One Step at a Time

We last left off with a simple definition of the markets.  Markets are a place where buyers and sellers meet to transact.  In the case of financial markets, suppliers of capital (i.e. buyers) allocate their money to spenders of capital (i.e. sellers).  This simple definition is important to revisit as we go through the stories of how investing got here today.

What exactly led to investing as we know it today?  What is its story?  And importantly, why learn the story behind it?  These are some questions to help guide us.

The history investing can be boiled down to a series of financial innovations that evolved to meet the needs of the buyers and sellers.  As the needs of the buyers and sellers changed, so did the financial innovations.  One of the most important innovations is one you are likely familiar with: currencies.

Currencies are one of the earliest examples of financial innovation.  Our earliest ancestors didn’t live in homes, cities, or villages.  They traveled and took everything they owned with them.  As populations grew, creating more mouths to feed, farming began to take hold.  Farming was a significant step for human evolution in that it created a food source that wasn’t as risky as hunting, created enough food to feed populations, store extra food that wasn’t consumed, and anchored communities of people to specific regions.  Farming also created more specialized labor. 

Surpluses of food along with the specialized labor and anchored communities allowed people to begin traveling to other communities to trade.  The economic idea of comparative advantage was formed.  Comparative advantage is the idea that countries specialize in one area (for example wine from France, or oil from Saudi Arabia). 

This trade also created a new set of problems.  Traveling to other communities put lives and wares at risk.  People could be kidnapped or killed, food could spoil, and all goods brought for trading purposes could be stolen.  Trade prior to currencies also created an imbalance in how things were valued. 

Currencies solved most of these problems.  They were easy to carry, were not subject to spoil, and had a relatively anchored value that facilitated trade of things that were clearly not equal in value. 

Like most other technology in our earliest days, currencies evolved first in the east, China in particular, and dispersed west to Europe.  China was the first to use coins and also paper currency. [1]   As coins became more commonly used, they took many different forms, and often portrayed a king or other important figure of the time.   

Fast forward through the Middle Ages, and we begin to find a financial system that begins to resemble our current system.  Financial innovation slowed in the East, migrated west, and Europe took on the role of creating new financial instruments.  Banks, mutual funds, joint stock companies, exchange-traded funds, and even a central bank were all innovations created by European countries.  These innovations are examples of how investing evolved and created more buyers and sellers in the market.

Northern Italy was once the hub of trading in Europe, and modern banking can trace its beginnings to the region.  Europe overall was exiting the Middle Ages and Europeans started using Hindu-Arabic numerals (our current 0-9 digits).  This greatly simplified calculations.  This new system of numbers, along with the introduction of a bill of exchange, and double-entry bookkeeping laid the foundation for a new financial system.

The bill of exchange solved a need that was applicable primarily to that time.  Religious laws were made against usury; or charging interest on loans.  Usury was a part of Christianity, Islam, and Judaism at various points in their histories. 

Financial innovation became an export for Italian merchants.  This resulted in new financial hubs in Northern Europe.  First in Bruges, where exchanges (beurs) began, then Antwerp which took advantage of its location and experienced innovation after innovation, and finally Amsterdam.

The Bank of Amsterdam is considered the first central bank and was chartered to end confusion around the quality of the coins in circulation.  People in that time period were known to slice portions of existing coins and use the pieces to create new coins.

It was around this time that the earliest versions of mutual funds began.  The goal of mutual funds at their beginning is the same as it is today; to provide smaller investors with the ability to diversify their investments.  These investments included things such as plantation loans or foreign government debt. [2]

This brief trip through time is intended to present a different view of history, particularly, investing history.  The needs of buyers and sellers were quite different in each of these time periods, and the investment vehicles evolved to meet those changing needs.  However, the last question remains unanswered.  Why is this worth understanding?

Knowing this bit of history helps frame where we are today.   For example, crypto-currencies have some striking similarities to early forms of currencies.  This will be covered in another post on currencies specifically.

The needs of buyers and sellers will always evolve, but human behavior rarely changes.  Studying human behavior during these periods of financial innovation provides great insight into how people will respond to similar financial innovation today.