And there were other ways to cash in: the shares of British mining firms planning to explore the new world were popular. The share price of one of them, Anglo mexican, went from 33 to 158 in a month. The big problem with all this was simple: distance. To get to south America and back in six months was good going, so deals were struck on the basis of information that was scratchy at best. The starkest example were the poyais bonds sold by Gregor MacGregor on behalf of a new country that did not, in fact, exist. This shocking fraud was symptomatic of a deeper rot. Investors were not carrying out proper checks.
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With inflation at around 1825 gilts offered only a modest return in real terms. They were safe but boring. Luckily investors had a host of exotic new options. By the 1820s London had displaced Amsterdam as Europes main financial hub, quickly becoming the place where foreign governments sought funds. The rise of the new global bond market was incredibly rapid. In 1820 there was just one foreign bond on the london market; by 1826 there were. Debt issued by russia, prussia peter and Denmark paid well and was snapped. But the really exciting investments were those in the new world. The crumbling Spanish empire had left former colonies free to set up as independent nations. Between 18 Colombia, chile, peru, mexico and guatemala successfully sold bonds note worth 21m (2.8 billion in todays prices) in London.
In the 1820s the excitement was over the newly independent Latin American countries that had broken free from Spain. Investors were especially keen in Britain, which was booming at the time, with exports a particular strength. Wales was a source of resume raw materials, cutting 3m tonnes of coal a year, and sending pig iron across the globe. Manchester was becoming the worlds first industrial city, refining raw inputs into higher-value wares like chemicals and machinery. Industrial production grew by 1825. As a result, cash-rich Britons wanted somewhere to invest their funds. Government bonds were in plentiful supply given the recent Napoleonic wars, but with hostilities over (and risks lower) the exchequer was able to reduce its rates. The 5 return paid on government debt in 1822 had fallen.3 by 1824.
In response to this aggressive regulation a group of 24 traders met on Wall Street—under a buttonwood tree, the story goes—to set up their own private trading club. That group was the precursor of the new York study Stock Exchange. Hamiltons bail-out worked brilliantly. With confidence restored, finance flowered. Within half a century new York was a financial superpower: the number of banks and markets shot up, as did gdp. But the rescue had done something else too. By bailing out the banking system, hamilton had set a precedent. Subsequent crises caused the financial system to become steadily more reliant on state support. Crises always start with a new hope.
And he knew Thomas Jefferson was waiting in the wings to dismantle all he had built. His response, as described in a 2007 paper by richard Sylla of New York University, was Americas first bank bail-out. Hamilton attacked on many fronts: he used public money to buy federal bonds and pep up their prices, helping protect the bank and speculators who had bought at inflated prices. He funnelled cash to troubled lenders. And he ensured that banks with collateral could borrow as much as they wanted, at a penalty rate of 7 (then the usury ceiling). Even as the medicine was taking effect, arguments about how to prevent future slumps had started. Everyone agreed that finance had become too frothy. Seeking to protect naive amateurs from risky investments, lawmakers sought outright bans, with rules passed in New York in April 1792 outlawing public futures trading.
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As many as 20 carriages a week raced between the life two cities to exploit opportunities for arbitrage. The jitters began in March 1792. The bus began to run low on the hard currency that backed its paper notes. It cut the supply of credit almost as quickly as it had expanded it, with loans down by 25 between the end of January and March. As credit tightened, duer and his cabal, who often took on new debts in order to repay old ones, started to feel the pinch. Rumours of duers troubles, combined with the tightening of credit by the bus, sent Americas markets into sharp descent.
Prices of government debt, bus shares and the stocks of the handful of other traded companies plunged by almost 25 in two weeks. By march 23rd duer was in prison. But that did not stop the contagion, and firms started to fail. As the pain spread, so did the anger. A mob of angry investors pounded the new York jail where duer was being held with stones. Hamilton knew what was at stake. A student of financial history, he was aware that Frances crash in 1720 had hobbled its financial system for years.
It was seen as a great deal: scrip prices shot up from 25 to reach more than 300 in August 1791. The bank opened that December. Two things put Hamiltons plan at risk. The first was an old friend gone bad, william duer. The scheming old Etonian was the first Englishman to be blamed for an American financial crisis, but would not be the last. Duer and his accomplices knew that investors needed federal bonds to pay for their bus shares, so they tried to corner the market.
To fund this scheme duer borrowed from wealthy friends and, by issuing personal ious, from the public. He also embezzled from companies he ran. The other problem was the bank itself. On the day it opened it dwarfed the nations other lenders. Already massive, it then ballooned, making almost.7m in new loans in its first two months. Awash with credit, the residents of Philadelphia and New York were gripped by speculative fever. Markets for short sales and futures contracts sprang.
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Americas new bonds would be traded in open markets, allowing the government to borrow cheaply. And America would also need a central bank, the first Bank of the United States (bus which would be publicly owned. This new bank was an exciting investment opportunity. Of the 10m in bus shares, 8m were made available to the public. The essay initial auction, in July 1791, went well and was oversubscribed within an hour. This was great news for Hamilton, because the two pillars of his system—the bank and the debt—had been designed to support each other. To get hold of a 400 bus share, investors had to buy a 25 share certificate or scrip, and pay three-quarters of the remainder not in cash, but with federal bonds. The plan therefore stoked demand for government debt, while also furnishing the bank with a healthy wedge of safe assets.
Yet well-intentioned reforms have made this problem worse. The sight of Britons stuffing Icelandic banks with sterling, safe in the knowledge that 35,000 of deposits were insured by the state, would have made bagehot nervous. The fact that professional investors can lean on the state would have made him angry. These five crises reveal where the titans of modern finance—the new York Stock Exchange, the federal Reserve, britains giant banks—come from. But they also highlight the way in which successive reforms have tended to insulate investors from risk, and thus offer lessons to regulators in the current post-crisis era. If one man deserves credit for both the brilliance and the horrors of modern finance it standardization is Alexander Hamilton, the first Treasury secretary of the United States. In financial terms the young country was a blank canvas: in 1790, just 14 years after the declaration of Independence, it had five banks and few insurers. Hamilton wanted a state-of-the-art financial set-up, like that of Britain or Holland. That meant a federal debt that would pull together individual states ious.
follows a familiar pattern. It starts with blame. New parts of the financial system are vilified: a new type of bank, investor or asset is identified as the culprit and is then banned or regulated out of existence. It ends by entrenching public backing for private markets: other parts of finance deemed essential are given more state support. It is an approach that seems sensible and reassuring. But it is corrosive. Walter Bagehot, editor of this newspaper between 18, argued that financial panics occur when the blind capital of the public floods into unwise speculative investments.
It can also act as a safety net, insuring against floods, fires or illness. By providing these two kinds of service, a well-tuned financial system smooths away lifes sharpest ups and downs, making an uncertain world more predictable. In addition, as investors seek out people and companies with the best ideas, finance acts as an engine of growth. Yet finance can also terrorise. When bubbles burst and markets crash, plans paved years into the future can be destroyed. As the impact of the crisis of 2008 subsides, leaving its legacy of unemployment and debt, it is worth asking if the right things are being done to support what is good biography about finance, and to remove what is poisonous. History is a good place to look for answers. Five devastating slumps—starting with Americas first crash, in 1792, and ending with the worlds biggest, in 1929—highlight two big trends in financial evolution. The first is that institutions that enhance peoples economic lives, such as central banks, deposit insurance and stock exchanges, are not the products of careful design in calm times, but are cobbled together at the bottom of financial cliffs.
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Finance is not merely prone to crises, it is shaped by them. Five historical crises show how aspects of todays financial system originated—and business offer lessons for todays regulators. What is mankinds greatest invention? Ask people this question and they are likely to pick familiar technologies such as printing or electricity. They are unlikely to suggest an innovation that is just as significant: the financial contract. Widely disliked and often considered grubby, it has nonetheless played an indispensable role in human development for at least 7,000 years. At its core, finance does just two simple things. It can act as an economic time machine, helping savers transport todays surplus income into the future, or giving borrowers access to future earnings now.