Book World Live: Niall Ferguson, Author of 'The Ascent of Money'
Tuesday, November 25, 2008; 10:00 AM
In today's rocky financial climate, it is vital to understand how the global economy came to be. Harvard Business School professor Niall Ferguson was online Tuesday, November 25 at 10 a.m. ET to discuss his new book, The Ascent of Money: A Financial History of the World, which explains the role of economics throughout all of human history and progress.
The transcript follows.
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Niall Ferguson: Niall Ferguson here, author of The Ascent of Money: A Financial History of the World. You've already posted a ton of questions, so I had better get to work!
Philadelphia, Pa.: How much have interest rates shifted through history and what role have interest rates played in determining economic vitality? I ask because I recall years ago seeing research that the economy seems to drive interest rates, i.e. interest rates respond more to economic changes, rather than interest rates being a major determinant in what later happens to the economy.
Niall Ferguson: It depends what you mean by interest rates. At will, central banks can adjust the short-term rate at which they lend to the banking system. But other rates are essentially determined by the supply and demand for credit. A good example is long-term interest rates, which are essentially determined by the supply of government bonds and the public's demand for them. The yield on a bond essentially combines the underlying natural rate of interest and a premium for default risk and depreciation risk.
Michigan City, Ind.: During the period of enforcement of Glass-Steagall in the United States we had very few bank failures. Beginning with its lax enforcement and continuing through the period since its repeal we have seem a growing number of failures of larger and larger banks. Do you believe its separation of commercial and investment banking, and the separation of deposit gathering and securities underwriting would be a wise move in today's environment?
Niall Ferguson: I must say, I struggle to see what role the repeal of Glass-Steagall has played in the recent crisis. Nearly all the problems that have struck the financial sector since August 2007 could have arisen if the Act had remained in force.
Washington, D.C.: Question: Compared with the Great Depression, is the housing market expected to keep on declining? Thanks.
Niall Ferguson: Right now the experts like Robert Shiller expect there to be further significant declines in housing prices. As the recession bites and unemployment rises, the downward pressure will persist. So we are looking ahead to many more foreclosures, I am afraid.
New York, N.Y.: Do you cover the philosophical discussions over economic systems? It seems over time that Max Weber better described the systems of economic management that exist whereas Marx failed in his predictions. Although, considering that China may emerge as the largest economy, does this save some of Marx's theories, or does it show that a future hybrid of Adam Smith, Marx, and Keynes may better describe what is happening in China?
Niall Ferguson: In this book I really focus on financial theorists, rather than the more general body of economic theory or (in Max Weber's case) sociology. I am doing some new work on Weber right now -- and especially his view of China -- but that's for another book. I also have little to say about Marx, who was pretty clueless about finance (he was a very unsuccessful stock market speculator, incidentally). The theorists who get more attention are the likes of Milton Friedman (on the monetary causes of the Depression) and Hyman Minsky (on financial crises).
Woodbridge, Va.: Greetings. Some notable figures, like Steve Forbes and Alan Greenspan, have expressed a preference for returning to a "new" gold standard. What are your thoughts? Thanks.
Niall Ferguson: I am doubtful about this. You have to remember that in its heyday the gold standard was associated with both a Great Deflation (1874-1896) and a Great Depression. Pegging global monetary systems to a precious metal would remove a significant amount of autonomy from monetary policy. Indeed, if implemented rigorously with free capital movements, it would preclude independent monetary policy for individual nation states. It seems to me that there are better ways of managing currencies than going back to gold.
East Lansing, Mich.: Prior to the Great Depression, farmers, migrant workers, members of oppressed groups like black people and Irish, etc. had been suffering for years. The Great Depression was identified when the economic problems spread to the financial sector and companies associated with industry. Likewise, a number of groups have suffered recently as wages stagnated, prices rose, underemployment, etc. under the Bush administration for years. These were also problems under G.H.W. Bush. However, these are being identified as problems as the economic problems spread to the financial sector and companies associated with industry. As many in the country have been blind to the long-term problems, does this set the country up for a slower recovery?
Niall Ferguson: It's true that farm prices (for example) were falling well before 1929. Many Americans felt none of the benefits of the Roaring Twenties. In the same way, many middle class and working class Americans have seen little or no significant growth in their real incomes over the past decade. The difference is that in our time it's been possible for people to raise their living standards despite stagnant incomes by borrowing. This has been an age of leverage, and it's coming to a painful end that will affect nearly everyone. Yes, this will be a protracted recession. And even when growth returns, it'll be at a lower rate than we've been used to.
Montreal, Quebec: Why was the press fast asleep at the switch when a great deal of the economic problems were quite apparent years ago?
Niall Ferguson: I think partly because the financial world was in denial about the risks of excessive leverage and the economics profession failed to appreciate the real significance of the global imbalances represented by the U.S. current account deficit. The number of people who foresaw the liquidity crisis was small, and we had to put up with quite a bit of mockery. I did manage to publish a few pieces on the subject of excess debt and the dangers that lay ahead, but the response was minimal. Remember also that the media were fixated on Iraq from 2003 until 2006.
Karachi, Pakistan: How are the developing countries going to fare given the current economic conditions?
Niall Ferguson: Not well. Despite being "Made in America" this crisis has the potential to hurt countries like Pakistan more than America itself. Unfairly, the U.S. continues to be regarded as a "safe haven" for investors, which is why the dollar has rallied in recent months. Meanwhile, economic trouble tends to lead to political instability in emerging markets, which scares investors off.
What will be the next form of "money"?: I thought that one of the primary characteristics of money was that it was a "store of value." What do you think will replace the U.S. dollar as a "store of value" in the next 5-10 years?
Niall Ferguson: The dollar lost much more value (in terms of purchasing power) in the 1970s than it has in the past ten years, when inflation has been relatively low. In any case, most people tend to "store value" in forms other than cash. Stocks and real estate looked like good hedges against inflation until last year, which was why investors bought as much as they could. Will anything replace the dollar? I don't see a rival in the euro, much less any Asian crisis. There certainly isn't enough gold to go round. So until someone invents a currency called "the barrel" (an oil-based money), the dollar will endure.
Worcester, Mass.: Thank you for enlightening us, Mr. Ferguson! I would like to ask you about uncertainty in the financial markets and, what is the source of it in economic terms?
Niall Ferguson: Uncertainty is a crucial term that I define in the book as something distinct from risk, to which some kind of probability can be attached. We all face a calculable risk of premature death from a road traffic accident. But no probabilistic statement can be made about a future terrorist attack on New York. It's uncertain. Part of the current trouble in derivatives markets stems from people confusing risk and uncertainty. You can insure against risk, but not really against uncertainty.
Washington, D.C.: I believe too many countries, particularly in Europe and elsewhere depend entirely too much on Americans to finance their defense I truly believe some of the massive deficit spending is because of defense spending. The Euro Zone has a GDP bigger than the US, this country should demand that rich Europeans pay their fair share. Your thoughts?
Niall Ferguson: I've been saying for some years that Social Security is a bigger financial burden than National Security -- the welfare state costs far more than the warfare state. At less than 4.5 per cent of GDP U.S. defense spending is well below its Cold War average. If the Bush administration had kept domestic spending under better control, the war in Iraq could have been waged without running large deficits.
Denver, Colo.: Can you envision a single global currency in the future, and could it serve to stabilize international relations or prevent runaway inflation in some state economies?
Niall Ferguson: I doubt it, though world money is quite an old idea. For a big nation state, there are strong arguments for retaining an independent monetary policy -- that's why Britain has resisted joining the Eurozone. The argument is less strong for small economies, which is why regional currencies are easier to imagine.
Pfafftown, N.C.: When did the concept of interest on borrowed money begin? What effect did interest income and interest expense have on people, societies and economies?
Niall Ferguson: Long, long ago -- interest seems to have been charged on loans roughly four thousand years ago in Ancient Mesopotamia. In medieval times, it was prohibited by the Church as "usury", a prohibition that still exists in Islamic law. But there are ways for lenders to get around such rules, as I show in The Ascent of Money.
Arlington, Va.: Why do you blame minority borrowers (i.e., attack CRA/Fannie/Freddie) for the debacle in subprime lending when the real culprits were the nondepository lenders, commissioned brokers, anything-for-a-buck bond raters, and Wall Street slicers/dicers? Please read "Chain of Blame" by Paul Muolo and Mathew Padilla.
Niall Ferguson: I don't blame minority borrowers, actually. In chapter 5, I describe in some detail the way predatory lenders sold subprime mortgages, focusing on the example of Detroit.
Munich, Germany: I'm not sure that even the Communists could ever have done away with money. Even some South Pacific Islanders used and still use large, wheel-shaped stones as currency.
Continuing in that vein of thought, how can the American Capitalist model die out if most of the developing world, China, India and Brazil included, strive to use American business practices and models?
Niall Ferguson: I talk in chapter 1 about primitive money and the few cases we know of moneyless societies.
I certainly don't see the American model of capitalism dying out. But I think what's being done in China is rather different. A significant part of China's growth is still based on large-scale state led infrastructure investment.
Bowie, Md.: In your books you name individuals culpable for past historical bubbles. Who are in the rogues' gallery this time? Probably a host of them? Danke schon.
Niall Ferguson: The circle of blame is quite wide, in my view. It won't do just to blame the bubbles on Alan Greenspan, though he certainly made his share of mistakes. I would also fault the SEC, which turned a blind eye to excessive leverage in the banking system, and Congress, which positively encouraged the excesses of subprime lending. And maybe a word should be said about the economics profession, many of whose leading lights were remarkably slow to spot the trouble that was approaching.
Washington, D.C.: It has become an almost default presumption that free trade is a net job killer and causes calamity for the anyone who isn't wealthy. Yet, I'm hard pressed to find a successful protectionist economy. Has there ever been a nation that became prosperous by putting up significant barriers to trade and investment?
Niall Ferguson: Actually, the United States did rather well in the nineteenth and early twentieth century, at a time when it imposed quite high import tariffs. What we don't know, of course, is how it would have fared under free trade. As a devotee of Adam Smith, I favor free trade as the optimal policy for the world as a whole. There seems little doubt that, under certain conditions, a country can derive some benefits from protection. But if every country puts up tariffs, everyone ends up worse off.
Nyack, N.Y.: How is a fractional reserve banking system relevant to the crisis we may now face?
Niall Ferguson: One way that central banks can temper the "irrational exuberance" of banks in good times is by varying reserve requirements rather than just relying on interest rates. We have recently seen the Chinese do this to great effect. It may be that this tool needs to be rediscovered by the Fed. But that is a decision for better times, which currently seem rather far away.
Laurel, Md.: How did, in general terms, the financial sector come to be such a big part of our economy? I can see how a country like Switzerland can become the world's banker; but was it ever conceivable that an enormous economy like the USA could get by making "nothing but money"?
Niall Ferguson: Financial services are a relatively small part of the U.S. economy compared with, say, Switzerland and the UK, but a much larger part than twenty or thirty years ago, when America still had a large manufacturing sector. I don't think it's necessarily a bad thing, because a successfully executed loan is as economically useful as a crankshaft handle or a bushel of wheat. But clearly the sector grew too large in recent years. And as it expanded, it grew more vulnerable to crisis.
Alexandria, Va.: Isn't Scotland in the United Kingdom because the Bank of Scotland failed due to the South Sea Bubble and the only way the Bank of England would bail it out was if the King of Scotland lost his independence?
Niall Ferguson: Not quite. The Act of Union was 1707, 13 years before the South Sea Bubble. It was the failure of Scottish Darien scheme that left the country's aristocratic political establishment eager for a bailout. Of course the Union of Crowns had happened much earlier, in 1603.
Laurel, Md.: When every bubble bursts, a lot of people retrospectively laugh at the people who had thought "this time it's different." Are there any traits common to times that really are different?
Niall Ferguson: Of course, things do become different over time. That's economic history. And each new technological or organizational breakthrough arouses all kinds of expectations for the future. What doesn't change is the human predisposition to exaggerate the money that can be made from any advance, whether it's the foundation of the South Sea Company or of lastminute.com. When people say "This time it's different", they mean "This time the bubble won't burst." It always does.
Michigan City, Ind.: I believe that the generation of mortgage backed securities, and their collateralization by a subsidiary of the same firm, and their insurance by yet another arm of the same corporation leads to lax standards that may have been more properly policed if each of them was a totally separate entity. Do you disagree?
Niall Ferguson: I am not sure. A lot of these functions were in fact performed by separate entities. And within the big banks, I was always struck by how little communication there was between different divisions.
Philadelphia, Pa.: Clearly this economic crisis is the worst we have seen in at least one generation. Do you believe that the socialization of these large institutions is key in navigating our way out of this situation? After all, we are supposed to be a capitalistic society where Darwinism is at its finest "survival of the fittest."
Niall Ferguson: I discuss this dilemma in the conclusion of The Ascent of Money. Clearly, we want to avoid a repeat of the 1930s, when thousands of banks failed and the monetary system imploded. But we also want to avoid the Japanese mistake of propping up defunct financial institutions, rather than liquidating them. And we certainly don't want to end up with a Soviet system of state controlled banking. My sense is that there has yet to be a full acknowledgment of the amounts that the big banks have lost, and this makes it hard to restore trust in them through government equity injections or purchases of "troubled" assets. Recapitalization is the way to go, I think. But we may also need a new government entity to take on the assets for which no market currently exists.
Annapolis, Md: Is the $13-plus trillion debt a major obstacle in re-engineering the global economy? Is there any possibility we could default? Is Iceland a red flag?
Niall Ferguson: We won't default, but we may end up trying to depreciate our way out of the debt. Foreign holders of U.S. bonds must feel nervous about the future of the dollar. But keep things in perspective. Historically, it's not an exceptionally high debt burden in relation to GDP.
Washington, D.C.: Your book looks great -- can't wait to read it. How did countries' status as a colony vs. a colonial power affect their access to capital and financial systems' development?
Niall Ferguson: I've co-written a whole article about this for the Journal of Economic History, with Moritz Schularick. It's referenced in the book. Essentially, being a colony cut the cost of capital for developing countries a hundred years ago. There was an imperial discount because colonial bonds were seen as having little or no default risk.
Silver Spring, Md.: Since housing prices went absurdly high several years ago, isn't the current situation more of a "correction," rather than a "downturn?" Shouldn't economists, the media, etc., begin to look at it from that perspective?
Niall Ferguson: I agree, but the "wealth effect" seems to be very powerful, both on the way up and on the way down. The other problem is the debt that people took on when they bought houses near the top of the market. Now that the homes are worth less than the loans, in many cases, they have little incentive to stick around.
Port-au-Prince, Haiti: Many analysts think that the present international financial crisis will end by the last quarter of 2009.
Do you think that this is accurate?
The Interamerican Development Bank (IDB) just stated yesterday that the crisis may end by the first quarter of 2010 in Latin America.
What to believe?
Niall Ferguson: Alas, I am a historian, not a forecaster. My guess is that we have negative growth for most of 2009 in the U.S., EU and Japan, and a more mixed story in Latin America. Brazil will do well, Argentina badly.
Niall Ferguson: Thanks to everyone for their questions. My repetitive strain injury is now becoming acute, and I have other appointments to keep, so forgive me for failing to answer all your questions. I hope you'll consider buying the book, which contains as many answers as I could find to the big questions about financial history. Have a great day.
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