Why study financial history? For historical context that helps to make sense of the current world.
Not surprisingly, the 2008–2009 global financial crisis sent many financial professionals looking to history for a sense of appropriate context and perspective to understand the magnitude of such a catastrophic financial shock. This, in turn, sparked a general interest in financial history but with few professional sources to turn to. At the 2014 Middle East Investment Conference, professor Adrian R. Bell, head of the ICMA Centre at the University of Reading’s Henley Business School, considered the question of whether modern finance existed in the Middle Ages.
Bell hesitated, but nonetheless conceded, that finance seems to be as old as the agricultural revolution in Mesopotamia more than 3,000 years ago. It was then that forward contracts carved into cuneiform tablets — one for barley (at an interest rate of 33.33%) and the other for silver (at an interest rate of 20%) — were entered into between a person and a god (at least the god’s intermediary, a priest). Put another way, finance seems to be an inevitable consequence of human activity, and its invention was predetermined.
So how does Bell look for evidence of finance’s presence through the ages? By looking for evidence of three distinct business transactions that lie at the heart of all finance, both today and historically:
- An understanding of the time value of money (i.e., interest on loans)
- An existence of forward contracts, such as whether they are for a bet, life insurance, home insurance, merchant venturers, and commodities
- Presence of a legal basis to transfer financial claims (i.e., secondary markets and bank drafts)
Using the above criteria as filters for historical documents, Bell sees evidence of finance in almost all ancient cultures, ranging from China — where paper money was invented — to medieval European bills of exchange. These bills, just like modern finance’s derivative contracts, were made intentionally complex to skirt the ancient regulatory authority, in this case, God. Apparently, God was omniscient in all things excepting finance. In all seriousness, the bills of exchange were made so complex so as to circumvent the Catholic church’s admonition against charging interest, which made usury a crime.
Ancient finance also had sovereign defaults on debts. Bell highlighted an early default that occurred when England’s King Edward III could not pay his debts back to the Italian merchants that lent him money. Edward’s annual income is estimated to have been £30,000, and it is believed that the merchants lent money to the English monarch such that his debt-to-GDP ratio was many orders of magnitude greater than 1×. Some things never change.
When asked about further similarities between ancient and modern finance, Bell said, “It has always been the same; it is about credit.” However, he starkly pointed out that what is different about modern finance is that now there is trading taking place on leverage just for trading’s sake. Bell said that this level of speculation is unique in human financial history.
Most interestingly, Bell pointed out that the interest rates quoted by historians are almost always wrong. This is because historians do not seem to understand the time value of money, and they report interest in absolute terms without making the usual adjustment for the passage of time. Consequently, the historical interest rates quoted are almost always far too high. Bell provided data that showed many interest rates were around the 14% range in the Middle Ages.
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