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8 September 2017 Financial Analysts Journal Book Review

The Origins of Value: The Financial Innovations That Created Modern Capital Markets (a review)

  1. Mark S. Rzepczynski
Through vignettes on the beginnings of finance in various periods and cultures, this beautiful book links the universal and timeless quest for solutions to investment problems associated with moving funds through time and space.

This work is a rarity—a financial coffee table book. It is a beautifully printed work with numerous color pictures and a size appropriate for out-of-bookcase display. Its visual appeal conjures up a fascinating historical march through the major innovations in capital markets and makes the reader want to savor gems of information about the origins of valuation.

Given the format, 20 articles, we expect it would be easy to curl up and read interesting vignettes in  The Origins of Value: The Financial Innovations That Created Modern Capital Markets  on the beginnings of finance in various periods and cultures. Such hopes will be largely fulfilled, because the book, covering a wide breadth of topics over many centuries, offers numerous remarkable glimpses of financial history. Bona fide intellectual benefits, however, will come only through hard work. This book provides neither a casual read nor a whimsical ride through the past.

Editors William Goetzmann and Geert Rouwenhorst, formidable financial researchers in their own right, contribute original work to the book while also achieving the proper blend of articles to explain financial innovation. They start with the premise that the origins of value rest on three fundamental innovations—intertemporal transfer of value, contracting of future outcomes, and negotiation of claims and contracts. Goetzmann and Rouwenhorst then find moments in history when these key concepts were introduced or advanced. In a strong introduction that is one of the book’s highlights, the editors tie the key themes together and deftly link them through time.

Several of the topically and temporally diverse articles stand out as particularly intriguing history for financial professionals. They range from the invention of interest payments in ancient Sumeria through issuance of the first Eurobonds in 19th century Germany to contingencies for inflation and war reparations. The link between these sundry stories is the quest for solutions to investment problems associated with moving funds through time and space. Although the articles focus on specific epochs, the problems are universal—in many cases, involving the same issues faced by current practitioners.

Finance began thousands of years ago with the transition to an agrarian society. Consumption could not coincide with the planting of crops, so mechanisms were needed to borrow today what will be produced tomorrow. From this simple origin, interest payments expanded through the development of complex lending arrangements and the ability to transfer ownership of claims. The increasing sophistication of debt instruments is captured in the story of a Dutch perpetuity that is still paying interest today after hundreds of years.

The evolution of finance is ultimately a process of search, negotiation, and structuring of claims between those who need credit and those who possess savings. Goetzmann and Rouwenhorst repeatedly return to the core theme that those who wish to intermediate credit will always spur financial innovation. They portray the history of financial exchanges as the attempt to cut the cost of searching for intermediation.

The theme of how to protect investments through time is artfully depicted as the response to the risks of a particular period. The environment, in short, drives innovation. For example, a fascinating piece by Robert Shiller describes the use of inflation-protected securities in early America. So, today’s Treasury Inflation-Protected Securities are not a brand-new idea but an outstanding example of innovation bred by prevailing conditions. In a similar vein, the book describes in detail the development of futures and options as a means of protecting against changes in the environment or state of nature.

Because capital can be transferred effectively only if it is negotiable, the authors discuss reliance on paper notes as means of facilitating trade in a number of historical periods. The development of exchanges and rules for negotiability are other key topic areas. To make the transfer of ownership work, financiers had to be willing to commit to rules, codes, and regulations and, ultimately, had to trust.

In the belief that people have made history as much as events have, the book profiles such key financial innovators as Leonardo Pisano Fibonacci and John Law. Mathematician Fibonacci is known in financial circles mainly through the use of his proportional numbers in technical trading, yet his work is also important for determining present values. Law’s reputation has been sullied by association with stock manipulation and the stock market bubble of the Mississippi Company, but he was a true innovator in monetary economics as well as corporate finance. His story demonstrates the level of complexity achieved in finance more than 250 years ago. A surprising financial innovator was Benjamin Franklin, who worked on printing designs to increase the negotiability of bonds.

Property rights, regulation, and government involvement are present throughout  The Origins of Value  but, disappointingly, are never directly addressed as essential elements of the origin of value and financial innovation. Without a well-defined legal structure to enforce conduct, history would show a less impressive record of efficiency in payment of interest and contracting of future outcomes. Comparative economics suggests that well-developed capital markets are no accident; they are tightly bound to systems of laws and cultural values. For example, the Roman invention of stock shares was lost with changes in government. The editors discuss issues of path dependency and accidents in innovation but do not fully explore the legal environment that appears vital to progress in financial methods.

A further shortcoming of  The Origins of Value  is its limited investigation of the catalysts for innovation—namely, trade and the need for capital. The cradles of finance, both the Italian city-states and Amsterdam, were outgrowths of trade. What enabled trade to flourish, notwithstanding the supreme status of gold throughout the world, was the acceptance of paper money. How did this happen? The book details the development of paper money in China, where it arose in connection with the Silk Road trade, but not in other parts of the world. There are other regrettable omissions, especially in the areas of banking, insurance, and the simple concept of trust.

On the positive side, several articles on China provide a valuable cross-cultural perspective that is lacking in most discussions of financial history. In addition, the editors’ selection of illustrative historical incidents is astute. Unfortunately, the contributors vary widely in the quality of their writing and some fail to establish a connection with the overarching themes discussed in the introduction. Overall coherence might have been better served by organizing the book thematically rather than chronologically.

Aside from the introduction,  The Origins of Value  conveys little of the passion that has been a hallmark of the best books on science and innovation. Too often, a dry focus on the facts leaves the reader without a sense of the competitive struggles that forced modern finance to grapple with issues of risk and uncertainty. Readers who expect from the contributors a flair for storytelling together with the erudition will be disappointed.

Any book that attempts to cover such a vast historical range will necessarily emphasize particular topics and, as a consequence, generate controversy. Gaps will necessarily arise as a function of the selective research interests of the authors. We hope these editors will continue to study financial history and further address some of the issues that get short shrift in the present work.

Nevertheless, given the wealth of possible topics, the very fact that this book will cause controversy makes it useful. Like a good work of art, The Origins of Value  gives rise to strong opinions. That trait alone may make it worth the price.


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