The second world war

History, when read voluntarily, is fascinating. Be it the history of finance or of human civilization.

I am currently going through a marvelous National Geographic feature on the Second World War. Though I have come across several dates and several broken accounts of the war, this one seems to promise the most. The series is appropriately named - Apocalypse, The second world war.

The account is quite simply put. Hitler comes to power in 1933 and slowly gains the confidence of the masses. Around the beginning of 1939, he annexes Austria, alarming the British and the French. However, they don't react. Then, he moves towards Chezkoslovakia. Tired by the first world war, Britain and France accept his move demanding that he stop there. However, Hilter had other plans. During the 1st World War, Germany had been split into two, to allow Poland to gain access to the sea. Hilter joins the two parts together, by conquering that part of Poland in September 1939. He assumed that Britain and France would not mind it too much. His mistake! France and Britain declare war on Poland a few days after. This is when the cat gets out of the bag pretty much.

House ownership across Britain and the US

Property ownership was a British concept to begin with. Not that people didn't own property other than the British but the association of strength and power with ownership of property was something of very British origin. In the 1700s, the power to vote resided with the wealthy land-owning aristocrats, the people who came to occupy the House of Lords in the parliamentary system later.

But as with any financial tale, this one did not have a very happy ending. These men-to-the-manor-born borrowed heavily to pay for their extravagant lifestyles, with their land and the agricultural revenues as collateral. However, come mid-1800s, as the prices of agricultural produce went down, so did the backing for these loans. As these aristocrats put their heads together to sort out finances, most of them realized that their borrowings were way more that the worth of their estates and their agricultural revenues put together. Most of the houses were acquired by the lenders and several of the rich elite had to move into rented houses, a big step down considering the opinions of those times.

That was Britain. Now the US.

Owning a house makes sense. It gives you security and ownership. However, before the great depression, only two-fifths of the US population owned their own homes. As the great depression struck, the few home owners there were, were also forced out of their homes for lack of mortgage payments. So how did this miserable situation turn around? The New Deal! Mr. Roosevelt took several steps to encourage people to invest money in house ownership. The government ensured that the money invested by the public to a bank as part of mortgage payments would be ensured by the government even if the bank went bust. A federal housing administration was setup to offer longer, larger and lower interest loans (20 to 30 years). And it also setup the 'Federal National Mortgage Association' which goes by the famous nickname - Fannie Mae - to stimulate the mortgage market.

Well all of that seems about right. What went wrong then? Well, the way it began was that these mortgages were not given out to any tom, dick and harry. They were only given to 'prime' candidates. The rest you probably know ....

Bonds and the American civil war

Then came the bonds. Bonds are not the most popular of financial instruments. The returns are low and there is always the risk of inflation catching up or overtaking their rate of return.

However, bonds are no small time contenders. The bond market is many times the world's stock markets put together. Moreover, they have been an instrumental tool for governments in times of economic strife. Cotton backed bonds were the main source of money for the Confederates, the southern US government, to get money to finance the war against the North. These bonds promised interest like any other bond. However, they went a step further. In case the interest could not be paid by the government, these bonds were exchangeable for cotton! Cotton, a rich cash-crop was an excellent backing to these bonds. Several people became interested and bought the bonds.

With money sourced from these bonds, the war dragged further. Finally, the North, understanding the importance of this crop in the scheme of things, played a master-stroke. Devoting a large section of their military strength to it, the North secured the port of New Orleans. New Orleans was the main exit point for all the cotton the south exported. With the port under northern control, the promise of cotton in exchange for the southern bonds to the bond-holders went down the drain. Their value plummeted and so did the source of money for the South contributing greatly to their defeat in the end.

The Medici

To look back at the ascent of the concept of modern day money, we need to take notice of Italy in the 1200s. Money, in token form, had come into being by then. However, lending was still not a profession of good standing. Christianity forbade usury, the practice of charging interest on the loan doled out. However, if a money-lender didn't charge interest, how would he make a living? How would he cover the defaults?

Jews were the answer to this riddle. A different religion allowed them a different set of rules. In Florence, sitting behind their benches, they gave loans without compunction or fear of the after-life. Dealing with numbers for generations on an end has clearly made them a smart bunch of fellows. The Christians could only sit in the side-lines, working away at their 'legitimate' professions.

This changed in the latter part of the 1300s. Giovanni de Medici, of the notorious Medici family in Venice, rose to clear his family of their stamp of infamy. Using his sharp intellect, he hit upon an ingenious way of tapping into the money business, and still remaining within the remit of the Christian laws. He started to work on Forex! There was no low forbidding a commission on changing currencies at the time. The commission, after all, was not interest. It was just a commission. And once this happened, there was no stopping the Medici family. By spreading their services far and wide in Italy, they grew in scale, allowing lower operating costs. Low costs and higher profits - the family became richer and more powerful. Two (three) queens and a pope eventually came from this family.

Fractional Reserve Banking

The history of money is fascinating. And it is not easy to get your head around it in one go. The way I understand it, banking began with goldsmiths being entrusted by normal people with their gold for safekeeping. They realized that at any point in time, only a fraction of the people (say 10%) will come back to demand their gold back. This fact allowed them to lend out gold to others, gold that was not theirs to begin with, and charge interest on it. This was the birth of fractional-reserve banking.

Most banks work on the same principle nowadays. Each bank has to maintain a capital ratio, a ratio of the amount of money in reserve, and the amount of money it lends out. This ratio changes, but is always less than one...

The masters of money ...

I have come across some fascinating documentaries tracing back the history of money and how economics had a major role to play in world affairs since the beginning of organized society. I might dedicate a few blogs to how things were ...