The Debt Crisis No One’s Talking About - Sir Niall Ferguson

We don't seem to be able to live within our means. I mean, we really are in trouble in that aspect of things, are we not? Yes, deep trouble. If you borrow to consume, well, that way lies trouble. And that's what we've been doing. finally going to be forced, whether you're China, Europe, the UK, the United States, to do something radical. And this is where Mr Millet is interesting.

Are we headed in a sort of 1920s direction, 1930s direction? The ideologies are the same old, same old. It's sort of depressing that we can't come up with new material, but... Those who enter adulthood without a clue about how interest rates work, who don't know what a bond yield is, who've never made an investment in the stock market and never will, those people will have worse lives than the people who get informed.

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So, Neil Ferguson, welcome back to Trigonometry. Good to be back. You are one, of course, one of our favourite historians to have on the show. And the thing that we want to talk to you about today is money. One of the things you have been prominent in trying to raise attention for and awareness of is the level of indebtedness the Western world is in, particularly as it relates to our military spending, because there's some historical patterns that are very unfavorable on that.

side of things. We'll get into that. But we thought you being one of the world's most interesting and prominent historians, the first thing we should talk about is something you wrote about immediately after the financial crisis in your book called The Ascent of Money, which is money... debt finance and the best place to start i think is right at the very beginning which is what is money and where does it come from

Well, it's great to be back. When you said we want to talk about money, I thought I don't owe them anything. In fact, I had the involuntary Scottish reaction. I nearly touched my wallet just to make sure it was there. Money is a very ancient thing. It's the way in which human beings transact that is superior to barter. And so we find thousands of years ago, you know, 2000 years before Christ.

that IOUs are being carved in little pieces of clay in ancient Mesopotamia. And that's really the origins of money because if our IOU... two silver rings. It's much more convenient to just write that down than for me to say, I think that's roughly three sheep or maybe two and a half goats. So money is just a way of making exchange.

much smoother than if you tried to do it by barter. I mean, if you've ever tried barter, you'll realize immediately the difficulty, that sheep and so forth are not that fungible. So that's the... key concept behind money and almost anything can serve as money when you say money these days there are still people who think that it's pieces of paper or

cloth, banknotes. Those have largely gone extinct in England as far as I can see, but Americans still tend to think of money as dollar bills. Older people will remember coins, round metal objects. So that was money for quite a few centuries, but that's relatively recent by historic standards. The first money is, as I said, play tablets with little inscriptions on them.

Shells have been used as money. Large, inconveniently large stones have been used as money. Pretty much anything can be used as money. Stephen Colbert once asked me on the Colbert Report, am I money? And I said, yes, if you want to be a medium of exchange, then you can be money. And I imagine that... There is a bit of a transition between barter and money in the sense that an IOU carved in a tablet, it implies a level of social trust or some sort of cultural adaptation and innovation.

to facilitate. Is that a fair assumption? It's important for money to work that it should be trusted. And in fact, I think I once wrote in The Ascent of Money that it's trust inscribed. particularly if it's a piece of clay. I mean, its intrinsic worth is almost zero. But if it says that it's exchangeable for two silver rings or three sheep, then... kind of have to believe that a counterparty will agree that that's the case so there's an element of of trust um that

It's why we don't really encounter money in prehistoric societies. It's something that really is associated with the beginnings of civilization. Of course, today, most money is invisible. It really exists in electronic ledgers of banks, and that's most money today. Relatively small amounts of money consist of banknotes and coins, tiny in some cases. And so most money is, in fact...

invisible electronic items in bank accounts. In fact, most money is created by banks when they credit somebody with an amount of money. We all have to trust banks for a system based on fractional reserve banking to work. You mentioned that the Ascendant Money was written after the financial crisis. That's incorrect. It was written before the financial crisis and published.

just before the failure of Lehman Brothers, which tells you that I anticipated the financial crisis, which I did, because the book was begun in 2006, at a point when very few people realised a huge financial crisis was coming.

But that was my motivation for writing it. I was very confident that a large financial crisis was coming. And at the heart of that crisis was a loss of trust in banks. You're so young you may not remember the lines outside Northern Rock. There were genuine bank runs in Britain and the United States. And so at the heart of modern money is the role of banks. If you lose trust in banks...

then you're in a financial crisis. And there's always been a connection between money and precious metals, particularly gold and silver. Why is that? I'm not sure if all was as... Right. Periodically, there has been. Gold is something that has been... prized by human beings since time immemorial for the obvious reason that it looks nice and it's extremely durable and it's scarce. These things are quite a combination.

So we've valued gold, and most civilizations have valued gold, but not always as money. And so gold was valued by, say, Inca civilization in South America, but wasn't used as money. The interesting thing that happened in the course of history was that people began to use amounts, fixed amounts of gold and fixed amounts of silver for payments. And the sort of classic...

gold and silver coins are precisely that. But the problem is that because gold is very rare and silver is relatively rare, you can only really use gold and silver coins for quite big transactions. And so you have the problem of, well, what do we do for small change? And hence the need to use base metals to produce coins for smaller scale transactions.

But the link that you mentioned becomes hugely important in the course of the late 17th, 18th and 19th centuries when it is decided, beginning in this country, England. to create a fixed relationship between money and gold comes to be called the gold standard and so pounds are defined in terms of a a quantity of of gold. This is one of Isaac Newton's many contributions to our civilization. At the same time, there were other systems that defined money in terms of a quantity of silver.

and systems which did both, bi-metallic systems. So for much of modern history, the kind of history that tends to get taught in schools in the 18th and 19th century, say at the time of the American Revolution, the French Revolution, going right through the 19th century. a time of Britain's rise to imperial dominance, we are in a world where there are fixed legal relationships between money and precious metal.

And so you can go to the Bank of England and say, I got this banknote that says £100 on it. I'd like the requisite amount of gold. So that was the kind of system that... for a period of centuries became very dominant, persisted through into the early 20th century. It was suspended during wartime for reasons we can get into, and it finally entirely broke down after.

World War II had a kind of afterlife as the Bretton Woods system when only the dollar had a relationship to gold. And then in 1971, Richard Nixon severed that final link. And since 1971, there's been no link between... precious metal and money, except that central banks like to keep in their reserves some quantity of gold. And before we get into that, because I think that's very important to the conversation that we are having.

I would like to delve into a very interesting story you told in the book, which is a man called, I think it's Francisco Pizarro, and his journey from Spain to South America. and creating a form of currency. So the dream, if you were in medieval Europe, was if only we could find some more gold, because there just wasn't that much. And indeed...

Part of the problem for medieval economies is just there doesn't seem to be that much gold or silver in these relatively underdeveloped agricultural economies. That produces some interesting innovations.

One of them is the bill of exchange, which is another form of IOU, only this time on paper, where merchant A says, I'll pay you, merchant B. x amount in in three months time and these ious bills of exchange were tremendously important particularly in the period after the black death when there's a serious labor shortage uh in in europe and there's also

chronic shortage of precious metal. So what do you do in a world where there isn't enough gold? Go and find some, obviously. And it's pretty clear that there isn't much in... say, England, not famous for its gold mines. And so a lot of exploration, a lot of what sends men in ships around the world, across the Atlantic or around the Cape of Good Hope in the other direction, is the search for gold.

And interestingly enough, the Spaniards strike it rich in Central and in South America. They find substantial deposits of precious metal in what today's... Bolivia, Peru, Mexico. And that is enormously good news for the Spanish or Castilian Empire, which acquires not only the territory... and the people living there as a result of the conquistador's success. But also it accesses all the mineral rights. I mean, there is literally a giant mountain of solid silver.

Potosi, which I remember visiting when we filmed the television series of A Sense of Money. There is a television version, by the way, for those who've lost the power of reading books. You can find it all. It was all stolen by YouTube, the intellectual property, brazenly.

So the series of Ascent of Money shows you the silver mountain, the great mountain, great mine of Potosi, which is one of the principal sources for bullion for gold and silver. And those were then sent. from Spain's empire in the Americas, all around the world, principally to pay for the incessant wars that the Spanish kings fought in Europe and elsewhere. I think this is...

taking us partly towards the modern conversation we want to have. But I also think it's an important conversation to have from a historical perspective as well, which is the leap from I owe you for this thing that you've given me to I owe you because you've given me money that I then have to repay you at a higher level. That is an extraordinary cultural adaptation that I imagine, first of all, it'd be interesting to know when that happens and how that happens, but also...

I imagine that is transformative for human society because it, among other things, allows you to effectively do things now that otherwise you'd have to wait 20 years to do. That's right. In the end, the most important development is to have institutions that can smooth all the different transactions that people want to make.

And these come to be called banks. And we can see the first modern banks emerging in Renaissance Italy. In Florence, the Medici start out is essentially... foreign exchange dealers where you can bring in your coins that you picked up trading in germany and exchange them for coins that are more likely to be acceptable in in rome and they sat on benches banky and that's where the word bank

comes from so what do banks do well banks create a kind of centralized exchange where people with money can deposit it and people who need money can borrow it again to put it really simply And this clearly greases the wheels of commerce. It's part of the reason why you see a significant uptick in economic development in northern Italy.

At the time of the Renaissance, there is a more advanced financial system there. At the same time, you can see in London, the merchants of London start to move beyond there being goldsmiths to there being... Bankers who can lend money to kings are really the progenitors of the modern city of London. Kings matter because, and also republics, but kings mostly matter because they always have greater financial needs.

then they can satisfy with taxes on their subjects. And so one of the early sources of debt finance is just the need that monarchs have. King of Spain needs money because he's fighting. wars against the Dutch who decide to revolt against Spanish rule. That's part of the attraction of having silver and gold mines in the New World. You can finance the wars that way.

So what we see happening in early modern Europe is the emergence of the modern financial institutions we know today, banks and systems of public debt. where governments can borrow from their subjects, or in the case of the Venetian Republic, from citizens in order to finance those big expenditures like wars.

that you can't really finance out of current tax revenues because they're way more expensive than the annual tax revenues can afford. Those are two big leaps forward in the financial system. And so by the time you get to... let's say 1700, you've already got certain key components of modern finance. You've got the concept of money as being coinage, but also potentially notes. You've got banks.

which allow borrowers and lenders to transact through some kind of central institution. And you've got the beginnings of a bond market. I'll pause to explain bonds. Quite important thing. to understand um so uh in a bond the government will say uh you're gonna lend me the government a hundred fill in the currency blank and um and each year, I'll pay you five of that.

5%. And I'll keep doing that for a fixed amount of time. It might be 10 years, it might be 100 years, it might be in perpetuity. And these bonds are the basis of government. debt management. So they originate in Italy, in Venice, and then all the different Italian city states develop that system of public finance. When you buy seafood, what do you worry about most?

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So the idea of borrowing money has, I imagine, existed for thousands of years by the point this happens. What is it that happens that that adaptation into banks actually takes place? Well, it complicates matters. that Christianity and indeed Islam both take a rather dim view of lending money at interest. There are even laws against it and the crime is... defined as usury. And so this makes the business of being a Medici somewhat more complicated than it would otherwise have been.

The way around it is that you don't explicitly charge interest, but you have commissions or payment arrangements that, in effect... charge interest. So there are ways around their workarounds. Sorry to interrupt. I think it's worth asking, where do the restrictions, I mean, for two major religions to...

to take a dim view of this, and you put it very diplomatically there, to have that attitude to lending. There's got to be some pretty serious motivation for that view. Where does that resistance to the idea of lending come from?

Well, the love of money is the root of all evil. Those are doubtless lines that you know. There is a recurrent theme in Christianity that... casts a shadow over the love of money, not money itself, it's the love of money that's the root of all evil, and views with some skepticism the activity of money changing. I think this has quite deep roots that are probably pre-Christian. Somehow it's all right if you own a bunch of sheep and the flock naturally increases because the sheep.

have lambs but it's it's not okay if that process happens to your flock of money so there's an aversion to the notion of the natural increase of money through interest or the interest that you might get from lending it out. So there's this moral distinction that gets drawn early on between it being okay for you to increase.

your agricultural capital through the natural increase of the sheep, but it's not okay for you to increase your finance capital. That moral opprobrium that's cast over money lending has an important...

feature because there is a group, a religious minority, that isn't constrained when it comes to lending money at interest, and that is the Jews. And so part of the issue... if you don't know what I'm talking about, try Shakespeare's Merchant of Venice, is that there is a group lending money at interest in Italy, indeed in much of Europe, that is neither Christian nor, for that matter, Muslim. it's a

A religious minority comes to be seen as a racial minority. And that's part of the reason that there is a kind of suspicion, antagonism towards the lending of money. But is there not also another thing? We have this great saying in Russian about borrowing.

money which is when you when you uh when you borrow money uh you take someone else's money you get someone else's money for a short period of time and when you pay it back you give away your own money forever there is a this disconnect in terms of how you feel about the process. And I mean, I don't know what the etymology of the term usury means, but there's a sort of, I think, instinctive feeling that people have, which is that someone who gives you money and charges you for that.

It's almost like if you borrow, I don't know, a rake from your neighbor to rake your garden, they wouldn't charge you for it. So why would you charge me for borrowing 100 quid? So that... kind of argument is quite common not only in Eastern Europe but in Western Europe too. And I think one explanation for this is that if you go back to the medieval and early modern period, interest rates are quite high.

Why is that? Well, it's risky to lend money. People who lend money to British kings, or indeed any European kings, would frequently be disappointed because the kings would say, you know what? You remember that money? I decided not to pay you. And what's your recourse? You don't have any. And if you put up too much trouble, off with your head. So part of the problem is that...

Interest rates in the medieval and early modern period are pretty high. I mean, double digits. And that makes it feel like it's really expensive. You know, credit card rate expensive. To borrow money, I think that's part of the story. Interest rates trend down historically as markets become more liquid, become more efficient, and risk is reduced because the rule of law starts to protect.

creditors but in the early modern period it's an expensive thing to take out a loan and it's expensive because so many people default on their loans i think that's the best explanation i can

I can really give you. Sorry, Francis, I just want to come back because I've interrupted Neil twice at this point. I mean, obviously, if I borrowed your rake for a year and used it aggressively to rake my garden... and the leaves uh and earth in my garden and i give it back to you it would have worn down somewhat so the rake would in practice be worth less If I borrow your car for a year and give it back to you and I say, well, thanks. Thanks very much. And you don't charge me your mug.

Because the car's worth a lot less than it was after I've spent a year driving it around, not worrying too much about it because it's not my car. So, I mean, practice. And you have no use for it. I have no use for it for a year, which I have to find some way of compensating for. So I'm not suggesting it's logical.

It isn't logical. No, it's not. So the key thing to get across here, because let's be clear, the constant drumbeat of hostility to moneylenders, to bankers, to Jewish bankers, to non-Jewish bankers... is kind of absurd. It's based on the kind of stupid notion that money doesn't have a price. But of course it has a price, just as the use of a...

car for a year or a rake for a year has a price. That's right. And so I derailed you only because I think this is an important distinction, but you were talking about the way that Renaissance Europe... made adaptations that created modern finance, or the beginnings of modern finance, and you were talking about why they were able to do that. I think it's a very striking feature.

of world history that these things happen in Europe. They do not happen, say, in China, which has a much simpler monetary system, which has a... a system of coinage, no real system of public debt, fairly basic and rather low yield system of taxation. China's empire runs on different rails. Why is that? I think, most plausible answer, which I also try to explore in a book called Civilization, is that Europe is divided into a lot of relatively same-sized polities. And these polities are in...

aggressive competition with one another. They regularly make war on one another. Periodically, one of them will try to create a European-wide empire and the others then band together to stop that. And war is in many ways the driver of financial innovation in Europe. And it just takes a very different form from the geopolitics of East Asia, which is characterised by one fairly large and more or less homogenous empire.

with a relatively low level financial system with taxes as a share of GDP much smaller. So one of the lessons of financial history is that you need to have the kind of stress of regular warfare to propel financial innovation forwards, as well as to propel scientific innovation, exploration. People are motivated by a sense that there isn't enough money for the needs of the state.

And that's why you set sail for the Americas, thinking you're going to the Indies, you're looking for precious metal. That's why you sit down, come up with the idea of public debt. Hey, wouldn't it be a good idea if the rich people lent the government money to fight the war? These innovations, I think, are propelled by the imperatives of geopolitical conflict in Europe. But in a way that we talk about the borrowing and the attitudes to people who lent us money.

Is that why Shakespeare talked about a pound of flesh when it came to Shylock? Well, if you think about the Merchant of Venice, Shylock is... trying to collect on a debt, but decides when it's clear that he can't be paid, that he will take full advantage of what he thinks is his power as a creditor and demand the death of the debtor.

And that leads, of course, to his coming a cropper, because as Shakespeare makes clear, that's actually a wicked thing to do. Absolutely. But it's also, there's a hypocrisy there, because as we've alluded to... Without borrowing, without taking essentially financial risk, innovation can't happen. And that's innovation whether it comes to...

exploration, whether it comes to setting up a business, whether it comes to a government, for instance, building infrastructure, we need to borrow. This is essential, isn't it? Well, it's very risky. I mean, Sharnock's being asked to finance oceanic trade and ships sink quite regularly in those days. So there's quite a substantial risk in financing any maritime trade.

That's, of course, the side of things which would make you sympathetic to Shylock before he decides to go for the pound of flesh. But I mean, I think the point you make is a really critical one.

Just as there's a cost to my borrowing a car for a year, or for that matter, a tractor, so there's a cost to my borrowing £100,000. to start a business. And anybody who's going to bet on my business being successful will need to be compensated for the risk. And that's at the heart of almost all financial transactions. What's the appropriate compensation? Because there are risks.

One risk is the default risk, which Sherlock encounters. Ah, sorry, I can't pay. The ship's all sank. What can I do? It was the weather. But there's other risk, too. Suppose that we contract this debt in pounds. But we do it in the 1970s, and in the period of the loan, the inflation rate rockets up, as it did when I was a kid, into above 20%.

And so the debtor gets to pay back in these depreciated patents, the purchasing power of which has been reduced in a year by 20%. There's also a risk there. So if you're lending, you ask yourself, what's the default risk? And what's the depreciation or inflation risk that I am running? And efficient financial markets, to use a term that's been much abused over the years.

deliver, if there's sufficient information and sufficient liquidity, they deliver a reasonable price for those risks. And we're talking about risks. stories that you tell in the book, which was fascinating, which is all about risk, is the story of Nathan Rothschild, which every... Look, people will know it's a famous name, but...

particularly the anti-Semites who will be, you know, the moment they hear the word Rothschild, they're immediately there, kind of the light bulbs start pinging. So let's talk about the story of Nathan Rothschild, because that's a story about financial risk, lending. but also vast amounts of wealth that come as a result of that. Yes, the story of how the Rothschilds made their first million is a famous one. It's even been made in two movies a couple of times, once by the Nazis.

gets to your point that this story has often been used by anti-Semitic writers. I wrote a history of the Rothschilds back in the 1990s based on the archives of the bank. here in London and tried to tease out what had really happened. It's important to tell these stories with historical documentation and as much accuracy as you can muster.

It's really the only possible antidote to the anti-Semitic myths. The myth says that in a somewhat illicit way, the Rothschilds... make money from the outcome of the Battle of Waterloo, while heroic Frenchmen and Britons, not to mention Germans, are perishing in the battle, they're profiting. So what really was going on? What was going on was that Britain and other European countries fought recurrent wars with France from the 1790s, from the period after the French Revolution, right up.

until the Battle of Waterloo in 1815. And a variety of different instruments were used to finance these wars, including bonds which the British government was able to issue in substantial quantities. and bankers. And the Rothschilds were one of a very significant number of bankers who contributed to financing the war effort against revolutionary and then Napoleonic France.

One of the most important things that the Rothschild brothers did, there were five in the course of the period prior to 1815. They left Frankfurt and established themselves in five different. financial locations. There was the original base in Frankfurt, there was a house in Vienna, a house in Naples, a house in Paris and a house in London. These five houses of Rothschild.

contributed primarily by advancing gold to the armies in the field. If you're an armed force marching your way, say, up from Spain towards France. But you really can't pay with paper. The locals want to have hard currency. And so part of the challenge was getting the gold to where it was needed.

ultimately by the Duke of Wellington's army. And the Rothschilds had been involved in those transactions, as well as other transactions, occasioned by the Napoleonic Wars. Okay, this is where it gets exciting. So the Napoleonic Wars appeared to be over. Before 1815, it appeared that Napoleon had been defeated and he had been sent into exile and on the Isle of Elba and a peace had arrived.

And when peace arrived, there was significantly less need for the gold that had been used to finance his ultimate defeat. When Napoleon makes a comeback for 100 days in 1815, culminate at the Battle of Waterloo, the Rothschilds, of course, are scrambled into action again to help finance another campaign against Napoleon. But nobody knows.

how long it's going to last. And indeed, it's reasonable to expect a long time because Napoleon has an incredible record of military success and he's back. The emperor is back. He appears to be back in control of France. When the news breaks...

that he's been defeated in the Battle of Waterloo, it takes a while for that news to spread. No internet, no telegraphs. The only way you can actually get news... around Europe in 1815 is to have guys on horseback riding to the Channel Coast, handing the message to somebody in a boat who gets across the Channel.

hands the message to another guy on a horse, horse gallops to London, news is delivered. The Rothschilds clearly got the news before the British government that Napoleon had been defeated. So their couriers were faster. And this certainly was part of the reason that they were able to make a significant amount of money.

But as I showed in the book, the House of Rothschild, also known as the world's banker in all good bookshops, there was a terrible moment when they thought they had actually blown up because they didn't expect. Napoleon to lose. They'd expected a protracted campaign and they'd accumulated a lot of gold in the expectation of that continued campaign. When they heard the news that it was all over and he'd lost again.

There's a moment of panic within the brotherhood. They're writing to one another, who has the money? I thought you had the money. Wait, where's the money? They really thought they'd overextended themselves and were about to come a cropper. Now, Nathan Rothschild... was not the eldest brother but he was the smartest brother he was the one uh in london and nathan was one of these people who can as they say in new york turn on a dime

As soon as he realises what's happened, Nathan radically shifts the position and goes long British government bonds, known to this day as gilts. He goes long British bonds because he thinks peace is now here. It's all over. These bonds are going to rally. In other words, interest rates are going to come down. We're going to peacetime economy. And it's that trade.

buying bonds before the rest of the market knew that Napoleon had been defeated, that made them a million pounds, which at that time was a lot of money. That's what really happened. And it then becomes part of the mythology. of the Rothschilds right down to the present day. Where is the allegation of cynicism or sinister behaviour within that? Where is the divergence between what you're telling, which is what happened, and the myths?

Beginning really not long afterwards, in the 1820s, particularly in France, critics of the Rothschilds, who certainly included... people sympathetic to bonaparte who were hostile to the restored royal regime began to portray all of this in a somewhat scurrilous light and there are two kind of pieces to this one is

well you know heroic people are laying down their lives and they're sitting in london uh making money and the second one is uh but there's some kind of insider knowledge there's something disreputable about the fact that they front run the market before even the British government knows the story. But that's sort of not enough for a conspiracy theory to have legs.

And so quite quickly, what you get is this element of the supernatural, that there's something really not quite right about the fact that they... can know this so early and and so you get the legend of a kind of talisman that protects the family and makes and makes the success of the business and this idea that there's a secret power at work

is interesting because it exists in the anti-Semitic literature or the anti-Rothschild literature and it exists in Jewish literature, including in Russia, with the notion that there's something magical about this family. They're kind of the super Jews and Rothschild refers to themselves as, you know, the royal family of Judaism. And so this idea that there's something kind of more to it than just business acumen, I think is part of what fuels this really powerful conspiracy theory.

I think what's interesting is it morphs into a series of apocryphal sayings along the lines of, you know, the time to invest is when there's blood in the streets.

or the sound of guns or of cannon fire is a chance to make money. Those apocryphal sayings... arise in the course of this story morphing into a myth. At the start of a new year, everyone talks about resolutions, but most people try to brute force change with willpower alone and burn out by February.

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the end of the reign of kings as well, because the way you described it when it came to kings in medieval Europe made so much sense to me. Of course, if I'm the king and I want to fight a war against France. I'm going to borrow money from whoever's going to lend it to me. It would be very, very strange in that situation to blame the lender for the war. That doesn't make any sense. But as you inch towards slightly...

less obviously visible people borrowing money, the government, whatever that is. You know, not saying that necessarily happened with the Napoleonic Wars, but just as you start to head towards democracy, you can see why... It's almost like, well, who is responsible for this? And of course, this modern narrative exists all the way through to, you know, the military industrial complex and so on. There's always this narrative that wars aren't being for.

by people in charge of governments who either have real geopolitical, geostrategic concerns or they want to show that they've got a bigger penis than the other guy or whatever it might be. It really is, you know, the shadowy... figures in the background who who just want to make money from it i think that's right in the course of the 19th century which is over time an increasingly democratic age where

More or less, everywhere there are widening of the franchise. Politics changes, and one of the targets of the more democratic politics is the relationships between... bankers, and politicians. And you get this in most countries. In the United States, there was always a skepticism about financial power. It was right at the earliest stages of the republic.

that you had the debate over whether there should even be a central bank. The decision not to allow New York to have too much political power to create Washington, D.C., is part of resistance, particularly by the southern founders. to Alexander Hamilton's vision of a quite British form of United States in which all power, financial and political, would be concentrated in New York. So the 19th century debate evolves in interesting ways.

offer a critique of those who run the financial markets and the Rothschilds were the dominant financial family for most of the 19th century far bigger than say JP Morgan who's a a newcomer new on the block in the late 19th century that the Rothschilds and finance become almost synonymous with one another the relationship between that financial world and the political world of kings

and of ministers prime ministers and finance ministers now those relationships existed of course they existed because the governments are consistently encountering the problem You seem to have a deficit, Your Majesty. And here's the choice. Raise taxes or cull the Rothschilds. Obviously, politically more convenient to go down the borrowing.

These relationships exist, they're documented, there's correspondence. I spent a great deal of my time in the 90s piecing all that together. The critique that comes from democratic political figures is... Well, there's something not quite right about this. I mean, A, aren't they making...

crazy amount of money, and surely that's ultimately taxpayers' money. And B, isn't it a little bit cosy that the Prime Minister is so close to Rothschild that, oh, his daughter's just married a member of the family. Those are the critiques. but they come from both the left and the right. And this is a really important thing. The critique of finance or finance capitalism is a socialist critique. It's there in Marx.

But it also becomes a critique on the far right. And in the 1820s, those distinctions aren't yet clear. They're just radicals, and radicals don't like this. They don't like the Rothschilds. They don't like the restored monarchy. By the time you get to the 1840s, 1850s, there are two flavours. You can be a Marxist, a social democrat, you can be for the workers and against the capitalists. But...

that's not quite strong enough drink for you, then you can join the nascent radical right, which ultimately evolves through populism into fascism. And you say, you know what? The real story here is the Jews. are taking the money of the Christians. And that's, I think, the kind of bifurcation that you see in the democratic politics of the 19th century. Doesn't a lot of this anger...

resentment, frustration, come from people who don't really understand money. They don't understand finance. They don't understand the bond market. So where you have this absence of knowledge... What then gets fed into it is conspiracy theories, anger, resentment, which then leads to anti-Semitism, resentment, which then leads to movements like communism, socialism, etc., fascism.

I think one of the odd things about the way education evolves in the course of the 19th century is that while we generally agree that it's a good idea to teach people literacy and numeracy. not to mention some history and maybe a foreign language, we never really sit down and teach them about finance. And indeed, financial illiteracy is a very striking feature of our world today.

it's a very complex financial world everybody is expected soon after they leave education and perhaps even before then to understand how a loan works even if it's just a student loan We expect people intuitively to know how interest rates work when they've probably only encountered the concept in a mathematics class.

So we have that problem that nobody really quite understands what a bond yield is. That is still true. I read just the other day in the newspaper that some British political figure didn't actually understand what a bond yield was. I remember noticing at Harvard when I was teaching a financial history course, which was a popular course, that quite a few of the teaching fellows, the graduate students, couldn't in fact explain very well to the undergraduates what bond yields were.

I think it's true that ignorance is one of the precursors to conspiracy theories when you actually explain what an interest rate is. and what risk is, the kind of risk that you run if you're a lender, why being a banker can give you sleepless nights. I think it becomes a little less mysterious why the Rothschilds became wealthy from the very outset.

They ran colossal risk, not only in 1814-15, but recurrently through the 19th century. They take on the risk, for example, of financing railways. They're very early to see the potential.

And railways are the big capital expenditure. They're the data centres of the 19th century. But to a large extent, these railroads in Britain and Western Europe... Built by private finance. Further east, it's the government that does it. There's enormous risk involved in building a railroad. It's an extremely expensive undertaking. It's a pretty unregulated market. And a lot of companies that built railroads did not make money.

indeed went bust. So I think people don't have a good understanding of risk, nor do they have a good understanding of the difference between risk and uncertainty. Something I try to explain in The Ascent of Money goes back to a distinction. the Chicago economist Frank Knight drew about 100 years ago. Risk is calculable. I mean, I roughly know the probability that each one of us will experience a car accident in the next year. We can kind of put a number on that because it's...

Fairly normally distributed. We all can figure out what our risk of being diagnosed with cancer is. Mine's higher than yours because I'm older than you. All that's calculable. And so when we're calculating how much we should pay in health insurance. That isn't actually tremendously difficult to figure out. But what is the probability of war breaking out that involves Britain? Actually, that's impossible to say. What's the probability there'll be another pandemic? Nobody knows.

When will there be a huge earthquake in San Francisco that completely ends Silicon Valley? Nobody knows. So that's the domain of uncertainty. So anybody who's embarking on a large-scale investment... whether they're lending the money or buying the equity, we'll come to that in a minute, is taking on risk. Some of it's calculable and some of it's not. And that is ultimately at the heart of capitalism.

cost of risk and uncertainty. And one of the things to pick up on there is you corrected me and I'm grateful for your correction and that you wrote your book before the financial crisis. I didn't know about that because I became aware of it shortly after. What did you see that other people didn't see? So in 2006, there were a couple of red lights that were flashing on the dashboard. And I wrote about it at the time.

There was a lot of debt accumulating the financial system. Household debt, particularly the famous subprime mortgages, loans that were taken out by relatively low-income families to buy homes. But there was also a lot of debt on bank balance sheets. And then there was debt that was not on their balance sheets in various off-balance sheet vehicles, part one. Part two, the cost of debt, interest rates, were rising.

And therefore, there was going to be a steady and sustained squeeze on any vulnerable borrowers, anybody who had overextended or any institution that was undercapitalized. You could see that. I could see that from late 2006. And I think the moment of truth for me was when one of my friends, Jim Tisch of Lowe's Corporation, sat me down with his mortgage specialist and she showed me a chart of when the subprime mortgages would reset.

Because the way the subprime mortgages worked was that you had a sweetener period when the payments that you had to make per month were relatively low, artificially low. But they reset after a certain period of time to a much higher market rate. And those resets were pretty much pre-programmed to happen in the course of 07. And so you could see that the trouble would start to build. in the course of 2007 and then finally would spill over in the full-blown crisis.

that we saw in 2008 for Bear Stearns, then Lehman Brothers, because the overextended investment banks were really the weak link. The interesting thing looking back on it is how few people saw that. That was partly because if you were making money in the market, you were incentivized not to see it. If the music is still playing, we'll keep dancing. That was what Chuck Prince, one of the bank's CEOs, famously said.

But I think there was also a kind of failure on the part of some economists for me to understand the precariousness of the debt dynamics. And in some ways it's... an advantage to be an economic historian, because you don't have some fancy mathematical model that you have to focus on. You're really just looking to do pattern recognition to see, well, we've seen this kind of...

debt dynamic before i think it's important to bring into the conversation something we haven't talked about yet which is the equity market because we've talked about banks we've talked about bonds but we haven't talked about the stock market And that's funny because actually people typically focus a lot more on the stock market than they do on the bond market. And certainly in the United States, most conversations about Wall Street are really conversations about the stock market.

And it's worth just understanding that because it was collateral damage in the financial crisis. I mean, equity markets tanked in the wake of the Lehman Brothers bankruptcy. But it wasn't really... at the heart of the crisis. So let's just quickly do a refresher on that because stocks or equities are just a way in which we can own a piece of a business, a piece of a company.

whether it's Apple or Alphabet or a much smaller company. If it's a publicly traded company, you can go and buy a little piece. of its equity, of its capital. There's more risk involved because the company can go bust and you get nothing if that happens. But there's more upside because if the company is Nvidia and you were smart enough to buy...

Nvidia stock on the eve of the launch of chat GPT, then your upside is massively bigger than in any other asset class. I wanted to throw that in because if you want to understand how the financial system works. You've got it populated with all the different components, and they accumulate over time. There's no equity market prior to the 18th century. That's essentially when you start to see something like a modern stock market.

Similarly, there isn't really much of an insurance market in the modern sense until the 18th century and the 19th century. And that brings us... perfectly to where we are today because one of the ingredients france has mentioned ignorance but another ingredient i think is pain uh another ingredient is uh terrible economic times another ingredient is

war, another ingredient, basically times when people feel that something has gone wrong. And the rise of the radical left and the radical right is something that I think is happening in our society today. I think it's undeniable. You know, here in the UK, the Zach Polanski's of the world. In the US, you have both the radical left and the radical right. And, you know, we've spoken to people on both sides of that. It's happening.

I don't know how you feel about it. I mean, you've talked a lot about the indebtedness levels, and it's obvious that's a huge problem. Are we headed in a sort of 1920s direction, 1930s direction? Well, it's a good question because the ideologies are the same old, same old. Yeah. I mean, it's sort of depressing that we can't come up with new material, but...

It's like the writers have just gone home and we're stuck with, oh, I'm really disillusioned. What can I have for my disillusionment? It's like, well, sir, we can offer you Marxism. If you'd like that, or if you'd rather something stronger, we've got some antisemitism. So it's essentially Zoran Mamdani or Nick Fuentes. And that's like, really? We've got a hundred years on the clock and it's those guys again?

That's somewhat disappointing. I feel we could be more creative. Maybe we're not reading enough manga. We're short of new ideas. So the question is, do we get the macroeconomic... context in which those ideas come in from the margins and become very popular. Because right now, the people attracted to the extreme ideas are still clearly a minority. I think... I mean, sorry to interrupt, Neil, but Mamdani's mayor of New York.

Yeah, but he's not going to be president of the United States. I mean, remember, New York politics is not at all representative of US politics. I'm just making the point. They are making inroads. Oh, unquestionably. But the key question is... Do we have enough economic volatility of the kind they had in the 20s and 30s to propel today's wannabe Hitler into a position of political power? And lots of...

so-called far-right populists aspiring to power. And the question is how many get there and obviously how radical are they when they get there? Same question for the left. New York can take a... kind of punt on socialism. Maybe Minneapolis might do it too, but I'm not sure that many other cities are going to do it. But remember, all this is happening after a period of sustained economic expansion.

where economists have predicted several of the last zero recessions, apart from the shock of the March 2020 onset of COVID, the economy has essentially been on expansion mode, certainly in the US. since the financial crisis. There hasn't been that much in the way of volatility by the standards of the 20th century. So when...

Andrew Ross Sorkin publishes his new book, 1929, we're all supposed to read it looking for traces of the 1920s in the 2020s. And of course, there are some because there are... 1920s people offering... projects of implausible economic viability are step forward Sam Altman of OpenAI, there's margin credit, there are traders. who buy stocks on the YOLO principle, you only live once, or on the FOMO principle because they have fear of missing out. That's all quite 1920s.

So what's the probability that we get the great shock of 29 followed by a decade of depression as we did in the 1930s? That is very low probability because we're unlikely to make the policy mistakes that were made. Back then. Which for what? Well, the key lesson of the Great Depression is that the Federal Reserve did almost everything wrong, everything to make matters worse. And when I was trying to navigate...

through the financial crisis, after I published the book, I did a lot of talks in a lot of institutions. The question was always, is it the Great Depression? And I would say, well, no, because Ben Bernanke, who was then the Fed chair, knows the... financial history of the Great Depression, and he's not going to do what the Fed did then, which was actually to tighten monetary policy. And that had the effect of causing multiple bank failures persistently right the way through from late 29.

all the way until Franklin Roosevelt is sworn in and finally shuts down all the banks in the famous Roosevelt bank holiday. We're not going to do that again. No central banker would make those mistakes again. In a sense, we've run the experiment because when the financial crisis happened, the Fed and other central banks did what came to be euphemistically called quantitative easing, i.e. they expanded the balance sheet, they bought lots of stuff.

that was otherwise going to tank in price. They bailed out key financial players. And we didn't have a Great Depression. I think, therefore, it's reasonable to assume that we're not going to have a Great Depression when the next recession hits, which eventually... It will. My student Tyler Goodspeed has a brilliant book coming out early next year called Recession, which everyone will have to read, showing what it takes to cause a recession. And it's usually more than one thing that goes wrong.

I think we will get, at some point, enough bad news to check the CapEx boom in AI. We'll get enough bad news, maybe geopolitical bad news. to make investors much more worried than they currently are about Taiwan. At some point, I'll be sitting here with you guys talking about how we got into the latest financial mess. But I doubt very much.

that that financial mess will lead to the kind of economic pain that we saw in the 1930s, without which it's hard to believe so many authoritarian leaders would have come to power. It's very hard to imagine the collapse of German democracy and the advent of Hitler without the huge shocks of hyperinflation in 1923 and then a crash, crash.

I mean, unemployment is like north of 25% in Germany by 1932. I can't see us going there again. So the bad ideologies, they're back. They never really went away. They're just back and somewhat attractive. To me, the weird thing is that they're attractive at a time of relative economic prosperity when there really isn't that much pain. You mentioned pain. What? We ain't seen pain.

Mass immigration, mass illegal immigration is probably a big driver of it. And I think maybe that's where some of the appeals have come. Of course, unquestionably. But the interesting thing about that is that if you cut it off... which is happening in both the US and the UK. You're going to get economic depression. Well, there'll be economic, not depression, but you'll have some, there's some economic cost to that. Yeah, yeah.

It's hard to run the NHS with immigrants. I would assume it's the US economy without cheap labor from the South runs in a very different way. And so... All of the changes that are currently being made in response to disillusionment about immigration will have some kind of as yet unclear economic consequences. Yeah, it's got to be calibrated correctly. I certainly feel that in the UK, I don't know how reliant Britain is on...

boat crossings from France. No. I don't think we are relying on that at all. In fact, I think it's a massive cost and drain on the economy. Yeah, absolutely. But there's one other thing on economics and finance that I think is a giant problem, and I wonder if you... know how it's ever going to get solved, which is we don't seem to be able to live within our means. And this is where, you know, Francis did, I think, as good a job as anyone can do of making the case why borrowing.

can be a really useful tool and it has been it allows civilization to grow fast it allows us to do things before we otherwise would have been take risks etc but when you become addicted to it in the way that we have I mean, we really are in trouble in that aspect of things, are we not? A mate of mine tries to quit vaping every new year, every time he fails for the same reason. He removes the habit, but never replaces a ritual. That sounds like you.

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deep trouble if you borrow to invest and you acquire some productive asset then what's not to like it'll probably help you repay the debt But if you borrow to consume, well, that way lies trouble. And that's what we've been doing. Let's put it really simply. The systems of public debt that evolved in the 20th century to finance wars, particularly the world wars. after the 1945 Allied victory began to transition to financing welfare. So we went from warfare to welfare states.

Those welfare states, which evolved in the 40s and then got another expansion in the 60s, assumed certain demographic features about fertility and longevity, which have completely changed. So we now don't have really any... countries outside of sub-Saharan Africa where fertility is above replacement rate, 2.1 children on average per woman. And we have in most countries...

Retirement ages that were kind of devised in the mid 20th century, while life expectancy is steadily increased and people can expect, therefore, to spend substantial parts of their lives retired. Our welfare states can't. cope with that on either side of the Atlantic. In the US, the real driver of the debt and the deficit is Social Security to retirement program and Medicare, free health care for the elderly.

In the UK, you have a whole system of benefits that can trace back to the Attlee government after 1945. It's all anachronistic, and it's really hard to reform. Why is it hard to reform?

Because there's a very, very powerful constituency that likes the status quo, called the elderly, and they're a huge proportion of the electorate and dependably vote. I think I read the other day that 40% of the german electorate more than 40 is now above retirement age so you can't get radical reforms through uh with that basic obstacle

Nobody who tries to reform these welfare states survives politically. Emmanuel Macron has been dead in the water since France. Why? Because he tried to make a microscopic increase in the French retirement age, and he's been twisting in the wind ever since. This is the problem. What does it lead to? It leads to there being deficits every year and not just in the bad years, which is wrong. The deficit every year in the US, six plus percent of GDP every year, as far as the eye can see.

Gross debt, now above 120% of GDP, higher than it was at the end of World War II. This is not sustainable. Ferguson's law, which I promulgated in January, because everybody should have a law. And I decided I would help. So I said, Ferguson's law states that any great power that spends more interest payments on its debt than on defence won't be great for much longer. Well, the UK stopped being a great power a long time ago.

been in violation of Ferguson's law for many years. But the US only crossed this threshold last year, and it's going to stay well above it for the foreseeable future until by about 2040, I think I worked it out. The US will spend twice as much on debt service, on debt interest, as it spends on defence. These are completely unsustainable trends. The problem is, politically, nobody wants or dares...

to go there. And so your next question is going to be, sir, how does this end, Neil? How does it end? And that's the big question. And there are a finite number of options, very, very limited range of options. Happy ever after option, okay? It has been done. You can have a really large debt and you can grow your way out of it. That's what Britain did after the Napoleonic Wars, going back to the time of the Rothschilds. Britain just ran.

primary budget surplus, and grew thanks to the Industrial Revolution. So that's the good way out. If that's to happen here in the 2020s, we need AI to be every bit as good as Sam Alton says it is. and the productivity growth to be so great that in a couple of years' time, this podcast will be generated by GPT-6, and you guys will be out of a job. So that's the good news.

Productivity gains will get you out of jail. Do I think that's likely? No. I think it's quite unlikely. I think it's unlikely... There might be some social consequences to that out. I think you would not be the only aggrieved people in this scenario. There'd be an entire generation of people with university degrees who wouldn't even be Uber drivers because the cars would also be driving themselves. Plan B. So then you...

kind of default you say go back to the medieval monarch approach ah you know that money uh that we owe you i don't know but i'm i'm really sorry about this i don't know how to pay you defaulting on the bondholders is something that used to be more or less a recurrent every decade experience in Latin America. But if you default on the people who receive benefits, particularly old age benefits, I don't know.

I'm just thinking you better have a plan for the private sector because your political career will be cut very short. What about plan C? How about we inflate it all away? How about we do what we did repeatedly after World War II? And we just reduce the real value of all these liabilities with a big, sudden, unexpected increase in inflation. That's going to be pretty unpopular too. The other problem is that a lot of the liabilities these days are index linked.

Because we went through this once before, and then the decision was, let's not do that again. Let's make sure that we can't inflate away the debt. So the number of ways out of this problem... is pretty small. I think what ends up happening is some combination of default, where in practice we reduce what we said we would pay out, and some element of inflation we inflate away.

or use financial repression, some of the liabilities, none of which is going to be fun, particularly for the people who've got significant amounts of money they expect to receive from government. or the people who've accumulated lots of pounds or dollars in savings. But I don't see any other way out. And it's not just the Western world.

I was reading about this. China's got a debt of 17.8 trillion. The Chinese debt's interesting because it's mostly at the local level. And it tends to kind of get passed over by people who are taken in by Xi Jinping is awesome. But actually, Xi Jinping is not awesome. The public finances of China, if you drill down, are about as bad as those of the United States. It's just that it's mostly local government.

debt. If you add up the liabilities, the public sector are about the same relative to GDP. And the deficit, the Chinese deficit might be even larger. The IMF did a study, I think a couple of years ago now.

where they calculated that the real deficit of the entire public sector was more like 15, 16% of GDP. So China has this problem. Of course it does, because it has a very rapidly aging population and its fertility rate has collapsed. So the demographics are the real driver here. If you leave your system unadjusted, it's just going to go insolvent unless you have a miracle rise in fertility.

That's vanishingly improbable, very, very unlikely. Or you might have a pandemic that really kills the elderly rather than just kind of half-heartedly does the way COVID did. So those... like those seem like pretty unlikely solutions, you're finally going to be forced, whether you're China, Europe, the UK, the United States, to do something radical. And this is where Mr Millet...

is interesting. The Argentine president is the only really fiscally radical leader in the world. He's the only one who's serious about this, who in his first year as president said, I'm reducing the deficit from 5% of GDP to zero. And he did it. So, you know, Malay has shown that you can be radical. But what's really interesting is you have to be, as the Argentines were, staring at 200, 300 percent inflation.

You have to have your economy just flat, face down in the ground to get the votes to do the radical stuff. Well, look on the bright side, Neil. That's probably going to happen. I console myself that in the end, everybody is Argentinian. Eventually, they all get there. And then everybody needs Malay. Neil, what a pleasure. We could carry on this conversation.

for many many hours it's always a fascinating insight final question is always the same what's the one thing that we're not talking about that we really should be well maybe we have been talking about it. I'm almost struck by how much less fun these conversations are.

conversations about money than conversations about sex or political extremism. And I actually think we've just had the conversation that a lot of people would rather not have because culture war is more fun. I mean, the culture war is just. much more fun but is it really a woman but my message already we have laughed yeah but i think we're talking right now what we've just done is we talked about the difficult

nasty, gnarly stuff that isn't going to go away. I mean, you may not be interested in financial history. Financial history is interested in you and those who don't understand debt dynamics. Those who enter adulthood without a clue about how interest rates work, who don't know what a bond yield is, who have never made an investment in the stock market and never will, those people will have worse lives.

than the people who get informed so the thing about the stuff i do at core it's boring but important and if you can't get your head around the stuff that's boring but important If you can't bear to get through the ascent of money because you'd just rather watch Nick Fuentes on YouTube, you will be poor and I will laugh. There we go. Neil, fantastic. Thank you very much.

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