Thursday, July 5, 2012

Reflections on The Ascent of Money, Part 3

The Ascent of Money: A Financial History of the World

Capital moves from the hands of those who have it to those who can make the most of it. If legal structures are lacking for the capital to move, then it will move in the underground economy in the most nefarious of ways (loan sharks, payday lenders, "shadow banking" system, etc). The best way to empower the poor is to create legal structures for financial innovation to bring money to them, because often the poor - as a percentage of income - make massive returns. Both the wealthy and the poor mutually benefit, and grow the national economy while they are at it, by such an arrangement.

Why do most people file for bankruptcy? Simple - because they don't have the cash to pay their bills. It sounds simple and it is, but it is a bit more complex than a prima facie case. You might have excellent future earnings and worthy assets, but it can all be lost just because your cash flow is bad - for both businesses and people.

Most people have jobs - well, maybe not in this day and age - but they have an income stream of some sort. Also, most people own stuff - clothes, cars, electronics, etc - which we can call assets. Bills come due and they are paid out of your cash-on-hand (the amount you currently have sitting in your checking account). Now - here is the challenge - what do you do if your bills cost more than the amount you have in your bank account?

Borrow against your future earnings, perhaps? Well, if you didn't have a credit card backed by a bank then you would have to visit a loan shark. Even if the developed world, many people have to go to a payday lender - which will cost you a metaphorical arm and a leg versus a physical arm and a leg a loan shark would.

Sell your assets? Well, you will never get them back at a reasonable price if you are selling them under duress. Do you really want to go visit a pawn shop? At least you have the option. Ah, but now you can take a second mortgage on your house or put up your car as collateral for a low interest loan. Guess, you don't have to visit a loan shark.

What's your alternative? Without modern finance, you could be out on the street in no time. Even with it, you still could find yourself in a short term jam. This is why a functioning social welfare system is necessary for any advanced economy; To provide short-term liquidity and solvency to people, so that they can stay on their feet. Insurance, for things such as injury and unemployment, means that life does not end because you had one bad day, week, or month. Many financial giants failed before they succeeded - and some failed many, many times before they did.

Next: The Future Just Happened

Michael Lewis sets out to write about the sociological implications of the invention of the internet in his book Next: The Future Just Happened, but very quickly he stumbles onto a truth: When the internet is at its zenith of sociological impact, nobody will notice - it will just be a part of everyday life. The internet will disappear into the background of every day life and no one will be talking about its "sociological impact" on society. In other words, it will be what it will be.

Light bulbs, telephone, and electricity. Trains, planes, and automobiles. Dishwasher, washing machine, and dryer. No one ever - not to be taken in the literal sense - looks at it and says "wow, this technology changed everything. Society is different today than it was yesterday because someone came up with this thing." When a technological becomes ubiquitous, it has the largest impact on society but no one ever talks about it. We just take it for granted. As we take financial innovation - Fixed-Rate Home Loans, Credit Cards, and Student Loans - for granted, simply because they are everywhere for us. We are annoyed at the credit card ads we get in the mail instead of being amazed in wonder at their existence. Why has access to money become so cheap and accessible? In other societies, the existence of these financial products are not guaranteed.

We should encourage that future financial innovation continues to do what it has done in the past. That means, at times, creating legal structures for it to function in a safe, beneficial matter. The regulators just need to be able to keep up with the innovators.

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