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.