I recently picked up the somewhat-pretentiously-titled book "Investing in US Financial History". I think I heard about it from a Bogleheads conference video discussion between, hm, I think William Bernstein and someone else. The book came up in passing and each person was visibly delighted that the other had read it. Bernstein has recently become one of my favorite writers, both on finance and other topics, so that was all the recommendation I needed to grab it.
This book is, astonishingly, the first book to ever cover the financial history of the United States. There are lots of books on particular financial episodes, like the Great Depression or the Great Financial Crash, and lots of general books on history that include high-level summaries of financial events but don't dive deeply into underlying causes. "House of Morgan" felt kind of similar, but IiUSFH starts roughly 60 years earlier, carries us through the present day (so about 30 years past the end of HoM), and is broader, looking at other players in banking and how the system as a whole works. The closest equivalent may be "Goliath", and there's a lot of overlap between them, but IiUSFH feels more informative to me.
The author Mark Higgins presents the thesis that economic history tends to repeat itself - not exactly, and not always, but most things that have happened recently are extremely similar to things that also happened in the distant past. It's important for everyone to be familiar with history so they can be prepared for coming crises (and presumably future opportunities; the book also covers periods of high growth and prosperity, but the most vivid passages relate to turmoil and disaster). Higgins is a professional money manager, and claims to mostly be writing for the benefit of other money managers, but also to public servants and individual investors (that's me!). He makes his case pretty convincingly, highlighting episodes in the past that we don't talk about very often but were even more devastating than, say, the 2008 or 2020 downturns were.
While looking throughout history, he has noticed some trends (but not laws - like Piketty, he places a strong emphasis on human agency and notes how specific choices lead to specific outcomes). If a new crisis happens shortly after the previous one, the response tends to be quicker and more effective than if we've gone through a long time without problems. He describes being surprised at how swiftly the economy recovered after the 2020 COVID-19 crisis; but looking back, that makes sense, since the lessons of the 2008 crash were so recent and so the Federal Reserve and other institutions had a game plan ready to go. He also notices that when a crisis happens, the public and the media usually look for a scapegoat to blame; but the crisis is almost always caused by flaws in the system itself, such as bad rules or improper incentives. And the solution to a crisis is often counter-intuitive. Recessions in the 1800s were especially severe because leaders took common-sense solutions to them, like tightening credit after excessive credit causes a crisis. It's taken a lot of experience, empirical data, and learning the hard way what the actual solutions are to these problems. Finally, he's noticed that the response to one crisis often plants the seeds for the next crisis. For example, in the Great Depression it was mostly smaller community banks that failed while larger national banks weathered the storm rather well, so there was an implicit assumption that "bigger is better" and an encouragement for smaller banks to roll into bigger banks; but that paved the way for the "too big to fail" mega-banks that took down the economy in the Great Financial Crisis.
Stepping back a bit - as you may have noticed, I've been reading a lot of books related to finance and economics lately. I think I'm starting to approach being (gasp) widely-read. That's pretty cool! I'm increasingly finding slightly varied perspectives on familiar topics and events, and able to see where some details are being elided, or add more nuance to what I thought I knew. I feel like I've moved a bit beyond The Guy Who's Only Read Thomas Piketty and going "I get a real Piketty vibe out of this".
One of the (many!) striking things I remember from Capital in the 21st Century is Piketty's data-driven look at the returns of university endowments. He shows how the three largest endowments (Harvard, Yale and Princeton) have the highest rates of return; and then the performance steadily decreases in tandem with the size of the endowment. Piketty's point is that the elite institutions have access to investments that are unavailable to regular people, like venture capital, private equity, unlisted stocks, mineral exploration, and so on. These wealthy institutions and wealthy individuals also have access to highly-paid and talented money managers who can utilize those investments, thus consistently beating market averages. So it's interesting that Higgins, who is a professional institutional investor, looks deeply into the Yale endowment in particular and institutional investing in general. From Higgins' data, which extends a good decade past Cit21C, most institutions have under-performed the market. The only exception is Yale, but he thinks this is because Yale was unusually blessed by particularly talented money managers, who created a culture of academic curiosity and rigor built around a very-long-term outlook. The Yale investors have shared their process publicly, but also state that in most cases people should just use cheap index funds. Higgins thinks that other institutions have seen Yale's success and assumed that it's due to their access to exotic investments; but when you get off the beaten path, it is extremely hard to make good choices, and most people are not as good as Yale's managers.
So, anyways, I feel like I now have a bit of a conversation going on in my head between John Bogle, Thomas Piketty and Mark Higgins, and that's pretty cool! Some other ideas I'd toss in there are that we've had a monster 15-year run in the S&P 500, which considerably raises the baseline for what index investors have been getting; it would be interesting to revisit this topic after the next market crash. It's intriguing to think that Bogle may have been right all along, and even the wealthiest people are subject to the relentless rules of humble arithmetic.
If I were to place all the econ books I've read on a continuum with "least favorable regarding Pierpont Morgan" to the left and "most favorable regard Pierpont Morgan" to the right, this book would be on the far right end of the scale, even beyond "House of Morgan". IiUSFH has the most complimentary and heroic portrayal of the man I've read to date. He benefits by drawing a strong contrast with contemporaries like Fisk and Gould who dominated the stock market immediately before him. Higgins emphasizes how Morgan always behaved ethically and put his clients' needs first. Pierpont definitely made money, but only in the process of making others money, not solely in his own interest like the stock jobbers.
But, again in the theme of being widely read, I now know quite a few things Higgins doesn't mention here. One of the most germane is probably that Pierpont had almost nothing to do with the stock market. He was a towering figure on Wall Street, but only in the world of merchant banking, bonds and loans. Higgins mentions the market crisis of 1907, but not the terrific anecdote of Pierpont needing to ask at what time the exchange opened - neither he nor his firm did business there. So it wasn't so much that Pierpont was a more highly evolved form of Gould, they were swimming in different lakes. Which doesn't take away from the admiration at Pierpont's actions - if anything, it enhances it, since he wasn't directly impacted by the market crash, but he realized the threat to the broader economy and seemingly acted out of a sense of noblesse oblige.
I read IiUSFH immediately after reading "A People's History of American Empire", a sort of abridged, updated and illustrated version of "A People's History of the United States." I wasn't planning to write up that book, but I might. In the meantime, I'll note that Pierpont has only a brief but a fully devastating appearance there, surrounded by other Gilded Age plutocrats. And even details like the Pecora Hearings get shaded in many different ways. Stoller practically pumps his fist in the air and cheers on the little guys taking on the Money Trust, breaking up the self-dealing oligopoly. Chernow spends many pages on the hearings, covering the circus-like spectacle of the proceedings, shows how well Pierpont comported himself compared to others. And for Higgins the hearings are a tragic conclusion, as an ungrateful nation turned on the man who saved them from a far greater disaster.
While all of the various books I've read have had varying perspectives on Pierpont Morgan and the Morgan bank(s), it's funny that literally every single book I've read touching on financial history makes it clear that National City Bank (today's Citibank) has always been uniquely awful and dangerous, even by the low standards of national Wall Street retail banks.
Still more varying perspectives: everyone seems to agree that World War 2 was largely caused by economics, and ties in with the Great Depression immediately preceding it, but authors tend to stress their own preferred topics or hobby horses in identifying specific accelerants. Piketty looks largely at the social and political instability caused by extreme inequality, such as the massive suffering within Germany under hyperinflation, as well as the relative economic power of France versus Germany in the wake of the Treaty of Versailles. Stoller looks at monopolies: he sees large industrial cartels like IG Farben in Germany enabling the consolidation of political and economic power, bundling everything up so it can be wielded to the particular aims of a dictator. Stoller quotes FDR's views that American-style small businesses help protect democracy and inoculate against fascism, keeping things small-scale and local.
Higgins takes a comprehensive view of WW2. He looks at the Treaty of Versaille and makes a particular note of exactly why it caused hyperinflation: Germany had a massive debt denominated in a foreign currency, which led to an "inflationary depression", which is something we in the US have been fortunate to have never experienced. But he doesn't look at these sort of economic ideas in a vacuum. He also notes the humiliation of surrendering German territory and factories to France. He takes a surprisingly deep look into Hitler as well: Hitler was an ignorant oaf, who would have had evil ideas no matter what, but was able to seize power due to the disorder and discontent fed by the economic collapse. Higgins also looks straight at the evil of antisemitism and the Holocaust: he noes how a Jewish assassin murdered the German ambassador to France, and Hitler's Germany retaliated by holding all Jewish people responsible for this crime: burning synagogues, killing innocent Jewish people, destroying their homes and neighborhoods. Hitler led the drumbeat of hatred for a people that ultimately culminated in the Holocaust. Like Piketty, Higgins is mostly concerned about the extreme social consequences of bad economics. The worst case isn't some billionaire getting too much money, it's societal collapse and the emergence of something far darker and more dangerous.
Earlier in the book, Higgins also looks at the American Civil War. He prefaces this section by saying that of course slavery was immoral and the human dimension of suffering can't be expressed in economic statistics. That said, in his own review of contemporary writings, it seems that at the time the overwhelming cause of the Civil War was westward expansion of slavery, which in turn was largely economic. The Southern economy was built around slave-driven agriculture, while the Northern economy had transitioned to a proto-industrial one organized around liberates labor. Southerners "needed" to keep slaves for their plantations to be sufficiently profitable, and also much of their wealth was in human bodies.
This aligns with Piketty's "Capital & Ideology" comparison of emancipation in the UK and France compared to the US. In the former, the state reimbursed slaveholders for "taking" their "legal" property, while in the US, the value of that property was so high that reimbursement wasn't a feasible option.
This isn't the main point, but I am reminded of Chernow's description of George Washington's disenchantment with slavery, which also came down to largely economic terms. In Washington's experience, freedmen would work harder and more ingeniously in pursuit of higher pay, while slaves would work the bare minimum to escape the whip, so slaves were far less productive and also required much more oversight. But, a lot changed between the late 18th century in Washington's time and the mid-19th century in Lincoln's time. I'm not an expert in this, but my understanding is that the invention of the cotton gin reshaped the cotton-growing market to make slave labor much more lucrative, and that in turn may have helped harden the political opinions from the Revolutionary-era sense that slavery was a dying institution to the later extreme views on racial superiority.
Overall, I really love the moral dimension of Higgins' writing. He gets fairly deep into the weeds of the technical aspects of finance, and I think I tend to associate a financial focus with moral relativism, but Higgins is much more aligned with someone like John Bogle: they both have a strong sense of civic responsibility and a strong belief in service and professionalism over self-interest. I think both Bogle and Higgins have written admiringly of the early incarnation of Merrill Lynch, which was incredibly scrupulous in its dealings and rebuilt shattered trust in securities after the chaos of the 1920s and misery of the 1930s.
In some ways reading this book reminded me of my first experience reading William Bernstein's "The Birth of Plenty," where the first part of the book is a full-throated defense of capitalism and economic growth, and then the authors make it abundantly clear that unfettered capitalism leads to inequality and misery, and they promote more socialism as a way to improve social outcomes. Higgins definitely lands more to the right of Piketty, but maybe a bit to the left of Bernstein.
I did have some more criticisms nearing the end of the book, while generally agreeing or at least sympathizing with his point of view:
Some of the data presentation felt misleading. He shares a chart from the St. Louis Fed which argues that federal tax receipts as a share of GDP have actually remained pretty consistent over the last 80 years. This is immediately preceded by a graph showing the large rise in medicare and medicaid expenditures. But the spending graph is given in nominal dollars, while the income graph is given as a share of GDP, so they aren't directly comparable at all. Furthermore, if you zoom in on the federal tax receipts graph, I think it actually tells a pretty powerful story. In 2000, at the end of the Clinton administration, federal tax revenue was 20% of GDP; by the end of the Bush administration, it had steadily diminished to 15%. That's a drop of 25%, which feels really significant! And that's huge context for the political discussions about what we can afford (wars, tax cuts) and what we can't (health care, infrastructure).
The federal tax receipts graph also downplays the range by extending its Y axis from 0% to 25%, making the variations between 15% and 20% seem minor. Immediately to the right is a chart that's meant to show the significant rise in annual GDP growth over two periods. Just eyeballing it, it looks like in the 1980s growth was twice as much as in the 1970s. But again that's misleading, because here the Y axis extends from 3.05% to 3.35%. If this graph also went from 0% to say 4% like the last graph, we would think that the difference was insignificant.
Anyways - these are items that I just kind of poked at since they didn't match my prior convictions. There's likely plenty of other data that I just nodded at and accepted since they matched my beliefs.
Another thing I mulled over was the trade deficit, which was very much in the news while I was reading this book. As Higgins mentions, one unusual aspect of the recovery after the recessions of the early 1980s through today is that our trade deficits have continued to grow. Historically, the US typically had trade deficits during recessions and switched back to trade surpluses in recoveries. Higgins has some thoughts about why we've maintained trade deficits during growth periods: we are privileged to (currently) have the US dollar as the global reserve currency, so there's no limit to how many foreigners are willing to hold dollars (when they wouldn't want to indefinitely grow their holdings of, say, rubles). We've also shifted from an economy based around physical production of agricultural and industrial products into one based on technology and services.
Anyways, as an aside I've really been enjoying Paul Krugman's writing on his recently revived substack. Many recent articles on the trade deficit, mocking the nonsense assertions that a trade deficit means subsidizing the exporting partner. One recent article looks at the trade deficit with China in particular. One of Krugman's arguments is that, when a country is doing well, it attracts more foreign investment, which by definition means a trade deficit. I'm not an expert in this field, but I've really been enjoying learning more about it, both fundamentals and the areas of policy disagreement.
I don't think Higgins should have gotten at any of this trade deficit stuff in the book - like with JP Morgan, he's giving an impressively broad view of history, there are a million rabbit holes he could go down, and I'm grateful to him for inspiring these thoughts, not disappointed in him not writing a 2000-page-long book.
The second-to-the-last section of the book covers the Great Financial Crash. This is probably the best explanation I've read of it yet, building on what I already knew and adding a lot more technical detail. This chapter reinforces several of Higgins' main theses. Bubbles are created when money is too freely available and investors become irrational, with roughly a 20-year expiration from the previous bubble. Bubbles are often caused by periods of transition when false ideas become widely accepted: for example, in the 2000s it was taken as gospel that there had never been a national decline in real estate values (even though that had been the primary cause of recessions in the 1820s and 1840s). It can be hard to see a bubble while it's forming because each player only sees their own immediate situation, which usually seems rational to them: it's only when you zoom out and see how the system as a whole is working where the bubble becomes obvious. In the case of the GFC, mortgage originators weren't concerned because they were immediately selling mortgages and didn't need to keep them on the books; mortgage resellers weren't concerned because they were slicing up and reselling mortgages; and investors weren't concerned because they trusted the rating agencies saying that the CDOs were high-grade low-risk investments.
In the aftermath of a crisis, we tend to focus on the actions of specific individuals or groups, but the crisis is usually the inevitable result of structural flaws in our system. If those underlying flaws aren't addressed, they'll recur in a future crisis; and often times the correction of one crisis will inadvertently plant seeds for the next crisis. One very obscure example: part of the banking reforms of the 1930s was a little-discussed "Section Q" that capped interest rates on bank accounts to something like 5-7%. The goal was to keep banks from aggressively acquiring additional deposits to expand the money supply. But for decades the market rate for interest was well below that so nobody noticed or cared. Once inflation hit in the 70s, money markets were created to dodge that regulation. But that ended up creating another "shadow banking system" similar to that which produced the Great Depression: MMFs looked and acted like bank savings accounts, but didn't have FDIC insurance, and thus were always vulnerable to bank runs. The real structural weakness behind the GFC was the shadow banking system; without it, the failure of subprime mortgages would have only impacted a part of the market and not threatened the whole economy.
This book is very contemporary, continuing through the COVID-19 pandemic and into the recovery. Kind of the last thing he touches on is inflation, which was spiking at the time of publication. Once again there's a strong overlap with Krugman here. The big economic debate of the last several years has been whether high inflation was "transitory," caused by supply chain disruptions, or "secular," caused by high wages. Those have very different policy prescriptions, since the former you can mostly just wait out, while the latter requires aggressive monetary tightening and higher unemployment. Higgins observes that there is active debate on the subject and we won't know for some time what the situation is, but he does observe that the post-COVID-19 inflation looks an awful lot like the post-Spanish-Flu inflation. In that case, World War I had ended and the influenza was abating, so there was a lot of pent-up demand for deferred services and goods; but the economy had been running on a war footing for some years and it took time to transition back to manufacturing civilian goods. Too many dollars chasing too few goods is what causes inflation. Likewise, with COVID-19, there was a lot of pent-up demand from the lockdown; people were then eager to spend, but less stuff was being produced due to illnesses and restrictions, and supply chains were jacked up (remember Ever Given?), leading to a spike in prices. So while Higgins doesn't definitively come down on the side of Team Transitory, he does see this scenario as being much more like 1919 than like the 1970s, when inflation became persistent and ingrained due to political bullying of the Federal Reserve.
And again, that's the main thesis of this book: history is important and has a lot to teach us! Almost nothing that happens is completely new. Looking to the past can help us understand the present and possible futures, both in preparing for risks and choosing the most effective solution for a given problem. And while things definitely aren't perfect, it does seem like as a country we've gradually come to learn our lessons, and can solve big problems before they turn into even worse problems. Alexander Hamilton, who Higgins reveres, was spectacularly effective, but downplayed his own genius, claiming that he just knew stuff because he read so much. I think that's what Higgins wants: people (especially leaders, but really all people) to read widely, understand all the different ways things can be, and be able to think critically about things.
No comments:
Post a Comment