The Ascent of Money_ A Financial History Part 1

The Ascent of Money.

A Financial History.

by Niall Ferguson.

Introduction.

Bread, cash, dosh, dough, loot, lucre, moolah, readies, the where-withal: call it what you like, money matters. To Christians, the love of it is the root of all evil. To generals, it is the sinews of war; to revolutionaries, the shackles of labour. But what exactly is money? Is it a mountain of silver, as the Spanish conquistadors thought? Or will mere clay tablets and printed paper suffice? How did we come to live in a world where most money is invisible, little more than numbers on a computer screen? Where did money come from? And where did it all go?

Last year (2007) the income of the average American (just under $34,000) went up by at most 5 per cent.1 But the cost of living rose by 4.1 per cent. So in real terms Mr Average actually became just 0.9 per cent better off. Allowing for inflation, the income of the median household in the United States has in fact scarcely changed since 1990, increasing by just 7 per cent in eighteen years. But the cost of living rose by 4.1 per cent. So in real terms Mr Average actually became just 0.9 per cent better off. Allowing for inflation, the income of the median household in the United States has in fact scarcely changed since 1990, increasing by just 7 per cent in eighteen years.2 Now compare Mr Average's situation with that of Lloyd Blankfein, chief executive officer at Goldman Sachs, the investment bank. In 2007 he received $68.5 million in salary, bonus and stock awards, an increase of 25 per cent on the previous year, and roughly two thousand times more than Joe Public earned. That same year, Goldman Sachs's net revenues of $46 billion exceeded the entire gross domestic product (GDP) of more than a hundred countries, including Croatia, Serbia and Slovenia; Bolivia, Ecuador and Guatemala; Angola, Syria and Tunisia. The bank's total a.s.sets for the first time pa.s.sed the $1 trillion mark. Now compare Mr Average's situation with that of Lloyd Blankfein, chief executive officer at Goldman Sachs, the investment bank. In 2007 he received $68.5 million in salary, bonus and stock awards, an increase of 25 per cent on the previous year, and roughly two thousand times more than Joe Public earned. That same year, Goldman Sachs's net revenues of $46 billion exceeded the entire gross domestic product (GDP) of more than a hundred countries, including Croatia, Serbia and Slovenia; Bolivia, Ecuador and Guatemala; Angola, Syria and Tunisia. The bank's total a.s.sets for the first time pa.s.sed the $1 trillion mark.3 Yet Lloyd Blankfein is far from being the financial world's highest earner. The veteran hedge fund manager George Soros made $2.9 billion. Ken Griffin of Citadel, like the founders of two other leading hedge funds, took home more than $2 billion. Meanwhile nearly a billion people around the world struggle to get by on just $1 a day. Yet Lloyd Blankfein is far from being the financial world's highest earner. The veteran hedge fund manager George Soros made $2.9 billion. Ken Griffin of Citadel, like the founders of two other leading hedge funds, took home more than $2 billion. Meanwhile nearly a billion people around the world struggle to get by on just $1 a day.4 Angry that the world is so unfair? Infuriated by fat-cat capitalists and billion-bonus bankers? Baffled by the yawning chasm between the Haves, the Have-nots - and the Have-yachts? You are not alone. Throughout the history of Western civilization, there has been a recurrent hostility to finance and financiers, rooted in the idea that those who make their living from lending money are somehow parasitical on the 'real' economic activities of agriculture and manufacturing. This hostility has three causes. It is partly because debtors have tended to outnumber creditors and the former have seldom felt very well disposed towards the latter. It is partly because financial crises and scandals occur frequently enough to make finance appear to be a cause of poverty rather than prosperity, volatility rather than stability. And it is partly because, for centuries, financial services in countries all over the world were disproportionately provided by members of ethnic or religious minorities, who had been excluded from land owners.h.i.+p or public office but enjoyed success in finance because of their own tight-knit networks of kins.h.i.+p and trust.

Despite our deeply rooted prejudices against 'filthy lucre', however, money is the root of most progress. To adapt a phrase from Jacob Bronowski (whose marvellous television history of scientific progress I watched avidly as a schoolboy), the ascent of money has been essential to the ascent of man. Far from being the work of mere leeches intent on sucking the life's blood out of indebted families or gambling with the savings of widows and orphans, financial innovation has been an indispensable factor in man's advance from wretched subsistence to the giddy heights of material prosperity that so many people know today. The evolution of credit and debt was as important as any technological innovation in the rise of civilization, from ancient Babylon to present-day Hong Kong. Banks and the bond market provided the material basis for the splendours of the Italian Renaissance. Corporate finance was the indispensable foundation of both the Dutch and British empires, just as the triumph of the United States in the twentieth century was inseparable from advances in insurance, mortgage finance and consumer credit. Perhaps, too, it will be a financial crisis that signals the twilight of American global primacy.

Behind each great historical phenomenon there lies a financial secret, and this book sets out to illuminate the most important of these. For example, the Renaissance created such a boom in the market for art and architecture because Italian bankers like the Medici made fortunes by applying Oriental mathematics to money. The Dutch Republic prevailed over the Habsburg Empire because having the world's first modern stock market was financially preferable to having the world's biggest silver mine. The problems of the French monarchy could not be resolved without a revolution because a convicted Scots murderer had wrecked the French financial system by unleas.h.i.+ng the first stock market bubble and bust. It was Nathan Rothschild as much as the Duke of Wellington who defeated Napoleon at Waterloo. It was financial folly, a self-destructive cycle of defaults and devaluations, that turned Argentina from the world's sixth-richest country in the 1880s into the inflation-ridden basket case of the 1980s.

Read this book and you will understand why, paradoxically, the people who live in the world's safest country are also the world's most insured. You will discover when and why the English-speaking peoples developed their peculiar obsession with buying and selling houses. Perhaps most importantly, you will see how the globalization of finance has, among many other things, blurred the old distinction between developed and emerging markets, turning China into America's banker - the Communist creditor to the capitalist debtor, a change of epochal significance.

At times, the ascent of money has seemed inexorable. In 2006 the measured economic output of the entire world was around $47 trillion. The total market capitalization of the world's stock markets was $51 trillion, 10 per cent larger. The total value of domestic and international bonds was $68 trillion, 50 per cent larger. The amount of derivatives outstanding was $473 trillion, more than ten times larger. Planet Finance is beginning to dwarf Planet Earth. And Planet Finance seems to spin faster too. Every day two trillion dollars change hands on foreign exchange markets. Every month seven trillion dollars change hands on global stock markets. Every minute of every hour of every day of every week, someone, somewhere, is trading. And all the time new financial life forms are evolving. In 2006, for example, the volume of leveraged buyouts (takeovers of firms financed by borrowing) surged to $753 billion. An explosion of 'securitization', whereby individual debts like mortgages are 'tranched' then bundled together and repackaged for sale, pushed the total annual issuance of mortgage backed securities, a.s.set-backed securities and collateralized debt obligations above $3 trillion. The volume of derivatives - contracts derived from securities, such as interest rate swaps or credit default swaps (CDS) - has grown even faster, so that by the end of 2007 the notional value of all 'over-the-counter' derivatives (excluding those traded on public exchanges) was just under $600 trillion. Before the 1980s, such things were virtually unknown. New inst.i.tutions, too, have proliferated. The first hedge fund was set up in the 1940s and, as recently as 1990, there were just 610 of them, with $38 billion under management. There are now over seven thousand, with $1.9 trillion under management. Private equity partners.h.i.+ps have also multiplied, as well as a veritable shadow banking system of 'conduits' and 'structured investment vehicles' (SIVs), designed to keep risky a.s.sets off bank balance sheets. If the last four millennia witnessed the ascent of man the thinker, we now seem to be living through the ascent of man the banker.

In 1947 the total value added by the financial sector to US gross domestic product was 2.3 per cent; by 2005 its contribution had risen to 7.7 per cent of GDP. In other words, approximately $1 of every $13 paid to employees in the United States now goes to people working in finance.5 Finance is even more important in Britain, where it accounted for 9.4 per cent of GDP in 2006. The financial sector has also become the most powerful magnet in the world for academic talent. Back in 1970 only around 5 per cent of the men graduating from Harvard, where I teach, went into finance. By 1990 that figure had risen to 15 per cent. Finance is even more important in Britain, where it accounted for 9.4 per cent of GDP in 2006. The financial sector has also become the most powerful magnet in the world for academic talent. Back in 1970 only around 5 per cent of the men graduating from Harvard, where I teach, went into finance. By 1990 that figure had risen to 15 per cent.a Last year the proportion was even higher. According to the Last year the proportion was even higher. According to the Harvard Crimson Harvard Crimson, more than 20 per cent of the men in the Cla.s.s of 2007, and 10 per cent of the women, expected their first jobs to be at banks. And who could blame them? In recent years, the pay packages in finance have been nearly three times the salaries earned by Ivy League graduates in other sectors of the economy.

At the time the Cla.s.s of 2007 graduated, it certainly seemed as if nothing could halt the rise and rise of global finance. Not terrorist attacks on New York and London. Not raging war in the Middle East. Certainly not global climate change. Despite the destruction of the World Trade Center, the invasions of Afghanistan and Iraq, and a spike in extreme meteorological events, the period from late 2001 until mid 2007 was characterized by sustained financial expansion. True, in the immediate aftermath of 9/11, the Dow Jones Industrial Average declined by as much as 14 per cent. Within just over two months, however, it had regained its pre-9/11 level. Moreover, although 2002 was a disappointing year for US equity investors, the market surged ahead thereafter, exceeding its previous peak (at the height of the 'dot com' mania) in the autumn of 2006. By early October 2007 the Dow stood at nearly double the level it had reached in the trough of five years before. Nor was the US stock market's performance exceptional. In the five years to 31 July 2007, all but two of the world's equity markets delivered double-digit returns on an annualized basis. Emerging market bonds also rose strongly and real estate markets, especially in the English-speaking world, saw remarkable capital appreciation. Whether they put their money into commodities, works of art, vintage wine or exotic a.s.set-backed securities, investors made money.

How were these wonders to be explained? According to one school of thought, the latest financial innovations had brought about a fundamental improvement in the efficiency of the global capital market, allowing risk to be allocated to those best able to bear it. Enthusiasts spoke of the death of volatility. Self-satisfied bankers held conferences with t.i.tles like 'The Evolution of Excellence'. In November 2006 I found myself at one such conference in the characteristically luxurious venue of Lyford Cay in the Bahamas. The theme of my speech was that it would not take much to cause a drastic decline in the liquidity that was then cascading through the global financial system and that we should be cautious about expecting the good times to last indefinitely. My audience was distinctly unimpressed. I was dismissed as an alarmist. One of the most experienced investors there went so far as to suggest to the organizers that they 'dispense altogether with an outside speaker next year, and instead offer a screening of Mary Poppins'.6 Yet the mention of Mary Poppins stirred a childhood memory in me. Julie Andrews fans may recall that the plot of the evergreen musical revolves around a financial event which, when the film was made in the 1960s, already seemed quaint: a bank run - that is, a rush by depositors to withdraw their money - something not seen in London since 1866. Yet the mention of Mary Poppins stirred a childhood memory in me. Julie Andrews fans may recall that the plot of the evergreen musical revolves around a financial event which, when the film was made in the 1960s, already seemed quaint: a bank run - that is, a rush by depositors to withdraw their money - something not seen in London since 1866.

The family that employs Mary Poppins is, not accidentally, named Banks. Mr Banks is indeed a banker, a senior employee of the Dawes, Tomes Mousley, Grubbs, Fidelity Fiduciary Bank. At his insistence, the Banks children are one day taken by their new nanny to visit his bank, where Mr Dawes Sr. recommends that Mr Banks's son Michael deposit his pocket-money (tuppence). Unfortunately, young Michael prefers to spend the money on feeding the pigeons outside the bank, and demands that Mr Dawes 'Give it back! Gimme back my money!' Even more unfortunately, some of the bank's other clients overhear Michael's request. The result is that they begin to withdraw their money. Soon a horde of account holders are doing the same, forcing the bank to suspend payments. Mr Banks is duly sacked, prompting the tragic lament that he has been 'brought to wrack and ruin in his prime'. These words might legitimately have been echoed by Adam Applegarth, the former chief executive of the English bank Northern Rock, who suffered a similar fate in September 2007 as customers queued outside his bank's branches to withdraw their cash. This followed the announcement that Northern Rock had requested a 'liquidity support facility' from the Bank of England.

The financial crisis that struck the Western world in the summer of 2007 provided a timely reminder of one of the perennial truths of financial history. Sooner or later every bubble bursts. Sooner or later the bearish sellers outnumber the bullish buyers. Sooner or later greed turns to fear. As I completed my research for this book in the early months of 2008, it was already a distinct possibility that the US economy might suffer a recession. Was this because American companies had got worse at designing new products? Had the pace of technological innovation suddenly slackened? No. The proximate cause of the economic uncertainty of 2008 was financial: to be precise, a spasm in the credit markets caused by mounting defaults on a species of debt known euphemistically as subprime mortgages. So intricate has our global financial system become, that relatively poor families in states from Alabama to Wisconsin had been able to buy or remortgage their homes with often complex loans that (unbeknown to them) were then bundled together with other, similar loans, repackaged as collateralized debt obligations (CDOs) and sold by banks in New York and London to (among others) German regional banks and Norwegian munic.i.p.al authorities, who thereby became the effective mortgage lenders. These CDOs had been so sliced and diced that it was possible to claim that a tier of the interest payments from the original borrowers was as dependable a stream of income as the interest on a ten-year US Treasury bond, and therefore worthy of a coveted triple-A rating. This took financial alchemy to a new level of sophistication, apparently turning lead into gold.

However, when the original mortgages reset at higher interest rates after their one- or two-year 'teaser' periods expired, the borrowers began to default on their payments. This in turn signalled that the bubble in US real estate was bursting, triggering the sharpest fall in house prices since the 1930s. What followed resembled a slow but ultimately devastating chain reaction. All kinds of a.s.set-backed securities, including many instruments not in fact backed with subprime mortgages, slumped in value. Inst.i.tutions like conduits and structured investment vehicles, which had been set up by banks to hold these securities off the banks' balance sheets, found themselves in severe difficulties. As the banks took over the securities, the ratios between their capital and their a.s.sets lurched down towards their regulatory minima. Central banks in the United States and Europe sought to alleviate the pressure on the banks with interest rate cuts and offers of funds through special 'term auction facilities'. Yet, at the time of writing (May 2008), the rates at which banks could borrow money, whether by issuing commercial paper, selling bonds or borrowing from each other, remained substantially above the official Federal funds target rate, the minimum lending rate in the US economy. Loans that were originally intended to finance purchases of corporations by private equity partners.h.i.+ps were also only saleable at significant discounts. Having suffered enormous losses, many of the best-known American and European banks had to turn not only to Western central banks for short-term a.s.sistance to rebuild their reserves but also to Asian and Middle Eastern sovereign wealth funds for equity injections in order to rebuild their capital bases.

All of this may seem arcane to some readers. Yet the ratio of a bank's capital to its a.s.sets, technical though it may sound, is of more than merely academic interest. After all, a 'great contraction' in the US banking system has convincingly been blamed for the outbreak and course of the Great Depression between 1929 and 1933, the worst economic disaster of modern history.7 If US banks have lost significantly more than the $255 billion to which they have so far admitted as a result of the subprime mortgage crisis and credit crunch, there is a real danger that a much larger - perhaps tenfold larger - contraction in credit may be necessary to shrink the banks' balance sheets in proportion to the decline in their capital. If the shadow banking system of securitized debt and off-balance-sheet inst.i.tutions is to be swept away completely by this crisis, the contraction could be still more severe. If US banks have lost significantly more than the $255 billion to which they have so far admitted as a result of the subprime mortgage crisis and credit crunch, there is a real danger that a much larger - perhaps tenfold larger - contraction in credit may be necessary to shrink the banks' balance sheets in proportion to the decline in their capital. If the shadow banking system of securitized debt and off-balance-sheet inst.i.tutions is to be swept away completely by this crisis, the contraction could be still more severe.

This has implications not just for the United States but for the world as a whole, since American output presently accounts for more than a quarter of total world production, while many European and Asian economies in particular are still heavily reliant on the United States as a market for their exports. Europe already seems destined to experience a slowdown comparable with that of the United States, particularly in those countries (such as Britain and Spain) that have gone through similar housing bubbles. The extent to which Asia can ride out an American recession, in the way that America rode out the Asian crisis of 1997-8, remains uncertain. What is certain is that the efforts of the Federal Reserve to mitigate the credit crunch by cutting interest rates and targeting liquidity at the US banking system have put severe downward pressure on the external value of the dollar. The coincidence of a dollar slide and continuing Asian industrial growth has caused a spike in commodity prices comparable not merely with the 1970s but with the 1940s. It is not too much to say that in mid-2008 we witnessed the inflationary symptoms of a world war without the war itself.

Anyone who can read a paragraph like the preceding one without feeling anxious does not know enough financial history. One purpose of this book, then, is to educate. It is a well-established 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.8 A 2008 survey revealed that two thirds of Americans did not understand how compound interest worked. A 2008 survey revealed that two thirds of Americans did not understand how compound interest worked.9 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. 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.10 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. 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.b 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 a.s.sume 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. 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 a.s.sume 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 inst.i.tutions and terminology is to find out where they came from. Only understand the origins of an inst.i.tution 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. The first chapter of this book traces the rise of money and credit; the second the bond market; the third the stock market. Chapter 4 tells the story of insurance; Chapter 5 the real estate market; and Chapter 6 the rise, fall and rise of international finance. Each chapter addresses a key historical question. When did money stop being metal and mutate into paper, before vanis.h.i.+ng 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?

In trying to cover the history of finance from ancient Mesopotamia to modern microfinance, I have set myself an impossible task, no doubt. Much must be omitted in the interests of brevity and simplicity. Yet the attempt seems worth making if it can bring the modern financial system into sharper focus in the mind's eye of the general reader.

I myself have learned a great deal in writing this book, but three insights in particular stand out. The first is that poverty is not the result of rapacious financiers exploiting the poor. It has much more to do with the lack lack of financial inst.i.tutions, with the absence of banks, not their presence. Only when borrowers have access to efficient credit networks can they escape from the clutches of loan sharks, and only when savers can deposit their money in reliable banks can it be channelled from the idle rich to the industrious poor. This point applies not just to the poor countries of the world. It can also be said of the poorest neighbourhoods in supposedly developed countries - the 'Africas within' - like the housing estates of my birthplace, Glasgow, where some people are sc.r.a.ping by on just 6 a day, for everything from toothpaste to transport, but where the interest rates charged by local loan sharks can be over eleven million per cent a year. of financial inst.i.tutions, with the absence of banks, not their presence. Only when borrowers have access to efficient credit networks can they escape from the clutches of loan sharks, and only when savers can deposit their money in reliable banks can it be channelled from the idle rich to the industrious poor. This point applies not just to the poor countries of the world. It can also be said of the poorest neighbourhoods in supposedly developed countries - the 'Africas within' - like the housing estates of my birthplace, Glasgow, where some people are sc.r.a.ping by on just 6 a day, for everything from toothpaste to transport, but where the interest rates charged by local loan sharks can be over eleven million per cent a year.

My second great realization has to do with equality and its absence. If the financial system has a defect, it is that it reflects and magnifies what we human beings are like. As we are learning from a growing volume of research in the field of behavioural finance, money amplifies our tendency to overreact, to swing from exuberance when things are going well to deep depression when they go wrong. Booms and busts are products, at root, of our emotional volatility. But finance also exaggerates the differences between us, enriching the lucky and the smart, impoveris.h.i.+ng the unlucky and not-so-smart. Financial globalization means that, after more than three hundred years of divergence, the world can no longer be divided neatly into rich developed countries and poor less-developed countries. The more integrated the world's financial markets become, the greater the opportunities for financially knowledgeable people wherever they live - and the bigger the risk of downward mobility for the financially illiterate. It emphatically is not a flat world in terms of overall income distribution, simply because the returns on capital have soared relative to the returns on unskilled and semi-skilled labour. The rewards for 'getting it' have never been so immense. And the penalties for financial ignorance have never been so stiff.

Finally, I have come to understand that few things are harder to predict accurately than the timing and magnitude of financial crises, because the financial system is so genuinely complex and so many of the relations.h.i.+ps within it are non-linear, even chaotic. The ascent of money has never been smooth, and each new challenge elicits a new response from the bankers and their ilk. Like an Andean horizon, the history of finance is not a smooth upward curve but a series of jagged and irregular peaks and valleys. Or, to vary the metaphor, financial history looks like a cla.s.sic case of evolution in action, albeit in a much tighter timeframe than evolution in the natural world. 'Just as some species become extinct in nature,' remarked US a.s.sistant Secretary of the Treasury Anthony W. Ryan before Congress in September 2007, 'some new financing techniques may prove to be less successful than others.' Such Darwinian language seems remarkably apposite as I write.

Are we on the brink of a 'great dying' in the financial world - one of those ma.s.s extinctions of species that have occurred periodically, like the end-Cambrian extinction that killed off 90 per cent of Earth's species, or the Cretaceous-Tertiary catastrophe that wiped out the dinosaurs? It is a scenario that many biologists have reason to fear, as man-made climate change wreaks havoc with natural habitats around the globe. But a great dying of financial inst.i.tutions is also a scenario that we should worry about, as another man-made disaster works its way slowly and painfully through the global financial system.

For all these reasons, then - whether you are struggling to make ends meet or striving to be a master of the universe - it has never been more necessary to understand the ascent of money than it is today. If this book helps to break down that dangerous barrier which has arisen between financial knowledge and other kinds of knowledge, then I shall not have toiled in vain.

1.

Dreams of Avarice.

Imagine a world with no money. For over a hundred years, Communists and anarchists - not to mention some extreme reactionaries, religious fundamentalists and hippies - have dreamt of just that. According to Friedrich Engels and Karl Marx, money was merely an instrument of capitalist exploitation, replacing all human relations.h.i.+ps, even those within the family, with the callous 'cash nexus'. As Marx later sought to demonstrate in Capital Capital, money was commoditized labour, the surplus generated by honest toil, appropriated and then 'reified' in order to satisfy the capitalist cla.s.s's insatiable l.u.s.t for acc.u.mulation. Such notions die hard. As recently as the 1970s, some European Communists were still yearning for a moneyless world, as in this Utopian effusion from the Socialist Standard Socialist Standard:

Money will disappear . . . Gold can be reserved in accordance with Lenin's wish, for the construction of public lavatories . . . In communist societies goods will be freely available and free of charge. The organisation of society to its very foundations will be without money . . . The frantic and neurotic desire to consume and h.o.a.rd will disappear. It will be absurd to want to acc.u.mulate things: there will no longer be money to be pocketed nor wage-earners to be hired . . . The new people will resemble their hunting and gathering ancestors who trusted in a nature which supplied them freely and often abundantly with what they needed to live, and who had no worry for the morrow . . .1

Yet no Communist state - not even North Korea - has found it practical to dispense with money.2 And even a pa.s.sing acquaintance with real hunter-gatherer societies suggests there are considerable disadvantages to the cash-free life. And even a pa.s.sing acquaintance with real hunter-gatherer societies suggests there are considerable disadvantages to the cash-free life.

Five years ago, members of the Nukak-Maku unexpectedly wandered out of the Amazonian rainforest at San Jose del Guaviare in Colombia. The Nukak were a tribe that time forgot, cut off from the rest of humanity until this sudden emergence. Subsisting solely on the monkeys they could hunt and the fruit they could gather, they had no concept of money. Revealingly, they had no concept of the future either. These days they live in a clearing near the city, reliant for their subsistence on state handouts. Asked if they miss the jungle, they laugh. After lifetimes of trudging all day in search of food, they are amazed that perfect strangers now give them all they need and ask nothing from them in return.3 The life of a hunter-gatherer is indeed, as Thomas Hobbes said of the state of nature, 'solitary, poor, nasty, brutish, and short'. In some respects, to be sure, wandering through the jungle bagging monkeys may be preferable to the hard slog of subsistence agriculture. But anthropologists have shown that many of the hunter-gatherer tribes who survived into modern times were less placid than the Nukak. Among the Jivaro of Ecuador, for example, nearly 60 per cent of male deaths were due to violence. The figure for the Brazilian Yanomamo was nearly 40 per cent. When two groups of such primitive peoples chanced upon each other, it seems, they were more likely to fight over scarce resources (food and fertile women) than to engage in commercial exchange. Hunter-gatherers do not trade. They raid. Nor do they save, consuming their food as and when they find it. They therefore have no need of money.

The Money Mountain More sophisticated societies than the Nukak have functioned without money, it is true. Five hundred years ago, the most sophisticated society in South America, the Inca Empire, was also moneyless. The Incas 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 Inca Empire, just as it was later supposed to be in a Communist society. And, as under Communism, the economy depended on often harsh central planning and forced labour. In 1532, however, the Inca Empire was brought low by a man who, like Christopher Columbus, had come to the New World expressly to search for and monetize precious metal.c The illegitimate son of a Spanish colonel, Francisco Pizarro had crossed the Atlantic to seek his fortune in 1502.4 One of the first Europeans to traverse the isthmus of Panama to the Pacific, he led the first of three expeditions into Peru in 1524. The terrain was harsh, food scarce and the first indigenous peoples they encountered hostile. However, the welcome their second expedition received in the Tumbes region, where the inhabitants hailed them as the 'children of the sun', convinced Pizarro and his confederates to persist. Having returned to Spain to obtain royal approval for his plan 'to extend the empire of Castile' One of the first Europeans to traverse the isthmus of Panama to the Pacific, he led the first of three expeditions into Peru in 1524. The terrain was harsh, food scarce and the first indigenous peoples they encountered hostile. However, the welcome their second expedition received in the Tumbes region, where the inhabitants hailed them as the 'children of the sun', convinced Pizarro and his confederates to persist. Having returned to Spain to obtain royal approval for his plan 'to extend the empire of Castile'd as 'Governor of Peru', Pizarro raised a force of three s.h.i.+ps, twenty-seven horses and one hundred and eighty men, equipped with the latest European weaponry: guns and mechanical crossbows. as 'Governor of Peru', Pizarro raised a force of three s.h.i.+ps, twenty-seven horses and one hundred and eighty men, equipped with the latest European weaponry: guns and mechanical crossbows.5 This third expedition set sail from Panama on 27 December 1530. It took the would-be conquerors just under two years to achieve their objective: a confrontation with Atahuallpa, one of the two feuding sons of the recently deceased Incan emperor Huayna Capac. Having declined Friar Vincente Valverd's proposal that he submit to Christian rule, contemptuously throwing his Bible to the ground, Atahuallpa could only watch as the Spaniards, relying mainly on the terror inspired by their horses (animals unknown to the Incas), annihilated his army. Given how outnumbered they were, it was a truly astonis.h.i.+ng coup. This third expedition set sail from Panama on 27 December 1530. It took the would-be conquerors just under two years to achieve their objective: a confrontation with Atahuallpa, one of the two feuding sons of the recently deceased Incan emperor Huayna Capac. Having declined Friar Vincente Valverd's proposal that he submit to Christian rule, contemptuously throwing his Bible to the ground, Atahuallpa could only watch as the Spaniards, relying mainly on the terror inspired by their horses (animals unknown to the Incas), annihilated his army. Given how outnumbered they were, it was a truly astonis.h.i.+ng coup.6 Atahuallpa soon came to understand what Pizarro was after, and sought to buy his freedom by offering to fill the room where he was being held with gold (once) and silver (twice). In all, in the subsequent months the Incas collected 13,420 pounds of 22 carat gold and 26,000 pounds of pure silver. Atahuallpa soon came to understand what Pizarro was after, and sought to buy his freedom by offering to fill the room where he was being held with gold (once) and silver (twice). In all, in the subsequent months the Incas collected 13,420 pounds of 22 carat gold and 26,000 pounds of pure silver.7 Pizarro nevertheless determined to execute his prisoner, who was publicly garrotted in August 1533. Pizarro nevertheless determined to execute his prisoner, who was publicly garrotted in August 1533.8 With the fall of the city of Cuzco, the Inca Empire was torn apart in an orgy of Spanish plundering. Despite a revolt led by the supposedly puppet Inca Manco Capac in 1536, Spanish rule was unshakeably established and symbolized by the construction of a new capital, Lima. The Empire was formally dissolved in 1572. With the fall of the city of Cuzco, the Inca Empire was torn apart in an orgy of Spanish plundering. Despite a revolt led by the supposedly puppet Inca Manco Capac in 1536, Spanish rule was unshakeably established and symbolized by the construction of a new capital, Lima. The Empire was formally dissolved in 1572.

Pizarro himself died as violently as he had lived, stabbed to death in Lima in 1541 after a quarrel with one of his fellow conquistadors. But his legacy to the Spanish crown ultimately exceeded even his own dreams. The conquistadors had been inspired by the legend of El Dorado, an Indian king who was believed to cover his body with gold dust at festival times. In what Pizarro's men called Upper Peru, a stark land of mountains and mists where those unaccustomed to high alt.i.tudes have to fight for breath, they found something just as valuable. With a peak that towers 4,824 metres (15,827 feet) above sea level, the uncannily symmetrical Cerro Rico - literally the 'rich hill' - was the supreme embodiment of the most potent of all ideas about money: a mountain of solid silver ore. When an Indian named Diego Gualpa discovered its five great seams of silver in 1545, he changed the economic history of the world.9 The Incas could not understand the insatiable l.u.s.t for gold and silver that seemed to grip Europeans. 'Even if all the snow in the Andes turned to gold, still they would not be satisfied,' complained Manco Capac.10 The Incas could not appreciate that, for Pizarro and his men, silver was more than s.h.i.+ny, decorative metal. It could be made into money: a unit of account, a store of value - portable power. The Incas could not appreciate that, for Pizarro and his men, silver was more than s.h.i.+ny, decorative metal. It could be made into money: a unit of account, a store of value - portable power.

To work the mines, the Spaniards at first relied on paying wages to the inhabitants of nearby villages. But conditions were so harsh that from the late sixteenth century a system of forced labour (la mita) had to be introduced, whereby men aged between 18 and 50 from the sixteen highland provinces were conscripted for seventeen weeks a year.11 Mortality among the miners was horrendous, not least because of constant exposure to the mercury fumes generated by the patio process of refinement, whereby ground-up silver ore was trampled into an amalgam with mercury, washed and then heated to burn off the mercury. Mortality among the miners was horrendous, not least because of constant exposure to the mercury fumes generated by the patio process of refinement, whereby ground-up silver ore was trampled into an amalgam with mercury, washed and then heated to burn off the mercury.12 The air down the mineshafts was (and remains) noxious and miners had to descend seven-hundred-foot shafts on the most primitive of steps, clambering back up after long hours of digging with sacks of ore tied to their backs. Rock falls killed and maimed hundreds. The new silver-rush city of Potosi was, declared Domingo de Santo Tomas, 'a mouth of h.e.l.l, into which a great ma.s.s of people enter every year and are sacrificed by the greed of the Spaniards to their "G.o.d".' Rodrigo de Loaisa called the mines 'infernal pits', noting that 'if twenty healthy Indians enter on Monday, half may emerge crippled on Sat.u.r.day'. The air down the mineshafts was (and remains) noxious and miners had to descend seven-hundred-foot shafts on the most primitive of steps, clambering back up after long hours of digging with sacks of ore tied to their backs. Rock falls killed and maimed hundreds. The new silver-rush city of Potosi was, declared Domingo de Santo Tomas, 'a mouth of h.e.l.l, into which a great ma.s.s of people enter every year and are sacrificed by the greed of the Spaniards to their "G.o.d".' Rodrigo de Loaisa called the mines 'infernal pits', noting that 'if twenty healthy Indians enter on Monday, half may emerge crippled on Sat.u.r.day'.13 In the words of the Augustinian monk Fray Antonio de la Calancha, writing in 1638: 'Every peso coin minted in Potosi has cost the life of ten Indians who have died in the depths of the mines.' As the indigenous workforce was depleted, thousands of African slaves were imported to take their places as 'human mules'. Even today there is still something h.e.l.lish about the stifling shafts and tunnels of the Cerro Rico. In the words of the Augustinian monk Fray Antonio de la Calancha, writing in 1638: 'Every peso coin minted in Potosi has cost the life of ten Indians who have died in the depths of the mines.' As the indigenous workforce was depleted, thousands of African slaves were imported to take their places as 'human mules'. Even today there is still something h.e.l.lish about the stifling shafts and tunnels of the Cerro Rico.

The Cerro Rico at Potosi: the Spanish Empire's mountain of money A place of death for those compelled to work there, Potosi was where Spain struck it rich. Between 1556 and 1783, the 'rich hill' yielded 45,000 tons of pure silver to be transformed into bars and coins in the Casa de Moneda (mint), and s.h.i.+pped to Seville. Despite its thin air and harsh climate, Potosi rapidly became one of the princ.i.p.al cities of the Spanish Empire, with a population at its zenith of between 160,000 and 200,000 people, larger than most European cities at that time. Valer un potosi Valer un potosi, 'to be worth a potosi', is still a Spanish expression meaning to be worth a fortune. Pizarro's conquest, it seemed, had made the Spanish crown rich beyond the dreams of avarice.

Money, it is conventional to argue, is a medium of exchange, which has the advantage of eliminating inefficiencies of barter; a unit of account, which facilitates valuation and calculation; and a store of value, which allows economic transactions to be conducted over long periods as well as geographical distances. To perform all these functions optimally, money has to be available, affordable, durable, fungible, portable and reliable. Because they fulfil most of these criteria, metals such as gold, silver and bronze were for millennia regarded as the ideal monetary raw material. The earliest known coins date back as long ago as 600 BC and were found by archaeologists in the Temple of Artemis at Ephesus (near Izmir in modern-day Turkey). These ovular Lydian coins, which were made of the gold-silver alloy known as electrum and bore the image of a lion's head, were the forerunners of the Athenian tetradrachm, a standardized silver coin with the head of the G.o.ddess Athena on one side and an owl (a.s.sociated with her for its supposed wisdom) on the obverse. By Roman times, coins were produced in three different metals: the aureus (gold), the denarius (silver) and the sestertius (bronze), ranked in that order according to the relative scarcity of the metals in question, but all bearing the head of the reigning emperor on one side, and the legendary figures of Romulus and Remus on the other. Coins were not unique to the ancient Mediterranean, but they clearly arose there first. It was not until 221 BC that a standardized bronze coin was introduced to China by the 'first Emperor', Qin s.h.i.+huangdi. In each case, coins made of precious metal were a.s.sociated with powerful sovereigns who monopolized the minting of money partly to exploit it as a source of revenue.

The Roman system of coinage outlived the Roman Empire itself. Prices were still being quoted in terms of silver denarii in the time of Charlemagne, king of the Franks from 768 to 814. The difficulty was that by the time Charlemagne was crowned Imperator Augustus Imperator Augustus in 800, there was a chronic shortage of silver in Western Europe. Demand for money was greater in the much more developed commercial centres of the Islamic Empire that dominated the southern Mediterranean and the Near East, so that precious metal tended to drain away from backward Europe. So rare was the denarius in Charlemagne's time that twenty-four of them sufficed to buy a Carolingian cow. In some parts of Europe, peppers and squirrel skins served as subst.i.tutes for currency; in others in 800, there was a chronic shortage of silver in Western Europe. Demand for money was greater in the much more developed commercial centres of the Islamic Empire that dominated the southern Mediterranean and the Near East, so that precious metal tended to drain away from backward Europe. So rare was the denarius in Charlemagne's time that twenty-four of them sufficed to buy a Carolingian cow. In some parts of Europe, peppers and squirrel skins served as subst.i.tutes for currency; in others pecunia pecunia came to mean land rather than money. This was a problem that Europeans sought to overcome in one of two ways. They could export labour and goods, exchanging slaves and timber for silver in Baghdad or for African gold in Cordoba and Cairo. Or they could plunder precious metal by making war on the Muslim world. The Crusades, like the conquests that followed, were as much about overcoming Europe's monetary shortage as about converting heathens to Christianity. came to mean land rather than money. This was a problem that Europeans sought to overcome in one of two ways. They could export labour and goods, exchanging slaves and timber for silver in Baghdad or for African gold in Cordoba and Cairo. Or they could plunder precious metal by making war on the Muslim world. The Crusades, like the conquests that followed, were as much about overcoming Europe's monetary shortage as about converting heathens to Christianity.14 Crusading was an expensive affair and the net returns were modest. To compound their monetary difficulties, medieval and early modern governments failed to find a solution to what economists have called the big problem of small change: the difficulty of establis.h.i.+ng stable relations.h.i.+ps between coins made of different kinds of metal, which meant that smaller denomination coins were subject to recurrent shortages, yet also to depreciations and debas.e.m.e.nts.15 At Potosi, and the other places in the New World where they found plentiful silver (notably Zacatecas in Mexico), the Spanish conquistadors therefore appeared to have broken a centuries-old constraint. The initial beneficiary was, of course, the Castilian monarchy that had sponsored the conquests. The convoys of s.h.i.+ps - up to a hundred at a time - which transported 170 tons of silver a year across the Atlantic, docked at Seville. A fifth of all that was produced was reserved to the crown, accounting for 44 per cent of total royal expenditure at the peak in the late sixteenth century. At Potosi, and the other places in the New World where they found plentiful silver (notably Zacatecas in Mexico), the Spanish conquistadors therefore appeared to have broken a centuries-old constraint. The initial beneficiary was, of course, the Castilian monarchy that had sponsored the conquests. The convoys of s.h.i.+ps - up to a hundred at a time - which transported 170 tons of silver a year across the Atlantic, docked at Seville. A fifth of all that was produced was reserved to the crown, accounting for 44 per cent of total royal expenditure at the peak in the late sixteenth century.16 But the way the money was spent ensured that Spain's newfound wealth provided the entire continent with a monetary stimulus. The Spanish 'piece of eight', which was based on the German But the way the money was spent ensured that Spain's newfound wealth provided the entire continent with a monetary stimulus. The Spanish 'piece of eight', which was based on the German thaler thaler (hence, later, the 'dollar'), became the world's first truly global currency, financing not only the protracted wars Spain fought in Europe, but also the rapidly expanding trade of Europe with Asia. (hence, later, the 'dollar'), became the world's first truly global currency, financing not only the protracted wars Spain fought in Europe, but also the rapidly expanding trade of Europe with Asia.

And yet all the silver of the New World could not bring the rebellious Dutch Republic to heel; could not secure England for the Spanish crown; could not save Spain from an inexorable economic and imperial decline. Like King Midas, the Spanish monarchs of the sixteenth century, Charles V and Philip II, found that an abundance of precious metal could be as much a curse as a blessing. The reason? They dug up so much silver to pay for their wars of conquest that the metal itself dramatically declined in value - that is to say, in its purchasing power with respect to other goods. During the so-called 'price revolution', which affected all of Europe from the 1540s until the 1640s, the cost of food - which had shown no sustained upward trend for three hundred years - rose markedly. In England (the country for which we have the best price data) the cost of living increased by a factor of seven in the same period; not a high rate of inflation these days (on average around 2 per cent per year), but a revolutionary increase in the price of bread by medieval standards. Within Spain, the abundance of silver also acted as a 'resource curse', like the abundant oil of Arabia, Nigeria, Persia, Russia and Venezuela in our own time, removing the incentives for more productive economic activity, while at the same time strengthening rent-seeking autocrats at the expense of representative a.s.semblies (in Spain's case the Cortes).17 What the Spaniards had failed to understand is that the value of precious metal is not absolute. Money is worth only what someone else is willing to give you for it. An increase in its supply will not make a society richer, though it may enrich the government that monopolizes the production of money. Other things being equal, monetary expansion will merely make prices higher.

There was in fact no reason other than historical happenstance that money was for so long equated in the Western mind with metal. In ancient Mesopotamia, beginning around five thousand years ago, people used clay tokens to record transactions involving agricultural produce like barley or wool, or metals such as silver. Rings, blocks or sheets made of silver certainly served as ready money (as did grain), but the clay tablets were just as important, and probably more so. A great many have survived, reminders that when human beings first began to produce written records of their activities they did so not to write history, poetry or philosophy, but to do business.18 It is impossible to pick up such ancient financial instruments without a feeling of awe. Though made of base earth, they have endured much longer than the silver dollars in the Potosi mint. One especially well-preserved token, from the town of Sippar (modern-day Tell Abu Habbah in Iraq), dates from the reign of King Ammi-ditana (1683-1647 BC) and states that its bearer should receive a specific amount of barley at harvest time. Another token, inscribed during the reign of his successor, King Ammi-saduqa, orders that the bearer should be given a quant.i.ty of silver at the end of a journey. It is impossible to pick up such ancient financial instruments without a feeling of awe. Though made of base earth, they have endured much longer than the silver dollars in the Potosi mint. One especially well-preserved token, from the town of Sippar (modern-day Tell Abu Habbah in Iraq), dates from the reign of King Ammi-ditana (1683-1647 BC) and states that its bearer should receive a specific amount of barley at harvest time. Another token, inscribed during the reign of his successor, King Ammi-saduqa, orders that the bearer should be given a quant.i.ty of silver at the end of a journey.19 If the basic concept seems familiar to us, it is partly because a modern banknote does similar things. Just take a look at the magic words on any Bank of England note: 'I promise to pay the bearer on demand the sum of . . .'. Banknotes (which originated in seventh-century China) are pieces of paper which have next to no intrinsic worth. They are simply promises to pay (hence their original Western designation as 'promissory notes'), just like the clay tablets of ancient Babylon four millennia ago. 'In G.o.d We Trust' it says on the back of the ten-dollar bill, but the person you are really trusting when you accept one of these in payment is the successor to the man on the front (Alexander Hamilton, the first Secretary of the US Treasury), who at the time of writing happens to be Lloyd Blankfein's predecessor as chief executive of Goldman Sachs, Henry M. Paulson, Jr. When an American exchanges his goods or his labour for a fistful of dollars, he is essentially trusting 'Hank' Paulson (and by implication the Chairman of the Federal Reserve System, Ben Bernanke) not to repeat Spain's error and manufacture so many of these things that they end up being worth no more than the paper they are printed on.

A clay tablet from second millennium BC Mesopotamia, front (above) and rear (opposite). The inscription states that Amil-mirra will pay 330 measures of barley to the bearer of the tablet at harvest time.

Today, despite the fact that the purchasing power of the dollar has declined appreciably over the past fifty years, we remain more or less content with paper money - not to mention coins that are literally made from junk. Stores of value these are not. Even more amazingly, we are happy with money we cannot even see. Today's electronic money can be moved from our employer, to our bank account, to our favourite retail outlets without ever physically materializing. It is this 'virtual' money that now dominates what economists call the money supply. Cash in the hands of ordinary Americans accounts for just 11 per cent of the monetary measure known as M2. The intangible character of most money today is perhaps the best evidence of its true nature. What the conquistadors failed to understand is that money is a matter of belief, even faith: belief in the person paying us; belief in the person issuing the money he uses or the inst.i.tution that honours his cheques or transfers. Money is not metal. It is trust inscribed. And it does not seem to matter much where it is inscribed: on silver, on clay, on paper, on a liquid crystal display. Anything can serve as money, from the cowrie sh.e.l.ls of the Maldives to the huge stone discs used on the Pacific islands of Yap.20 And now, it seems, in this electronic age nothing can serve as money too. And now, it seems, in this electronic age nothing can serve as money too.

The central relations.h.i.+p that money crystallizes is between lender and borrower. Look again at those Mesopotamian clay tablets. In each case, the transactions recorded on them were repayments of commodities that had been loaned; the tablets were evidently drawn up and retained by the lender (often in a sealed clay container) to record the amount due and the date of repayment. The lending system of ancient Babylon was evidently quite sophisticated. Debts were transferable, hence 'pay the bearer' rather than a named creditor. Clay receipts or drafts were issued to those who deposited grain or other commodities at royal palaces or temples. Borrowers were expected to pay interest (a concept which was probably derived from the natural increase of a herd of livestock), at rates that were often as high as 20 per cent. Mathematical exercises from the reign of Hammurabi (1792-1750 BC) suggest that something like compound interest could be charged on long-term loans. But the foundation on which all of this rested was the underlying credibility of a borrower's promise to repay. (It is no coincidence that in English the root of 'credit' is credo credo, the Latin for 'I believe'.) Debtors might periodically be relieved - indeed the Laws of Hammurabi prescribed debt forgiveness every three years - but this does not appear to have deterred private as well as public lenders from doing business in the reasonable expectation of getting their money back.21 On the contrary, the long-term trend in ancient Mesopotamia was for private finance to expand. By the sixth century BC, families like the Babylonian Egibi had emerged as powerful landowners and lenders, with commercial interests as far afield as Uruk over a hundred miles to the south and Persia to the east. The thousands of clay tablets that survive from that period testify to the number of people who at one time or another were in debt to the Egibi. The fact that the family thrived for five generations suggests that they generally collected their debts. On the contrary, the long-term trend in ancient Mesopotamia was for private finance to expand. By the sixth century BC, families like the Babylonian Egibi had emerged as powerful landowners and lenders, with commercial interests as far afield as Uruk over a hundred miles to the south and Persia to the east. The thousands of clay tablets that survive from that period testify to the number of people who at one time or another were in debt to the Egibi. The fact that the family thrived for five generations suggests that they generally collected their debts.

It would not be quite correct to say that credit was invented in ancient Mesopotamia. Most Babylonian loans were simple advances from royal or religious storehouses. Credit was not being created in the modern sense discussed later in this chapter. Nevertheless, this was an important beginning. Without the foundation of borrowing and lending, the economic history of our world would scarcely have got off the ground. And without the ever-growing network of relations.h.i.+ps between creditors and debtors, today's global economy would grind to a halt. Contrary to the famous song in the musical Cabaret Cabaret, money does not literally make the world go round. But it does make staggering quant.i.ties of people, goods and services go around the world.

The remarkable thing is how belatedly and hesitantly the idea of credit took root in the very part of the world where it has flourished most spectacularly.

Loan Sharks Northern Italy in the early thirteenth century was a land subdivided into multiple feuding city-states. Among the many remnants of the defunct Roman Empire was a numerical system (i, ii, iii, iv . . .) singularly ill-suited to complex mathematical calculation, let alone the needs of commerce. Nowhere was this more of a problem than in Pisa, where merchants also had to contend with seven different forms of coinage in circulation. By comparison, economic life in the Eastern world - in the Aba.s.sid caliphate or in Sung China - was far more advanced, just as it had been in the time of Charlemagne. To discover modern finance, Europe needed to import it. In this, a crucial role was played by a young mathematician called Leonardo of Pisa, or Fibonacci.

The son of a Pisan customs official based in what is now Bejaia in Algeria, the young Fibonacci had immersed himself in what he called the 'Indian method' of mathematics, a combination of Indian and Arab insights. His introduction of these ideas was to revolutionize the way Europeans counted. Nowadays he is best remembered for the Fibonacci sequence of numbers (0, 1, 1, 2, 3, 5, 8, 13, 21 . . .), in which each successive number is the sum of the previous two, and the ratio between a number and its immediate antecedent tends towards a 'golden mean' (around 1.618). It is a pattern that mirrors some of the repeating properties to be found in the natural world (for example in the fractal geometry of ferns and sea sh.e.l.ls).e But the Fibonacci sequence was only one of many Eastern mathematical ideas introduced to Europe in his path-breaking book But the Fibonacci sequence was only one of many Eastern mathematical ideas introduced to Europe in his path-breaking book Liber Abaci Liber Abaci, 'The Book of Calculation', which he published in 1202. In it, readers could find fractions explained, as well as the concept of present value (the discounted value today of a future revenue stream).22 Most important of all was Fibonacci's introduction of Hindu-Arabic numerals. He not only gave Europe the decimal system, which makes all kinds of calculation far easier than with Roman numerals; he also