Money. Money? Money! (IV)

Anyone who can read a post like the preceding one without feeling anxious does not know enough financial history. One purpose of these articles, then, is to educate. It is a wellestablished fact, after all, that a substantial proportion of the general public in the English-speaking world is ignorant of finance. According to one 2007 survey, four in ten American credit card holders do not pay the full amount due every month on the card they use most often, despite the punitively high interest rates charged by credit card companies. Nearly a third (29 per cent) said they had no idea what the interest rate on their card was. Another 30 per cent claimed that it was below 10 per cent, when in reality the overwhelming majority of card companies charge substantially in excess of 10 per cent. More than half of the respondents said they had learned 'not too much' or 'nothing at all' about financial issues at school. A 2008 survey revealed that two thirds of Americans did not understand how compound interest worked. In one survey conducted by researchers at the University of Buffalo's School of Management, a typical group of high school seniors scored just 52 per cent in response to a set of questions about personal finance and economics. Only 14 per cent understood that stocks would
tend to generate a higher return over eighteen years than a US government bond. Less than 23 per cent knew that income tax is charged on the interest earned from a savings account if the account holder's income is high enough. Fully 59 per cent did not know the difference between a company pension, Social Security and a 401 (k) plan.*

(NB *  40i(k) plans were introduced in 1980 as a form of defined contribution retirement plan. Employees can elect to have a portion of their wages or salaries paid or 'deferred' into a 401 (k) account. They are then offered choices as to how the money should be invested. With a few exceptions, no tax is paid on the money until it is withdrawn.)

Nor is this a uniquely American phenomenon. In 2006, the British Financial Services Authority carried out a survey of public financial literacy which revealed that one person in five had no idea what the effect would be on the purchasing power of their savings of an inflation rate of 5 per cent and an interest rate of 3 per cent. One in ten did not know which was the better discount for a television originally priced at £250: £30 or 10 per cent. As that example makes clear, the questions posed in these surveys were of the most basic nature. It seems reasonable to assume that only a handful of those polled would have been able to explain the difference between a 'put' and a 'call' option, for example, much less the difference between a CDO and a CDS.


Politicians, central bankers and businessmen regularly lament the extent of public ignorance about money, and with good reason. A society that expects most individuals to take responsibility for the management of their own expenditure and income after tax, that expects most adults to own their own homes and that leaves it to the individual to determine how much to save for retirement and whether or not to take out health insurance, is surely storing up trouble for the future by leaving its citizens so ill-equipped to make wise financial decisions.

The first step towards understanding the complexities of modern financial institutions and terminology is to find out where they came from. Only understand the origins of an institution or instrument and you will find its present-day role much easier to grasp. Accordingly, the key components of the modern financial system are introduced sequentially. Each artical addresses a key historical question. When did money stop being metal and mutate into paper, before vanishing altogether? Is it true that, by setting long-term interest rates, the bond market rules the world? What is the role played by central banks in stock market bubbles and busts? Why is insurance not necessarily the best way to protect yourself from risk? Do people exaggerate the benefits of investing in real estate? And is the economic inter-dependence of China and America the key to global financial stability, or a mere chimera?

to be continued...