History of Finance - Rise of the debt market

Money plays the most important role in our lives. It has performed a terrifyingly dominant role in carving the fates of kingdoms, families, dynasties and now countries.

From ancient Mesopotamia to the modern banks on Wall street, the ascent of money has been an indispensable part in the ascent of man. From the fluctuating prices of the homes we own to the high speed industrialization in China and India, the power of Finance is vivid wherever we look at.

500 years ago, the powerful Inca empire of pre Colombian America (South America) had no real concept of money. The Inca Empire appreciated the aesthetic qualities of rare metals. Gold was the sweat of the Sun, Silver was the tears of the moon, Labor was the unit of value in the Inca society. But in 1532, the Inca empire run across a man whose hunger for money lead him across the Oceans in search for it.

Francisco Pizarro had come from Spain to upper Peru attacking and defeating the Inca army. He struck it rich by discovering the Cerro Rico (Rich Hill). Towering nearly 16,000 feet above sea level, it was a money mountain where silver could be found. In the 250 years of Spanish rule, more then 2 billion ounces of silver (1 ounce = 28 gms) were extracted from those mines. The Inca’s could not understand why the Europeans had such a lust for gold and silver. But, what they failed to foresee was the shiny silver metal could be more than just a souvenir for the Europeans - It could be made into money, a store of value, a unit of account, portable power. The silver was refined with mercury and shipped to Europe In the form of bars and coins. Cerro Rico made the Spanish rich beyond their dreams.

And yet all the silver in Cerro Rico could not hold the inexorable economic and political decline of Spain’s Empire. The reason is that the Spaniards had dug up such an excessive amount of Silver that the metal itself faced a sharp decline in value. All those silver coins didn’t make Spain richer, instead, it only made prices of other commodities higher, as an increased quantity of money chased the same amount of goods. The Spaniards failed to understand one important underlying principle that governs modern finance even today - money is worth only equivalent to what other people are ready to give for it. This has remained constant 500 years afterwards, whether money is in the form of gold bullion, silver coin or the modern day bank loan. Even lumps of clay can work in a similar way, if people have confidence in them.

In ancient Mesopotamia, nearly 4000 years ago people used clay tablets to commit themselves to particular financial transactions. Hence the clay tablet represented the debt that was to be paid to the one who possessed it. This was in essence the same concept as our present day paper money. It was a promise to pay, just like the notes of today.

In today’s World we are just not happy with money in the format of a paper but one that exists in our bank accounts, technically in an intangible shape. The backbone to this entire structure is trust. Money is about trust, even faith. Trust in the person paying you the money, trust in the central bank issuing the money, trust in the commercial bank that honors the cheques and so on. It was this idea of trust that lead to credit, where you could rely on people to borrow money, and pay it back on a certain future date. That’s why credit comes from the latin word Credo, which means “I believe”. Without the invention of credit, the entire economic history of our present new world would have been impossible. Credit literally doesn’t make the world go around, but it definitely does make vast quantities of people, goods and services go around the world.

The world however has not always been very nice to money lenders. Early money lenders were not thanked for their services, but were highly disregarded and looked down upon. This is depicted in the famous William Shakespeare’s novel “Merchant of Venice”, wherein Shylock is depicted as a blood sucking hungry money lender who demands for a pound of flesh from Antonio, as collateral for the money loaned out. Jews who stayed in Venice had to wear a yellow hat and they were confined to a stay in a ghetto. The reason why the Italians accepted the Jews was simple. The Jews could provide a service that christian merchants were forbidden to do. Lending money at an interest was a sin as per catholic law. The medieval churches laws on usury made it difficult for finance to grow rapidly in eastern Europe, as no god-fearing christian would risk the barbarity of hell. The price the Jews paid for performing this service was social exclusion. Money lenders were hated people, not only because they charged interest for what they loaned out, but also because of the risk that the borrower went through for defaulting on a loan was very severe. Money lenders on the other hand had to be ruthless, since the risk of even a single person defaulting would incur a huge loss for them. They had to find an answer to the dilemma they faced. If they were too generous they didn’t make any profits and if they were too hard-nosed then that would increase the chances of the lender defaulting. The answer was to get bigger and more powerful.

It was time to invent banks.....