Lisa Simpson
Apr 6,2010
In: Finance

It is Finance and Finance Alone that Drives the Economy

It is finance and finance alone that drives the economy.

The average citizen of America is 22 times richer than the average Chinese. But capital flows from China to USA and it is the savings of China that is fueling American consumption. To understand this anomaly one has to analyze the fact that it is finance and finance alone that drives the economy.
The lurking question is whether finance is the vital engine that propels growth in the economy or is it the constant source of instability in world economy? British historian Niall Ferguson comes to defend finance in his brilliantly written new book The Ascent of Money. The main theme of the book is that the “ascent of money has been the one of the driving forces behind human progress.”
The debut of banking has been simultaneous with the birth of credit. The money market stretched further with the coming of bond markets during the 13th century and of the stock markets in 17th century. The 18th century saw the first entry of insurance and pension funds. In the 19th appeared options and futures and the real estate market appeared in the 20th century. Each of these stages represented consecutive waves of financial innovations that evolved.

Thus it is the story of money continuously reinventing itself as empires came and went. The 16th century Inca Empire gave way to that of Spain – the latter having gauged the value of silver. The Incans thought of silver as something shining and exotic only. They called it “tears of the moon.” Spain minted tons of silver in Upper Peru engaging the conquered Incans and slaves from Africa in harsh labour. But such large amounts were extracted that the value of the metal fell and with it the golden days of the Spanish Empire.

One of the prime reasons behind Spain’s failure was its inability to keep up with new financial innovation called banking that was emerging. The Spaniards failed to understand that money is not only silver – it involved trust in relationships based on credit and debit between persons. It is on this that the banking institution stands. Following Italy the other cities like Amsterdam, London and Stockholm came to understand this and thus they became the new power centres.

Next emerged the bonds – debt papers issued by governments or mega corporations to raise finances from the public. The bond market was born as a tool to support different states of Italy in their internal warfare in 13th century. It was the bond market that influenced the winds of war – led to the defeat of Napoleon as a consequence of “contest between two rival financial systems.” The French had failed to develop an equally strong debt market. It was the bonds that played the deciding role in the American Civil War and World War I.