Independent Research and the Foundations of Modern
March 11, 2004
For some, modern
finance started when they walked into their first lecture in
Economics 101. For others, it was the inception of the Federal
Reserve System with the concept of a "flexible" currency
way back in 1914.
For those around then, it was thought to be new and modern and,
with the contagion of the 1929 boom, John Moody (yes, of Moody's)
claimed it was vastly superior to the widely discredited previous
agency, the Treasury System. His scornful view, which was conventional
wisdom of the day, should be compared very carefully with the
regard for the old system when it was excitingly modern.
But before getting into exquisite ironies, it's worth noting
that there have been six New Financial Eras since the first one
blew out in 1720. Each has been identical in duration, compulsive
participation, and dramatic climax. In all previous examples,
senior bankers, journalists, and even satirists were capable
of identifying the action, in real time, as a financial bubble.
Even the first one was properly labeled, but in a remarkable
lapse of perspective our leading financial types were unable
to make the distinction in 1999 and 2000.
The explanation of this failure is too serious for any luncheon,
particularly today's. So we will follow the thread of modern
finance back in time, specifically to the unbridled regard for
the old Treasury System during the financial bubble that climaxed
in September, 1873. As with examples before or since, the exhaustion
of a speculative frenzy is anticipated by increasing financial
stress, indicated by soaring interest rates within an inverting
yield curve and widening credit spreads.
This was the case in late summer 1873 and the leading NY newspaper
editorialized that the Treasury-Secretary had powers greater
than those of a mere central banker and therefore nothing could
go wrong. The irony is that the initial phase of the contraction
lasted for six years and in England, which was the preeminent
economy, the period from 1873 to 1895, was eventually described
as "The Great Depression." That's by senior economists
and they seriously discussed remedies and preventatives until
as late as 1939. That's when another and more pressing "Great
Depression" was suddenly discovered. It's true.
In order to avoid a lot of details, it's best to go to a summary
about what's really modern in finance - actually, not much. Since
at least Roman times, there are examples of buying panics and
agencies with the urge to over-issue credit finding each other
and creating a bubble. And such over-excitement has always been
followed by severe credit contractions.
Furthermore, policymaking tools have always been the same. Currency
depreciation, protectionism to change trade flows, forced loans,
programs for the poor, and artificially lowered interest rates
for farmers. A delightful book, "The New Deal in Old
Rome" relates how policymakers then fought contraction
with acronyms. Of course, President Roosevelt ended the 1930s'
Depression with a wonderful set ranging from NIRA (National Industrial
Recovery Act) to the TVA (Tennessee Valley Authority) and the
emperors attacked contractions with acronyms ranging from HOLC
(Home Owners Loan Corporation to FCA (a farm credit administration).
Actually, Rome's bureaucrats attacked the business community
with depreciation and confiscatory taxation until the empire
While policymakers' habits have changed little over the past
2000 years, a new tool did arrive in 1694 with the inception
of the Bank of England, which eventually provided a widely circulating
set of notes from a single bank. After some defaults, the modern
convertible bank note provided its efficiencies to both domestic
and international trade.
Although a new tool of government and trade, the central bank
was only one aspect of the development of modern finance. Essentially,
this was the evolution of a means to exchange equity and debt
and, by this, we are talking about the liquidity that only a
public market provides.
in the form of options and forward settlements in interest rates
or foreign exchange transactions date back to the 13th Century,
which was a mark of modernity. When necessary, some of these
transactions were designed to bypass the compulsion of those
in government who didn't understand the markets and felt compelled
to impose arbitrary notions about artificially lowering interest
rates or preventing them from rising through usury laws.
However, it is reasonable to note that a really modern financial
world started voluntarily in the mid-1600s when there were enough
publicly traded stocks with enough participants to label the
action as a stock market or, to use the latest in portfolio theory,
a market of stocks.
Either way, it was private initiative at its best and, as history
recorded, soon at its extreme. The first big boom set the model
for all others since. The speculative mania funded innovation
in business, the action became compulsive, and collapsed. Impatience
and chagrin followed.
The first mania was in turnpike roads and the improvements in
productivity were fabulous and soon known to all. Then there
was a delay until the benefits were realized and the impatient
reflected upon the former good times with the boom. A wit celebrated
the phenomenon with a poem:
with Turnpikes are grown
much in fashion
the hardest Tax in all our Nation
when Wine & Women
& Stock-Jobbing past;
the Turnpike must help us at last
of the crash in the energy play in the mid-1980s. At congressional
hearings, outraged politicians were working over the CEO of a
busted Oklahoma bank. When asked where the depositors' money
had gone, he said, "Oh, we spent it on wine, women, and
song - the rest we just pissed away."
This classic pattern of brokerage, underwriting, and crowd behaviour
has replicated many times since. Although violent at times, it
must ultimately be seen as constructive for there is no better
way of raising and productively employing capital than through
freely trading markets.
With the development of publicly traded stock and bond markets,
the next step towards a fully modern market was the advent of
research, independent of the function of creating and distributing
The term broker or, as it was written and likely pronounced in
the early days, "brogger," dates back to the 1500s.
Underwriting is another function of finance and it was originally
described as undertaking. A remarkable example of this and government
gullibility occurred with the prototype of the modern new financial
That "new era" started with the end of the "old
era" of inflation in 1609 (think 1920). The immediate hard
recession and subsequent weak pricing abilities created widespread
unemployment, particularly in the cloth trade. At the time, England
shipped basic cloths to the Netherlands, which was the financial
and commercial centre of the world. Those who didn't know better
became envious of the "value added" obtained by finishing
the cloth in Flanders and promoted a scheme to capture this by
finishing the cloth in England. Today, this would be the equivalent
of taking Western Canada's raw materials and setting up production
to sell cars to Japan. In a post-inflation stagnation, it was
impossible to support existing, let alone additional, capacity.
Within a sluggish economy, a projector persuaded the British
Crown to finance the duplication in England of cloth-finishing
capacity. As business conditions began to deteriorate in 1618
(think 1929), the King became apprehensive - particularly as
successful merchants described the scheme as "a Sepulcher
- attractive without, Dead bones within."
Then in November of that fateful year, which was seasonally appropriate
for financial calamity, the Archbishop recorded that the King
told the projector, "in could bloud before ye Council
Table yet if he had abused him by wrong information his 4 quarters
should pay for it." As this meant "hanged, drawn
and quartered," the Archbishop continued with "ye
poore Alderman stood infinitely amazed."
As the scheme included supporting the domestic economy by buying
unfinished cloths, it prompted other practical comment.
A well known letter-writer by the name of Chamberlain observed
that it was strange that "the wisdome of the state could
be induced to [rely upon] the vaine promises of ydle braines."
Other than this, little is known about Chamberlain but, as he
is described as a writer rather than as a broker, undertaker,
or merchant, it is tempting to consider him as an independent
Until efficient printing presses became available, overly ambitious
governments believed the promises of alchemists and were their
main funders. In the 1560s, the newsletter of one of the most
powerful banks in history derided alchemists so perhaps Chamberlain's
ridicule of other schemes by " ydle braines"
was practical and not too isolated.
His comments would be applicable to the boasts of many interventionist
economists of the past 100 years.
While it would be interesting to learn more about Chamberlain's
role in financial history, John Houghton started what could be
called the first market letter in 1692 and it is tempting to
conclude that this was the start of independent research and
it preceded central banking by two years. Identifying himself
as independent of brokers, he intended to record the industrial
progress of the time. Following a leading article or essay, each
edition provided commercial intelligence as well as quotations
on some senior stocks.
In the latter, some were listed by their nicknames, of which
one is still traded. Despite 310 years, the "Bay" is
still the term for the Hudson Bay Company. One called "Wreck"
was involved in salvaging shipwrecks and "Blue" was
not the predecessor of IBM but a manufacturer of coloured wallpaper.
Beyond convoluted phrasing, the other difficulty for today's
reader is the font used in the 1690s. The small "s"
looks very much like a small "f" so Houghton's advice
to those who were totally averse to equities went as follows:
"My readers [should not be] pre-poffeffed against
Trading in Stocks."
Over the years, his essays included instruction on option strategies
with, as they were called then, "puts" and "refusals."
One was titled "The Great Mystery of Buying More Than
All" and described a successful short squeeze, which
elaboration is not needed for this audience.
Most, if not all, of the elements of modern finance were established
by the late 1600s. Houghton's publication must have been worthwhile
for it ran through very volatile conditions from 1692 to 1707.
For example, from a high in 1692 of 260, the "Bay"
plunged to 80 in 1697 and, on the same move, East India fell
from 200 to 37.
This brings us to the two most abused concepts in the financial
literature. One dates back to the 1570s, which is the notion
that some agency or clique of key players can raise or lower
interest rates at will. Depending upon the position of the viewer,
these have occurred as either complaints or boasts. To this day,
the history of interest rates has shown little regard for either
The other concept dates to the James I bust of 1618-1622 and
it is typically uttered by some intellectual with inadequate
market experience and too much personal outrage about the liquidity
vacuum that follows every speculative binge. The subsequent hard
times seem to prompt those with an enormous ego to provide a
remedy. Essentially, these have been the same whether from Misselden
in the 1620s' bust and contraction to Keynes in the 1930s' equivalent.
There is no need to be concerned that Keynes plagiarized the
same concepts promoted by his predecessors. Hayek observed that
Keynes was "totally ignorant" about financial
Generally, these ideas come under the "fund of credit"
notions that proponents claim as a cure for the fallout of too
much credit being created "out of thin air" during
a wild asset inflation.
On the other hand, not enough can be said about the contributions
of earlier merchants, traders, and financiers in building today's
prosperity. Were they bright? - Of course, can you imagine doing
interest rate calculations in pounds, shillings, and pence, and
in Roman Numerals - all without a yield book?
To be serious, the posterity of every successful entrepreneur
is today's vast pool of capital, which created and ensures our
remarkable standard of living. Over the centuries, successful
entrepreneurs and investors have learned the impartial rules
and disciplines of the marketplace, but only a few wrote down
the market sense they all knew so well.
The fantasies of the "ydle braines" of Misselden
or Keynes have been placed in perspective by the common sense
of Sir Thomas Gresham, as one of the great traders in history.
As Elizabeth's financial agent in the world's financial capital,
then in Antwerp, he recorded "streat" wisdom in letters
to Her Majesty, which she wisely acted upon.
Although it is not known if John Houghton was wealthy, his posterity
is a record of good advice and quite likely the innovator of
independent research. There have been other successful students
of the market, such as the 1920s' Jesse Livermore, whose ghost-written
"Memoirs of a Stock Market Operator" is well
worth reading. Also, we shouldn't overlook Daniel Drew's sage
advice from the 1860s on short-selling. "He that sells
what isn't his'n must ultimately deliver or go to prison."
Gerald Loeb's "The Battle of Investment Survival,"
published in 1934, made the classic quip about stock analysts
"In a bull market, who needs them and in a bear market
who wants them?"
However, as fascinating as financial history is, it is time to
close out this address.
Ladies and gentlemen, please stand with me and raise your glass
"to the absence of ydle braines and to John Houghton,
the Father of Independent Research."
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