Practical analysis for investment professionals
13 September 2017

Finance: How It Made Civilization Possible

In the inaugural interview of the Conversations with Frank Fabozzi series from the CFA Institute Research and Policy Center, William N. Goetzmann will speak with Frank J. Fabozzi, CFA, on Wednesday, 17 January, at 12 pm EST.

What is finance, where does it come from, and why does it matter?

William N. Goetzmann, of the Yale School of Management, addressed these questions in his presentation at the 62nd Annual Financial Analysts Seminar. He led participants on a tour through financial history, illuminating distinctive artifacts that demonstrate the critical role finance has played in the development of human civilization and laying out a hopeful vision of how it will continue to propel human progress.

“Finance is a technology,” Goetzmann, the author of Money Changes Everything, explained. “The simplest kind of financial technology is a loan. I borrow money today and I pay it back tomorrow. But if you don’t have that dimension of time, it’s not finance. Finance really requires that there be some passage of time between the beginning of a contract or agreement and the fulfillment of the agreement.”

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As a concept then, finance is quite simple. But in practice, how do you build systems to codify trust and assess the value of time and risk?

It turns out, humanity has been working on that for 5,000 years.

One of the first recorded financial contracts comes from ancient Mesopotamia. It looks like a “big blob of clay,” in Goetzmann’s words, and has cone-like shapes and other carvings that set out the terms of the contract.

“These clay balls were agreements that were designed to prevent falsification just in the way blockchain does,” he said. “They didn’t even have writing. They needed to use symbols to represent quantities.”

These forms of finance helped to create complex urban societies, Goetzmann explained.

“When you had people living in cities where not everybody could go and farm, you had to have a way of planning very carefully for delivery of things in the future,” he said. “You had to have a system of accounting to figure out how many farmers do you need to bring in enough food to feed everybody every day. And so that’s the role that finance began to play as cities needed this tool to grow.”

Indeed, writing, when it first developed in ancient Sumer, was invented for financial contracting and accounting, Goetzmann said.

And as cities grew, they devised more varieties of financial instruments.

An example of one of these financial tools: a Sumerian vase tablet, about the size of a pineapple, that was made about 2,500 BCE. The tablet is actually a reparations document, Goetzmann explained, in fact, the first-known extant reparations document.

“This is the first document that has compound interest,” Goetzmann said. “The first one that had this notion of money making money. Three little dots are how they express this vast number.”

Beyond money making money, finance was also critical to the creation of representative government.

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Coinage and Democracy in Ancient Greece

Coinage developed in Greece as part of the foundation of Athenian democracy.

A requirement for building a representative government is establishing a sense of belonging among the citizens of the state.

“One way of getting a lot of buy-in from the people that comprised the tribes of ancient Athens was to put them all on the public dole,” Goetzmann explained. “There’s nothing that makes you buy into being part of an organization, nothing like getting a salary.”

How did Athens pay its citizens? By having them serve on juries — big, 500-person juries — in exchange for payment in coins.

“Why did they have a jury that large?” Goetzmann asked. “This was a way of bringing people together and getting a commitment to a state. The money was a crucial part of forging a new kind of political entity.”

For Athens, building that collective identity was imperative to its survival. But it wasn’t enough. Other financial tools had to be created to ensure the city’s future. Athens could not grow enough food in its immediate vicinity to feed itself.

“The way it solved that problem: It became a center for contracting in the Eastern Mediterranean,” Goetzmann explained.

Grain ships would travel across the Mediterranean from Egypt all the way up to the Black Sea and bring their wares back to Athens. To facilitate this trade, Athens constructed a system of merchant courts to codify and litigate the various arrangements. The Athenian court systems also adjudicated financial contracts.

“Athens is the first place where we actually had surviving contractual records of these maritime voyages that had specific conditional clauses,” Goetzmann remarked.

Sailing to the Black Sea, for example, was riskier during certain times of the year. So contracts were developed to pay investors for that added risk.

“There was very clear recognition that risk is something that had to be compensated with an extra amount of return,” Goetzmann said.

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China: Currency and Cash

Around the same time that the Greeks started minting coins, halfway across the world, the Chinese were doing the same thing.

Goetzmann highlighted a Chinese copper coin from the city state of Qi. Shaped like a knife, the coin has a hole in it so that string could be threaded through and a number of coins carried around on one long loop.

“The reason I show you this: This ancient city had a philosopher,” Goetzmann said. “His name was Master Guan Zhong. Guan Zhong was the first economist.”

Guan Zhong came up with an elaborate theory about money and how it served the economy. His theory had practical applications, helping to determine when a state should mint more coinage or less and also how to weaponize the currency in conflicts with rivals.

“So money became an instrument for controlling the economy and waging monetary war on Qi’s neighbors,” Goetzmann said. “And that’s pretty sophisticated for 400 BC.”

A thousand years later, China minted another critical financial tool.

“China’s great innovation is paper money,” Goetzman said, as he displayed an image of Chinese cash money from the Ming Dynasty, circa 1370 AD.

The Chinese first printed money with wood blocks, but those wore out, so they converted to copper plates, Goetzmann said. And since not everyone could read, the currency depicted what it was worth through imagery.

China printed paper money for over 300 years, from roughly 1100 AD to about 1425, he said, but gave it up as something of a “failed experiment,” and didn’t start printing it again for about 400 years.

“Why?” Goetzmann asked. “Because the government couldn’t help itself from just printing too much. So China also invented hyperinflation.”

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Venetian Bonds

From China, Goetzmann returned to the Mediterranean, to the Rialto Square in Venice, where traders and bankers used to buy and sell bonds. Bonds emerged in Venice in the aftermath of a dispute with the Byzantine Empire. When the emperor confiscated Venetian goods and arrested Venetian merchants in what was then Constantinople in 1171, Venice built a fleet to recover its people and property, paying for the ships with tax money that it promised to pay back after the successful conclusion of the war. Unfortunately, the fleet was decimated by the plague and the seized goods were never recovered.

Unable to pay back what it owed, the city instead pledged to pay interest — 6% a year — on the loans until the principal could be returned. Of course, the principal could never be paid back, but those who held the bonds liked receiving that 6% a year, and soon a bond market emerged and evolved.

“It was a new technology for saving,” Goetzmann said. “They could sell these promises, they could sell these bonds, they could trade them. You could buy a bunch of them and make sure that your child, for example, who might not be able to work, would be able to have an income into the future.”

Soon other European states started emulating the Venetian example, and fixed income grew into a pillar of finance.

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Stocks were the next major innovation in finance, Goetzmann explained.

Most tend to point to the Dutch East India Company as the first corporation with equity stakes. But Goetzmann focused on two mill companies formed in Toulouse, France, in 1372 and 1373. The companies were each the product of a merger of a series of smaller mills that, once consolidated, could better share the costs and risks.

The companies kept records that date from 1372 to 1946 when one of the mill corporations was nationalized in the aftermath of World War II. Annual meeting reports, stock prices, information about dividends, grain prices, etc., were all recorded and set down for posterity.

The merger documents laid out rules the company had to follow to maintain shareholder trust. As these companies grew over time, they encountered new problems and devised solutions. They hired independent auditors to look at the books and separated the CEO function from that of board members. All of these procedures came down to addressing “problems of trust,” Goetzmann said. “In order to aggregate capital into a company to do amazing things, you had to solve problems of trust.”

And that structure was then used to finance the pricey and uncertain voyages of discovery that followed in the ensuing centuries.

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And with Stocks Come Stock Bubbles

But the tools of finance are not always applied well and stocks proved no different.

Goetzmann displayed a Dutch book, The Great Mirror of Folly, from 1720. That year was a tough one for finance. The South Sea Bubble had burst, spreading stock market turmoil throughout Europe. “Twenty-seven different countries in total had a feverish explosion in stock market conditions,” he said. In one print Goetzmann showed from the book, the artist evoked a behavioral explanation for the bubble, one that alluded back to the tulip mania of the 1600s.

“The central image is a theory about why stock prices or, in this case, commodities prices would go up,” Goetzmann said, pointing to the hat of one of the characters depicted. “Not only is it the hat of a fool, it’s hollow. It’s saying, ‘Look, people have lost their minds.'”

The print also depicted the cause of the insanity. Toward the edge of the print looms a devil with horns and wings. In its hands is a fishing pole with a document hanging on the end of it as bait.

“The document is a contract,” Goetzmann said. “It’s a futures contract, for tulips. The whole idea is that the devil is trying to hook people with this strange financial instrument.”

Despite the excesses of the South Sea Bubble, tulip mania, the Great Depression, the Great Recession, or any of the innumerable panics and crashes that have troubled history, Goetzmann stressed that finance has largely served as a force for good. To emphasize the point, he concluded his talk with two prints and a comparison of the two economic thinkers they depicted, Thomas Malthus and the Marquis de Condorcet.

The former had a gloomy take on human progress, inspiring the term “dismal science” to describe the study of economics. Malthus theorized that when people have enough to eat they will inevitably reproduce themselves to the point of starvation, that food production can only expand arithmetically whereas human demand increases exponentially.

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A Hopeful Vision

Condorcet had a different take. In The Progress of Human Kind, he explored how finance could actually ease these burdens, proposing that the rational tools of finance and economics could be applied to solve humanity’s biggest dilemmas.

“He had this vision of essentially a social security fund,” Goetzmann said. “He was a mathematician so he said, ‘Look, let’s do the math. If you grow at a certain rate and you contribute this amount, you’re going to have enough. Time will help solve the problem.’ And so that was his proposition.”

“When people get more money, they have fewer children not more children,” Goetzmann observed. “As their financial risks go down, the number of children they have goes down. So the Malthus calculations don’t make any sense at all.”

“I’m on Condorcet’s side,” he concluded.

So returning to the questions posed at the outset: “Why is finance important?” Goetzmann asked. “The invention of writing, the invention of mathematics — those two things count for something.”

But beyond that, he alluded back to Condorcet’s conception of finance as a vehicle of human progress. “This vision of finance being a tool for us to solve the fundamental problems of humankind,” he said, “I think we’re moving in that direction.”

For more from William N. Goetzmann, don’t miss “Hedge Funds and Stock Price Formation,” co-authored with Charles Cao, Yong Chen, and Bing Liang for the Financial Analysts Journal.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Paul McCaffrey

Paul McCaffrey is the editor of Enterprising Investor at CFA Institute. Previously he served as an editor at the H.W. Wilson Company. His writing has appeared in Financial Planning and On Wall Street, among other publications. He is a graduate of Vassar College and the Craig Newmark Graduate School of Journalism at CUNY.

7 thoughts on “Finance: How It Made Civilization Possible”

  1. Bud Haslett says:

    Will Goetzmann also contributed to the recent CFA Institute Research Foundation publication on Financial Market History. His chapter on Bubble Investing: Learning from History can be downloaded for free at

  2. Chuck t says:

    Very interesting presentation.
    The greeks had a better concept of risk. A ship actually sinking in the black sea vs. the volatility of previous contract prices.

  3. Steven Mattas says:

    Great Article. The role of finance contributing to development from ancient society to present day society is amazing.

  4. Jean-Francois BOUILLY says:

    A must read for those who think that “this time is different ”
    Thanks for this very good article

  5. Steve Houseworth says:

    Mostly good. However the initial idea that people who were living in cities needed a way to plan for the future and have accounting, places the consequence in front of the predicate. Like saying that people domesticated wolves. In reality wolves which were more tolerant of being near people began to trust people who provided food. The wolves selected people, not the converse. Similarly, people began living in cities because they devised ways to cooperate, to plan and to provide security – both physical and actuarial. Cooperating to live in groups larger than small families, clans or tribes was a symbiosis, all tangled together.

  6. Kirk Cornwell says:

    Capital accumulation has led the charge to “civilization” and now threatens to undo it. It remains to be seen how civilized we stay with 90% of the wealth in the hands of 10% of the population.

  7. Derek Horstmeyer says:

    Great summary and explanation of his seminar

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