Blowing Bubbles: The Company You Keep (part II)

But how much power did even large shareholders have? Little. When the Company's directors petitioned the government to be released from their obligation to publish ten-year accounts in 1612 - the date when  investors were supposed to be able to withdraw their capital if they chose to - permission was granted and publication of the accounts and the repayment of investors' capital were both postponed. The only sop to shareholders was that in 1610 the Seventeen Lords agreed to make a dividend payment the following year, though at this stage the Company was so strapped for cash that the dividend had to be paid in spices. In 1612 it was announced that the VOC would not be liquidated, as originally planned. This meant that any shareholders who wanted their cash back had no alternative but to sell their shares to another investor.

Blowing Bubbles: The Company You Keep (part I)

Behind the ornate baroque façade of Venice's San Moise church, literally under the feet of the tens of thousands of tourists who visit the church each year, there is a remarkable but seldom noticed inscription:

HONORI ET MEMORIAL JOANNIS LAW EDINBURGENSES REGII
GALLIARUM AERARII PREFECTI CLARISSIMA

'To the honour and memory of John Law of Edinburgh. Most distinguished controller of the treasury of the kings of the French.' It is a rather unlikely resting place for the man who invented the stock market bubble.

An ambitious Scot, a convicted murderer, a compulsive gambler and a flawed financial genius, John Law was not only responsible for the first true boom and bust in asset prices. He also may be said to have caused, indirectly, the French Revolution by comprehensively blowing the best chance that the ancien régime monarchy had to reform its finances. His story is one of the most astonishing yet least well understood tales of adventure in all financial history. It is also very much a story for our times.

Blowing Bubbles (part II)

Stock market bubbles have three other recurrent features. The first is the role of what is sometimes referred to as asymmetric information. Insiders - those concerned with the management of bubble companies - know much more than the outsiders, whom the insiders want to part from their money. Such asymmetries always exist in business, of course, but in a bubble the insiders exploit them fraudulently. The second theme is the role of crossborder capital flows. Bubbles are more likely to occur when capital flows freely from country to country. The seasoned speculator, based in a major financial centre, may lack the inside knowledge of the true insider. But he is much more likely to get his timing right - buying early and selling before the bubble bursts - than the naive first-time investor. In a bubble, in other words, not everyone is irrational; or, at least, some of the exuberant are less irrational than others. Finally, and most importantly, without easy credit creation a true bubble cannot occur. That is why so many bubbles have their origins in the sins of omission or
commission of central banks.

Nothing illustrates more clearly how hard human beings find it to learn from history than the repetitive history of stock market bubbles. Consider how readers of the magazine Business Week saw the world at two moments in time, separated by just twenty years. On 13 August 1979 , the front cover featured a crumpled share certificate in the shape of a crashed paper dart under the headline: The Death of Equities: How inflation is destroying the stock market'. Readers were left in no doubt about the magnitude of the crisis:

Blowing Bubbles (part I)

The Andes stretch for more than four thousand miles like a jagged, crooked spine down the western side of the South American continent. Formed roughly a hundred million years ago, as the Nazca tectonic plate began its slow but tumultuous slide beneath the South American plate, their highest peak, Mount Aconcagua in Argentina, rises more than 22,000 feet above sea level. Aconcagua's smaller Chilean brethren stand like gleaming white sentinels around Santiago. But it is only when you are up in the Bolivian highlands that you really grasp the sheer scale of the Andes. When the rain clouds lift on the road from La Paz to Lake Titicaca, the mountains dominate the skyline, tracing a dazzling, irregular saw-tooth right across the horizon.

Looking at the Andes, it is hard to imagine that any kind of human organization could overcome such a vast natural barrier. But for one American company, their jagged peaks were no more daunting than the dense Amazonian rainforests that lie to the east of them. That company set out to construct a gas pipeline from Bolivia across the continent to the Atlantic coast of Brazil, and another - the longest in the world - from the tip of Patagonia to the Argentine capital Buenos Aires. Such grand schemes, exemplifying the vaulting ambition of modern capitalism, were made possible by the invention of one of the most fundamental  institutions of the modern world: the company. It is the company that enables thousands of individuals to pool their resources for risky, long-term projects that require the investment of vast sums of capital before profits can be realized.

The Resurrection of the Rentier

In the 1920s, as we have seen, Keynes had predicted the 'euthanasia of the rentier\ anticipating that inflation would eventually eat up all the paper wealth of those who had put their money in government bonds. In our time, however, we have seen a miraculous resurrection of the bondholder. After the Great Inflation of the 1970s, the past thirty years have seen one country after another reduce inflation to single digits. (Even in Argentina, the official inflation rate is below 10 per cent, though unofficial estimates compiled by the provinces of Mendoza and San Luis put it above 20 per cent.) And, as inflation has fallen, so bonds have rallied in what has been one of the great bond bull markets of modern history. Even more remarkably, despite the spectacular Argentine default - not to mention Russia's in 1998 - the spreads on emerging market bonds have trended steadily downwards, reaching lows in early 2007 that had not been seen since before the First World War, implying an almost unshakeable confidence in the economic future. Rumours of the death of Mr Bond have clearly proved to be exaggerated.

The Euthanasia of the Rentier (part IV)

This is not a bad metaphor for Argentine financial history in the past thirty years. Where Bernardo Grinspun attempted debt rescheduling and Keynesian demand management, Juan Sourrouille tried currency reform (the Austral Plan) along with wage and price controls. Neither was able to lead the critical interest groups down his own forking path. Public expenditure continued to exceed tax revenue; arguments for a premature end to wage and price controls prevailed; inflation resumed after only the most fleeting of stabilizations. The forking paths finally and calamitously reconverged in 1989: the annus mirabilis in Eastern Europe; the annus horribilis in Argentina.

In February 1989 Argentina was suffering one of the hottest summers on record. The electricity system in Buenos Aires struggled to cope. People grew accustomed to five-hour power cuts. Banks and foreign exchange houses were ordered to close as the government tried to prevent the currency's exchange rate from collapsing. It failed: in the space of just a month the austral fell 140 per cent against the dollar. At the same time, the World Bank froze lending to Argentina, saying that the government had failed to tackle its bloated public sector deficit. Private sector lenders were no more enthusiastic. Investors were hardly likely to buy bonds with the prospect that inflation would wipe out their real value within days. As fears grew that the central bank's reserves were running out, bond prices plunged. There was only one option left for a desperate government: the printing press. But even that failed. On Friday 28 April Argentina literally ran
out of money. Tt's a physical problem,' Central Bank Vice-President Roberto Eilbaum told a news conference. The mint had literally run out of paper and the printers had gone on strike. 'I don't know how we're going to do it, but the money has got to be there on Monday,' he confessed.

The Euthanasia of the Rentier (part III)

It was to Lenin that Keynes attributed the insight that 'There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.' No record survives of Lenin saying any such thing, but his fellow Bolshevik Yevgeni Preobrazhensky* did describe the banknote-printing press as 'that machine-gun of the Commissariat of Finance which poured fire into the rear of the bourgeois system'.

[NB* Murder rather than euthanasia was Preobrazhensky's forte; he was of all the Bolshevik leaders the one most directly implicated in the execution of Nicholas II and his family.]

The Russian example is a reminder that Germany was not the only vanquished country to suffer hyperinflation after the First World War. Austria - as well as the newly independent Hungary and Poland - also suffered comparably bad currency collapses between 1917 and 1924 . In the Russian case, hyperinflation came after the Bolsheviks had defaulted outright on the entire Tsarist debt. Bondholders would suffer similar fates in the aftermath of the Second World War, when Germany, Hungary and Greece all saw their currencies and bond markets collapse.*

[NB* The highest recorded inflation rate in history was in Hungary in July 1946, when prices increased by 4.19 quintillion per cent (419 followed by sixteen zeros).]

If hyperinflation were exclusively associated with the costs of losing world wars, it would be relatively easy to understand. Yet there is a puzzle. In more recent times, a number of countries have been driven to default on their debts - either directly by suspending interest payments, or indirectly by debasing the currency in which the debts are denominated - as a result of far less serious disasters. Why is it that the spectre of hyperinflation has not been banished along with the spectre of global conflict?

The Euthanasia of the Rentier (part II)

All the warring countries went on war bonds sales-drives during the war, persuading thousands of small savers who had never previously purchased government bonds that it was their patriotic duty to do so. Unlike Britain, France, Italy and Russia, however, Germany did not have access to the international bond market during the war (having initially spurned the New York market and then been shut out of it). While the Entente powers could sell bonds in the United States or throughout the capital-rich British Empire, the Central powers (Germany, Austria-Hungary and Turkey) were thrown back on their own resources. Berlin
and Vienna were important financial centres, but they lacked the depth of London, Paris and New York. As a result, the sale of war bonds grew gradually more difficult for the Germans and their allies, as the appetite of domestic investors became sated.

Much sooner, and to a much greater extent than in Britain, the German and Austrian authorities had to turn to their central banks for short-term funding. The growth of the volume of Treasury bills in the central bank's hands was a harbinger of inflation because, unlike the sale of bonds to the public, exchanging these bills for banknotes increased the money supply. By the end of the war, roughly a third of the Reich debt was 'floating' or unfunded, and a substantial monetary overhang had been created, which only wartime price controls prevented from manifesting itself in higher inflation.

The Euthanasia of the Rentier (part I)

The fate of those who lost their shirts on Confederate bonds was not especially unusual in the nineteenth century. The Confederacy was far from the only state in the Americas to end up disappointing its bondholders; it was merely the northernmost delinquent. South of the Rio Grande, debt defaults and currency depreciations verged on the commonplace. The experience of Latin America in the nineteenth century in many ways foreshadowed problems that would become almost universal in the middle of the twentieth century. Partly this was because the social class that was most likely to invest in bonds - and therefore to have an interest in prompt interest payment in a sound currency - was weaker there than elsewhere. Partly it was because Latin American republics were among the first to discover that it was relatively painless to default when a substantial proportion of bondholders were foreign. It was no mere accident that the first great Latin American debt crisis happened as early as 1826-9, when Peru, Colombia, Chile, Mexico, Guatemala and Argentina all defaulted on loans issued in London just a few years before.

Driving Dixie Down (II)

In i860 the port of Liverpool was the main artery for the supply of imported cotton to the British textile industry, then the mainstay of the Victorian industrial economy. More than 80 per cent of these imports came from the southern United States. The Confederate leaders believed this gave them the leverage to bring Britain into the war on their side. To ratchet up the pressure, they decided to impose an embargo on all cotton exports to Liverpool. The effects were devastating. Cotton prices soared from 6%d per pound to 27%d. Imports from the South slumped from 2.6 million bales in 1860 to less than 72,000 in 1862. A typical English cotton mill like the one that has been preserved at Styal, south of Manchester, employed around 400 workers, but that was just a fraction of the 300,000 people employed by King Cotton across Lancashire as a whole. Without cotton there was literally nothing for those workers to do. By late 1862 half the workforce had been laid off; around a quarter of the entire population of Lancashire was on poor relief. They called it the cotton famine. This, however, was a man-made famine. And the men who made it seemed to be achieving their goal. Not only did the embargo cause unemployment, hunger and riots in the north of England; the shortage of cotton also drove up the price and hence the value of the South's cotton-backed bonds, making them an irresistibly attractive investment for key members of the British political elite. The future Prime Minister, William Ewart Gladstone, bought some, as did the editor of The Times, John Delane.

Driving Dixie Down (I)

In May 1863, two years into the American Civil War, Major-General Ulysses S. Grant captured Jackson, the Mississippi state capital, and forced the Confederate army under Lieutenant-General John C. Pemberton to retreat westward to Vicksburg on the banks of the Mississippi River. Surrounded, with Union gunboats bombarding their positions from behind, Pemberton's army repulsed two Union assaults but they were finally starved into submission by a grinding siege. On 4 July, Independence Day, Pemberton surrendered. From now on, the Mississippi was firmly in the hands of the North. The South was literally split in two.

The fall of Vicksburg is always seen as one of the great turning points in the war. And yet, from a financial point of view, it was really not the decisive one. The key event had happened more than a year before, two hundred miles downstream from Vicksburg, where the Mississippi joins the Gulf of Mexico. On 29 April 1862 Flag Officer David Farragut had run the guns of Fort Jackson and Fort St Philip to seize control of New Orleans. This was a far less bloody and protracted clash than the siege of Vicksburg, but equally disastrous for the Southern cause.

Rothschild - The Bonaparte of Finance (part IV)

Meanwhile, Radicals on the Left bemoaned the rise of a new power in the realm of politics, which wielded a veto power over government finance and hence over most policy. Following the success of Rothschild bond issues for Austria, Prussia and Russia, Nathan was caricatured as the insurance broker to the 'Hollow Alliance', helping to protect Europe against liberal political fires.

In 1821 he even received a death threat because of 'his connexion with foreign powers, and particularly the assistance rendered to Austria, on account of the designs of that government against the liberties of Europe'. The liberal historian Jules Michelet noted in his journal in 1842: 'M. Rothschild knows Europe prince by prince, and the bourse courtier by courtier. He has all their accounts in his head, that of the courtiers and that of the kings; he talks to them without even consulting his books. To one such he says: "Your account will go into the red if you appoint such a minister." ' Predictably, the fact that the Rothschilds were Jewish gave a new impetus to deep-rooted anti-Semitic prejudices. No sooner had the Rothschilds appeared on the American scene in the 1830s than the governor of Mississippi was denouncing 'Baron Rothschild' for having 'the blood of Judas and Shylock flow[ing] in his veins, and . . . unit[ing] the qualities of both his countrymen.' Later in the century, the Populist writer 'Coin' Harvey would depict the Rothschild bank as a vast, black octopus stretching its tentacles around the world.

Rothschild - The Bonaparte of Finance (part III)

To an extent that even today remains astonishing, the Rothschilds went on to dominate international finance in the half century after Waterloo. So extraordinary did this achievement seem to contemporaries that they often sought to explain it in mystical terms. According to one account dating from the 1830s, the Rothschilds owed their fortune to the possession of a mysterious 'Hebrew talisman' that enabled Nathan Rothschild, the founder of the London house, to become 'the leviathan of the money markets of Europe'. Similar stories were being told in the Pale of Settlement, to which Russian Jews were confined, as late as the 1890s. As we have seen, the Nazis preferred to attribute the rise of the Rothschilds to the manipulation of stock market news and other sharp practice. Such myths are current even today. According to Song Hongbing's best-selling book Currency Wars, published in China in 2007, the Rothschilds continue to control the global monetary system through their alleged influence over the Federal Reserve System.

The more prosaic reality was that the Rothschilds were able to build on their successes during the final phase of the Napoleonic Wars to establish themselves as the dominant players in an increasingly international London bond market. They did this by establishing a capital base and an information network that were soon far superior to those of their nearest rivals, the Barings.

Rothschild - The Bonaparte of Finance (part II)

Mobilizing such vast amounts of gold even at the tail end of a war was risky, no doubt. Yet from the Rothschilds' point of view, the hefty commissions they were able to charge more than justified the risks. What made them so well suited to the task was that the brothers had a ready-made banking network within the family - Nathan in London, Amschel in Frankfurt, James (the youngest) in Paris, Carl in Amsterdam and Salomon roving wherever Nathan saw fit. Spread out around Europe, the five Rothschilds were uniquely positioned to exploit price and exchange rate differences between markets, the process known as arbitrage.
If the price of gold was higher in, say, Paris than in London, James in Paris would sell gold for bills of exchange, then send these to London, where Nathan would use them to buy a larger quantity of gold. The fact that their own transactions on Herries's behalf were big enough to affect such price differentials only added to the profitability of the business. In addition, the Rothschilds also handled some of the large subsidies paid to Britain's continental allies. By June 1814, Herries calculated that they had effected payments of this sort to a value of 12.6 million francs. 'Mr Rothschild', remarked the Prime Minister, Lord Liverpool, had become 'a very useful friend'. As he told the Foreign Secretary Lord Castlereagh, 'I do not know what we should have done without him . . .'. By now his brothers had taken to calling Nathan the master of the Stock Exchange.

Rothschild - The Bonaparte of Finance (part I)

Nathan Mayer Rothschild

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; his correspondents are innumerable; his couriers outrun those of sovereign princes, and absolute sovereigns; ministers of state are in his pay. Paramount in the cabinets of continental Europe, he aspires to the domination of our own.

Those words were spoken in 1828 by the Radical MP Thomas Dunscombe. The man he was referring to was Nathan Mayer Rothschild, founder of the London branch of what was, for most of the nineteenth century, the biggest bank in the world. It was the bond market that made the Rothschild family rich - rich enough to build forty-one stately homes all over Europe, among them Waddesdon Manor in Buckinghamshire, which has been restored in all its gilded glory by the 4th Lord Rothschild, Nathan's great-great-great-grandson. His illustrious forebear, according to Lord Rothschild, was 'short, fat, obsessive, extremely clever, wholly focused . . . I can't imagine he would have been a very pleasant person to have dealings with. 'His cousin Evelyn de Rothschild takes a similar view. 'I think he was very ambitious,' he says, contemplating Nathan Rothschild's portrait in the boardroom at the offices of N. M. Rothschild in London's St Swithin's Lane, 'and I think he was very determined. I don't think he suffered fools lightly.'

Though the Rothschilds were compulsive correspondents, relatively few of Nathan's letters to his brothers have survived. There is one page, however, that clearly conveys the kind of man he was. Written, like all their letters, in almost indecipherable Judendeutsch (German transliterated into Hebrew characters), it epitomizes what might be called his Jewish work ethic and his impatience with his less mercurial brothers:

I am writing to you giving my opinion, as it is my damned duty to write to you . . . I am reading through your letters not just once but maybe a hundred times. You can well imagine that yourself. After dinner I usually have nothing to do. I do not read books, I do not play cards, I do not go to the theatre, my only pleasure is my business and in this way I read Amschel's, Salomon's, James's and Carl's letters . . . As far as Carl's letter [about buying a bigger house in Frankfurt] is concerned . . . all this is a lot of nonsense because as long as we have good business and are rich everybody will flatter us and those who have no interest in obtaining revenues through us begrudge us for it all. Our Salomon is too good and agreeable to anything and anybody and if a parasite whispers something into his ear he thinks that all human beings are noble minded[;] the truth is that all they are after is their own interest.

Small wonder his brothers called Nathan 'the general in chief. 'All you ever write', complained Salomon wearily in 1815 , 'is pay this, pay that, send this, send that.' It was this phenomenal drive, allied to innate financial genius, that propelled Nathan from the obscurity of the Frankfurt Judengasse to mastery of the London bond market. Once again, however, the opportunity for financial innovation was provided by war.