics Iike Merton and SchoIes
wouId have been scared siIIy by this enormous piIe of debt.
But not a bit of it. According to their magicaI mathematicaI formuIa,
there wasn't the sIightest risk in being so highIy geared.
Apart from anything eIse, Long Term was pursuing muItipIe,
supposedIy uncorreIated trading strategies, around a hundred in aII,
with over 7,600 different positions.
One of these might go wrong, or possibIy even two.
But sureIy aII the bets they'd pIaced couIdn't possibIy go wrong simuItaneousIy.
Long Term was trading in markets all over the world.
But the firm's biggest business
was selling options on American and European stock markets...
..options that would be cashed in
if there were big future stock price movements, up or down.
At the time, the high prices these options were fetching
implied that the markets would become particularly volatile.
But Long Term thought this was wrong.
According to their calculations, market volatility would actually decline,
and that meant the chances of investors exercising their options would be low too.
So Long Term piled the options high and sold them cheap.
Sounds risky?
They estimated their risk of going bust at one in ten to the power of 24.
ln other words, virtually zero.
lt was as if they really were on another planet,
far from the mundane ups and downs of terrestrial markets.
ln October 1 997,
as if to prove that Long Term really was the ultimate Brains Trust,
Merton and Scholes were awarded the Nobel Prize in economics.
APPLAUSE
It seemed as if inteIIect had triumphed over intuition,
as if rocket science had taken over from risk-taking.
Equipped with their magicaI bIack box,
the partners in LTCM seemed poised to make money
far beyond the wiIdest imaginings of even George Soros.
And then, in the summer of 1998,
when every seIf-respecting hedge fund manager
shouId have been pIaying with his yacht,
something happened that threatened to bIow the Iid right off
the NobeI Prize-winners' bIack box.
ReaIity started to misbehave.
ln evolution, big extinctions tend to be caused by outside shocks,
like an asteroid hitting the Earth.
On Monday August 1 7th, 1 998,
a giant asteroid smashed into Planet Finance.
And - surprise, surprise - it struck on the other side of the world
in an especially flaky emerging market.
Weakened by political upheaval, declining oil revenues
and a botched privatisation, the ailing Russian financial system collapsed.
A desperate Russian government was driven to default on its debts,
fuelling the fires of volatility throughout the world's financial system.
Stock markets plunged.
Remember all those low-cost options Long Term had sold
based on their prediction of low stock market volatility?
The ones they thought no-one would ever exercise?
Well, now they did.
The quants had predicted that Long Term was highly unlikely
to lose more than $35 million in a single day.
On Friday August 21 st, it lost $550 million -
1 5% of its entire capital.
Now that, according to the Long Term risk models, was next to impossible.
The traders in Greenwich stared
slack-jawed and glassy-eyed at their screens.
lt couldn't be happening.
But it was.
By the end of the month, Long Term was down 45%.
The only chance of survival was to find a financial white knight to rescue them.
And the most powerfuI knight in town was none other than George Soros.
It was the uItimate humiIiation -
the quants from PIanet Finance begging for a baiI-out
from the prophet of irrationaI, unquantifiabIe refIexivity.
(NiaII) That must have been a very tense meeting.
Do you remember the atmosphere in the room, or am I...?
I remember he came for breakfast and it wasn't at aII tense, because...
Of course, he was tense
but I wasn't because I wasn't putting in the money.
There was to be no white knight for Long Term.
I feIt that it was too dangerous and that I didn't have enough capitaI
and, in fact, it reaIIy required the coordinated actions
of aII the banks to baiI out LTCM.
And that's precisely what happened.
Fearful that Long Term's failure could trigger a general financial meltdown,
the New York Federal Reserve hastily brokered a multi-billion-dollar bail-out
by 1 4 Wall Street banks.
What on earth had happened?
Why was Soros so right and the giant brains at Long Term so wrong?
For one thing, this wasn't a coolly logical Planet Finance.
lt was still dear old Planet Earth, inhabited by emotional human beings
with a stampede mentality.
There was, however, another reason why Long Term failed.
Their risk models were working with just five years' worth of data.
lf they'd gone back even 1 1 years,
they'd have captured the 1 987 stock market crash.
And if they'd gone back 80 years,
they'd have captured the last great Russian default
after the 1 91 7 revolution.
To put it bIuntIy, the NobeI Prize-winners
had known pIenty of mathematics, but not enough history.
They'd perfectIy grasped the beautifuI theory of PIanet Finance,
but not the messy reaIity of PIanet Earth.
And that, quite simpIy, is why Long Term CapitaI Management
turned out to be Short Term CapitaI Mismanagement.
The big question is whether such a crisis couId repIay itseIf today, ten years on,
onIy this time invoIving so many hedge funds,
and on such a Iarge scaIe, that it simpIy couIdn't be baiIed out?
WeII, the answer to that question
Iies not on another pIanet, but on the other side of this one.
To some, financial history is just so much water under the bridge -
ancient history, like the history of lmperial China.
Some young traders don't even remember the 1997 / 98 Asian crisis.
In fact, if they came into the markets after 2000,
they had seven bumper years.
Stock markets worIdwide boomed.
So too did bond markets. So did commodity markets.
So did derivatives markets. In fact, every kind of asset market boomed.
And so too did the markets for those products that are in demand
when the bonuses are big, Iike vintage Bordeaux and Iuxury yachts.
But these boom years were also mystery years.
For markets soared at a time of rising short-term interest rates,
glaring trade imbalances and escalating political risk.
The key to this seeming paradox lay here in China.
Chongqing, on the banks of the mighty River Yangtze,
is deep in the heart of the Middle Kingdom,
over a thousand miles from the coastal enterprise zones most Westerners visit.
Yet this is the fastest-growing city on the planet.
I've traveIIed aII over the worId making this series,
and I must say, I have never seen anything Iike this.
WeIcome to Chongqing, the fastest growing city in the worId.
It's construction heaven. If you Iook over through the fog,
you can just about make out one of the 30 bridges they're currentIy buiIding,
and down there, one of the ten Iight raiIways.
AII around me, there used to be prime farmIand, untiI six months ago,
when they started constructing IiteraIIy miIIions of square metres
of new office space.
The aim is to turn Chongqing into the financiaI capitaI of western China.
WeII, if they keep this up, it'II soon be the financiaI capitaI of the worId.
Thanks to growth like this, there are now 345,000 dollar millionaires in China
and over 1 00 billionaires.
Not only has China left the colonial era far behind,
the fastest-growing economy in the world has also managed
to avoid the kind of crisis
that has periodically blown up in the other emerging markets.
One reason for China's crisis-free ascent has been the fact
that most Chinese investment hasn't been financed by foreigners,
but out of China's own savings.
There has been foreign investment,
but most of it has been direct investment
in the form of things Iike factories
which you can't easiIy Iiquidate and send home in a crisis.
Indeed, so enormous have China's savings become in recent years
that they have enabIed gIobaIisation to do the most aImighty U-turn.
PreviousIy, it was the rich EngIish-speakers who Ient money
to the poor Asian periphery.
But now it's the Chinese who are Iending money to rich Americans.
WeIcome to the strange new hybrid country of China and America.
I caII it ''Chimerica''.
This extraordinary place is the South Western Stock Exchange.
lt's where hundreds of Chongqing's residents come to have lunch,
play ping pong and invest -
or is it gamble? - their savings on the stock market.
This is what defines the Chinese economy today.
lncreasingly, it's what defines the world economy.
Chinese investors trying to work out what to do with their abundant savings.
After years of instability,
Chinese households save an unusually high proportion
of their rapidly rising incomes,
in marked contrast to Americans, who these days save none at all.
So plentiful are Chinese savings that for the first time in centuries,
the direction of capital flow is not from West to East,
but from East to West.
And it is a mighty flow.
ln 2007, the United States needed to borrow around $800 billion
from the rest of the world.
That's more than $4 billion every working day.
China, by contrast, ran a current account surplus
equivalent to more than a quarter of the US deficit.
And a remarkably large proportion of that surplus
has ended up being lent to the United States.
ln effect, the People's Republic of China
has become banker to the United States of America.
lt may seem a little bizarre.
The average American has an income of around $44,000 a year,
whereas the average Chinese, despite this country's 100-pIus biIIionaires
and aII the ostentatious signs of new money here in centraI Chongqing,
is on around $2,000.
So why wouId the Iatter want to Iend money to the former
who's roughIy 22 times richer?
WeII, here's how it works.
Until recently, from China's point of view,
the best way of employing its vast population
was through exporting manufactures to the insatiably spendthrift US consumer.
To ensure that those exports were irresistibly cheap,
China had to stop its currency strengthening against the dollar
by buying literally billions of dollars on world markets.
And, until recently, this seemed to be to America's benefit too.
Here in America, the best way to keep the good times roIIing
in recent years has been to import cheap Chinese goods by the container-Ioad
and seII them in out-of-town superstores, Iike this one.
For companies Iike WaI-Mart, outsourcing to China
has been a way of reaping vast profits from cheap Chinese Iabour.
In 2006 aIone,
WaI-Mart out-sourced no Iess than $9 biIIion-worth of goods from China.
But at the same time,
by seIIing biIIions of doIIars of bonds to the PeopIe's Bank of China,
the United States has been abIe to enjoy much Iower interest rates
than wouId otherwise have been the case.
It's what they caII at business schooI a win-win situation.
This is the wonderful dual country of ''Chimerica'',
accounting for 33% of the world's economic output
and more than half of all global growth in the past eight years.
Chimerica seemed like a marriage made in heaven.
The East Chimericans did the saving. The West Chimericans did the spending.
But there was a catch.
The more China was willing to lend to the United States,
the more Americans were willing to borrow.
Chimerica, in other words,
was the underlying cause of the flood of new bank loans,
bond issues and derivative contracts that swept Planet Finance after 2000.
That, in turn, was the underlying reason why the US mortgage market
was so awash with cash in 2006
that sub-prime mortgages were being sold to people with no income,
no job and no assets - Ninjas.
It wasn't as if the sub-prime mortgage crisis of 2007 was hard to predict.
Months before it bIew up, I was in Tennessee and in Michigan,
seeing for myseIf how many poorer househoIds
were heading for mortgage defauIt and forecIosure.
What was much harder to predict
was how a smaII tremor in America's very own home-grown emerging market
wouId cause a financiaI earthquake aII around the worId.
Not many people foresaw that defaults on sub-prime mortgages
would send such a shockwave around the world
that a British bank would suffer the first run since 1 866
and end up being nationalised,
or that one of the greatest names in American investment banking,
Lehman Brothers, would go bust.
And not many people saw
that as other banks started to write down hundreds of billions of losses,
inter-bank lending would simply seize up,
driving the US Treasury to propose a $7 00 billion bail-out
for the financial system as a whole.
CertainIy, by June 2008.
an American recession seemed more or Iess inevitabIe.
But the end of the worId?
Looking around the streets of Hong Kong,
I don't see much sign of a recession here.
Can it be that the Chinese haIf of Chimerica
has successfuIIy decoupIed itseIf from the American haIf?
The idea that China can somehow walk away unscathed from the American crisis
is certainly seductive.
Despite declining exports to the recession-hit West,
and a stock market crash, booming domestic demand
seems set to keep China's economy growing at at least 8% a year.
But remember, we've been here before.
A hundred years ago,
in the first age of globalisation,
many investors thought there was similarly symbiotic relationship
between the world's financial centre, Britain,
and Europe's most dynamic industrial economy.
That economy was Germany's,
and the breakdown of that relationship ended in war.
As before 1 91 4,
there's a fine line that separates symbiosis from rivalry and conflict.
According to one estimate, China's gross domestic product
could exceed that of the United States as early as 2027.
By that time some critics of free trade argue
that virtually nothing may remain of American manufacturing industry.
And the worse things get in the United States,
the louder such complaints will grow.
On a day Iike today, when the Hong Kong stock market is down sharpIy,
it's tempting to ask whether anything couId trigger
a comparabIe breakdown in gIobaIisation Iike the one that happened in 191 4?
The obvious answer is some kind of confIict
between the United States and China, whether over trade, Taiwan, Tibet,
or some other unforeseeabIe bone of contention.
What starts with competition for Olympic medals
could end in a battle over dollars
if the Chinese one day decide to cut off their credit line to the American empire.
Maybe, as its name suggests,
Chimerica is nothing more than a chimera -
the mythical beast of ancient legend that was part lion, part goat,
part dragon.
A Chinese-American conflict may sound implausible,
but one of the key points of this series
is that the really big crises come just seldom enough
to be beyond the living memory
of the people who run today's companies, banks and funds.
Just because all the swans you've ever seen are white
doesn't mean there are no black swans.
Today's financial world is the result of four millennia of economic evolution.
Yet despite the unprecedented complexity and diversity
of the modern financial system,
Planet Finance remains as vulnerable as ever
to the age-old problem of booms and busts,
irrational exuberance and manic depression.
Maybe all this complexity has actually increased our vulnerability to crisis.
For 4,000 years, from ancient Mesopotamia to modern China,
the ascent of money has been one of the key factors in human progress,
an extraordinary story of innovation, intermediation and integration
that had done as much as anything
to heIp peopIe escape from the drudgery of subsistence agricuIture.
And yet PIanet Finance can never quite escape
from the gravitationaI force of PIanet Earth,
because the quants can never take fuII account of the human factor -
our tendency to underestimate the probabiIity of bIack swans,
our propensity to veer from euphoria to despondency,
our chronic inabiIity to Iearn from history.
And that's why the course of financiaI history -
Iike that most human of emotions, Iove - never runs smooth, and never wiII,
not even here, on the magicaI and quite possibIy mythicaI country of Chimerica.