Money Makes the World Go Round - A Brief History of Finance

It was in the musical “Cabaret” that Sally Bowles sang “money makes the world go round” -and she wasn’t wrong.

Indeed, it’s often said that #cashflow is the lifeblood of #business and #finance can help that cash continue to flow through a business.

In this first article in a series focused on finance and the importance of cash, we shall explore the history of finance. Firstly we have to ask, what is finance?

What is finance?

In the business world, finance is someone else’s money invested or lent so a business can trade and (hopefully!) generate a #profit and a return to the finance provider.

Without finance, businesses wouldn’t be able to grow as quickly due to being dependent solely on internally generated funds. Without finance, individuals wouldn’t have the money to buy homes due to insufficient cash resources to make the purchase outright.

The World before Finance

Prior to the invention of money, society operated a barter system.

If you wanted to sell goats then you had to exchange your goats with someone who, firstly, wanted goats and, secondly, had goods or services you needed.

Over time, those exchanges grew in sophistication and, around 6,000 BC, Mesopotamian farmers began borrowing animals and seeds with some of the resultant livestock and crops being the repayment mechanism for that borrowing.

This was an important step up from bartering and the first examples of #borrowing and #lending.

Since those ancient days, the borrowing and lending process has evolved and apart from the occasional hiccup (see below), we now have a very complex finance industry taking advantage of newly developed technologies.

How did the finance industry get to where it is today?

The finance industry has grown exponentially since those embryonic days in Mesopotamia.

Here are some milestones in its history:

5,000 BC – interest rates

In Sumer, where the first borrowing and lending system started, as society continued to develop so did the complexity of people’s needs and the concept of charging interest was born.

Indeed, the Sumerian word for interest was “mas”, the same word they used for “calf” thereby maintaining finance’s link to livestock and farming.

Sumerian interest rates varied depending on whether the loan was against grain or silver – surely, the first risk adjusted cost of financing.

3,800 BC – financial services regulation

The financial transactions of the Sumerians were, ultimately, formalised in the Code of Hammurabi.

That Code also set the price for silver and controlled the interest charged on silver loans, given us the first finance services regulation.

3,000 BC – promissory note

A 5,000 year old Mesopotamian clay tablet has been discovered that acted as a promissory note for silver.

1,200 BC – shells as currency

In China, cowry shells started to be used as a form of money and that use spread across Asia and parts of Africa.

Did you know that cowry shells were still being used as currency in parts of India as recently as the early 19th Century?

1,000 BC – coins as currency

Again in China, coins made from stamped pieces of valuable metal (bronze and copper) were introduced - enabling people to pay for goods by counting coins and not by weight of payment. That improved ease of trade.

400 BC – collateral for loans

In ancient Greece, pawnbrokers lent money and took collateral from borrowers as security to reduce the risk of default or loss – a system still in use today!

300 BC – bill of exchange

One of the earliest bills of exchange was in India during the Maurya dynasty where those instruments helped to finance sea-borne trade.

200 BC – financial centres

In ancient Rome, coins were stored in the basement of temples as priests and temple workers were considered the most trustworthy in society.

The temples also loaned money and therefore could be regarded as the first financial centres.

314 – ban on clerics charging interest

With the Church holding more and more power over people’s lives, the charging of interest by clerics on loans was considered usury and therefore contrary to religious beliefs.

This happened in both Christian and Muslim society.

1179 – ban on laymen charging interest

The ban on usury (interest charging) was ultimately extended to all of society. The Torah still permitted the charging of interest but Jewish lenders were only permitted to charge interest on loans to Gentiles (non-Jewish) borrowers.

Early 16th Century – interest charging permitted

Over time, the economic benefits of finance were better understood, leading to the removal of interest charging restrictions and the beginning of the financing system we know today.

Nevertheless, there was an English law that fixed the maximum interest that could be charged on a loan, with anything above that rate still being classed as usury.

1531 – stock exchange

The first stock exchange, the Handelsbuers, opening in Antwerp in 1531. At that time, Antwerp was a major trading port and a centre for the diamond industry (and still is).

1542 – bankruptcy laws

In England, bankruptcy law goes back to the mid-16th century. That original Act was aimed at people “who craftily obtaining into their hands great substance of other men’s goods …… not minding to pay or return to any of their own creditors, their debts and duties”.

Did you know that the word ‘bankrupt’ comes from both Italian and Latin? Banca being Italian for bench and rupt being Latin for broken, thus broken bench. In Italy, as Jews were not permitted to hold land, they lent money from benches. When a money lender ran out of finance, his bench would be broken!?

1553 – joint stock company

The first joint-stock company, the Company of Merchant Adventurers to New Lands, was chartered in London in 1553.

1602 – Initial Public Offering (IPO)

The Dutch East India Company, in 1602, invited the general public to invest in the company’s trading adventures. Around 1,100 members of the Dutch public subscribed for shares.

1612 – cash dividend

Again, it was the Dutch East India Company who, in 1612, paid the first cash dividend. That was not its first dividend payment to shareholders though.

In 1610, the company had paid a dividend but the currency used was not cash but spices – almost taking us back to Sumerian times!

1620s – forward contracts

Forward contracts were an innovation in 17th century Amsterdam's sophisticated clearing process. The Dutch called these contracts “time bargains”.

1637 – financial bubble

Time bargains were not without problems as speculators were attracted into the market.

With more and more speculation taking place, there was increased market volatility leading to market collapse and financial loss.

The most famous example from this era was the tulip bulb bubble that burst in 1637 when forward buying by speculators drove prices to unsustainable heights. Not the last time that a bubble has caused financial market volatility and collapse!

1661 – issue of banknotes

Stockholms Banco was the first European bank to issue banknotes. Those notes replaced the copper plate money that had previously circulated in Sweden.

1668 – central banks

Again, in Sweden, the Riksens Standers Bank (Estates of the Realm Bank) was founded in 1668, due to the failure of Stockholms Banco the previous year!

As a central bank, Riksens Standers Bank controlled Sweden’s money supply and printed a national currency.

1680s - annuities

Towards the end of the 17th century, interest calculations were combined with age-dependent survival rates to create the first life annuities.

1808 – modern international finance

Globalisation of trade drove the need for new ways of financing across borders.

Mayer Rothschild, from Frankfurt, sent his sons to the other major European trading cities (London, Naples, Paris and Vienna) to set up banks to enable risk mitigated international financing of business to be transacted.

1929 – financial collapse

In October 1929, the US stock market collapsed with millions of investors losing money.

Prior to October 1929, productivity had already been declining and unemployment rising in the USA. Those factors coupled with low wages, agricultural problems, a credit bubble and overvalued US Stocks meant that sooner or later something had to give.

The Wall Street Crash was that severe downwards correction. The correction lasted years, hitting its low point in 1933 with the Great Depression.

1940s – finance as a discipline separates from economics

Finance, as a study of theory and practice distinct from economics, started to develop in the 1940s.

At that time, there was a growing focus on cash management and financial controls – hardly surprising given the financial trauma of the late 1920s and early 1930s.

1956 – credit cards

The mid-20th century saw another innovation in finance with the launch of credit cards – plastic money - and the rise of consumer credit.

1980s - online banking and lending

With the evolution of computing and electronic data, banking and lending started to become available online. Borrowers could apply for loans without having to leave their house or office.

1986 – financial deregulation

"Big Bang" (deregulation of London financial markets) happened in 1986 and was the catalyst to confirm London's position as the pre-eminent global centre for finance.

2000s - alternative finance

The early years of the 21st century saw the launch of peer to peer lending.

It also saw a rise in the alternative finance market, where business finance providers other than banks (and their leasing and HP subsidiaries) became more and more prevalent as a source of finance for business purposes.

2008 – global financial crisis

They say that if you don’t learn from history, you are doomed to repeat it. In 2008, excessive risk taking, the unfettered growth in the financial derivatives market and the bursting of the US housing market bubble all contributed to a global financial crisis.

This perfect storm required significant Government intervention to steady the financial markets. In the UK, most of us will recall the nationalisation of Northern Rock and the financial rescues of HBOS and RBS. The high point (or low point to be more accurate) of the global financial crisis was the bankruptcy of Lehman Brothers in September 2008.

2010s – era of low interest rates

Following the global financial crisis, interest rates were significantly reduced. The UK base rate fell from 5.75% in 2007 to 0.50% in 2009 and stayed at that rate until 2016.

Low interest rates made borrowing more affordable with many borrowers (and lenders) not too concerned about the risk of future interest rate rises.

Indeed, the UK base rate fell to an historic low of 0.1% in early 2020.

2020 – global pandemic

The impact of the global pandemic meant that historically low interest rates were no compensation for being unable to trade, a fate that affected many businesses, as the UK went into lockdown on 23rd March 2020.

Lockdown resulted in another wave of Government intervention in the financial markets – the Coronavirus Job Retention Scheme, the Coronavirus Business Interruption Scheme then Bounce Back loans. As a consequence, businesses survived but many with little “wool on their back”.

2022 – the double whammy of higher interest rates and higher inflation

Hard on the heels of the financial blows from the pandemic and at a time of increased debt on balance sheets came further world-wide economic shocks.?

In the UK, interest rates rose and hit 3.5% by the end of 2022 and 4% in early 2023, adding to the cost of servicing borrowings.

At the same time, inflation (which had already been creeping back into the world’s major economies) spiked, in the UK, at 9% pa in 2022 and exceeded 10% in early 2023.

This double whammy of 4% interest rates and 10% inflation has put considerable strain on UK businesses’ profit margins and ability to generate cash. Particularly so if a business has been unable to pass on its cost increases through higher selling prices.

For individuals, high inflation has affected their cost of living but, for many, the interest rate rises haven’t hit yet due to fixed rate mortgages. However, a raft of those fixed rates end in 2023 (up to 1.4 million) and that would lead to far higher mortgage payments for those borrowers, should interest rates not begin to fall again.