The Ascent of Money (2008) – Episode 6 – Chimerica [Transcript]

Niall Ferguson investigates the globalisation of the Western economy and the uncertain balance between the important component countries of China and the US.
The Ascent of Money (2008) - Episode 6 - Chimerica

Niall Ferguson investigates the globalisation of the Western economy and the uncertain balance between the important component countries of China and the US. In examining the last time globalisation took hold – before World War One, he finds a notable reversal, namely that today’s money is pouring into the English-speaking economies from the developing world, rather than out.

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In our time, we’ve witnessed the zenith of global finance. In 2006, the world’s total economic output was worth around $47 trillion – that’s 47 followed by 12 zeroes. The total value of stock and bond markets was roughly $119 trillion – more than twice the size. And the amount outstanding of the strange new financial life form known as derivatives was $473 trillion – ten times larger.

By the summer of 2007, it seemed as if the Earth had turned into Planet Finance. As never before, the world was interconnected, but not just by cables, container ships and jet planes. By 24/7 dealing rooms and international investment banks.

In this series, we’ve seen how the markets for credit, bonds, stocks, insurance and real estate all evolved in Europe and North America. Well, now it’s time to tell the story of how those financial innovations conquered the world. This is the story of financial globalisation.

Globalisation is something we take for granted today. And yet for all the advantages of an interconnected world, perfectly exemplified by Hong Kong’s astonishing humming container port, there’s a downside to globalisation, and that is its vulnerability – its vulnerability to financial shocks, because finance isn’t an exact science, and its vulnerability to political forces beyond the control of the bankers.

The ascent of money has seldom been smooth. Time and again, it’s been punctuated by big and painful crises. Just ten years ago, it seemed that these crises were more likely to blow up in emerging markets, like Asia. Yet today, it’s the West that’s caught up in a full-blown credit crunch, while Asia seems scarcely to have noticed. Indeed, a new phenomenon has come to define the world economy. American borrowers have come to rely on Chinese savers – a symbiotic relationship between China and America that I call “Chimerica”. But can we be sure that Chimerica will save this era of financial globalisation?

The chilling reality is that a hundred years ago, another age of financial globalisation ended not with a whimper, but with a bang. And there’s no reason why that shouldn’t happen again in our time.

Chimerica

It used to be said that “emerging markets” were places where they have emergencies. Investing in faraway places can make you rich, but when things go wrong, it’s often been a fast track to financial ruin. That’s why many of today’s apparently unstoppable emerging markets are really re-emerging markets.

These days, of course, the ultimate re-emerging market is China. To talk to some people, there’s simply no limit to the amount of money to be made here. And it’s certainly true that over the past 20 years, the mainland has followed the example set here in Hong Kong, and boomed. And yet this isn’t the first time that foreign investors have piled into China, aiming to make megabucks from the world’s most populous nation. And the last time, those foreign investors lost almost as many shirts as the local tailors here can stitch together in a week.

The key problem with overseas investment, then as now, is that it’s hard for an investor in London or New York to see what a foreign government or company is up to when they’re an ocean or more apart. If the foreign borrower decides to default on its debts, what’s an investor to do? The answer before 1914 was brutally simple but effective. Get your government to send in the navy. By guaranteeing European political control, gunboat diplomacy provided reassurance for British investors even at the remotest extremities of the world economy. The Royal Navy provided the firepower that underwrote the first age of globalisation… and its pioneers, like William Jardine… and James Matheson. Jardine and Matheson were buccaneering Scots who’d set up a trading company in the southern Chinese port of Canton in 1832. Not to put too fine a point on it, their most profitable line of business was drug dealing. They shipped opium produced under British Government control in India to China’s population of addicts – a trade that China’s Emperor had banned. On March 10th, 1839, an imperial official named Lin Zexu arrived in Canton under orders from the Emperor to stamp out the trade. He besieged the British opium warehouses, blocking any further imports. 20,000 chests of opium valued at £2 million were confiscated and literally thrown in the sea. Faced with catastrophic losses, Jardine hurried to London to lobby the British Government to send a gunboat.

Well, Jardine got his wish granted. On August 23rd, 1840, British gunships landed here on Hong Kong Island. The Qing Empire was about to feel the full force of history’s most successful narco-state.

As Jardine had predicted, the Royal Navy made short work of the Chinese defences. With south-western China under British control, the opium trade was given free rein. Drug addiction exploded. Large tracts of the country slid into rebellion and anarchy. But for Jardine Matheson, with their head office now established in Hong Kong, the glory days of Victorian globalisation had arrived. By 1900, the firm had diversified into more respectable lines of business. It had its own breweries, its own cotton mills, its own insurance company, and its own railways, like the one they built from Kowloon to Canton.

Back in 1913, an investor in London had an extraordinary range of foreign opportunities, and nothing illustrates that better than the ledgers of N M Rothschild & Sons. Just a single page from 1913 lists no fewer than 20 different foreign securities, including bonds issues by Chile, Egypt, Germany, Hungary, Italy, not forgetting 11 different railway companies, including four from Argentina, two from Canada and, down here, the good old Kowloon to Canton railway line.

For the first time in history, the world economy was truly united by a combination of low trade and high finance. Yet this first era of financial globalisation was to be brought to a violent halt by the world’s first truly global conflict. On June 28th, 1914, the heir to the Austrian throne, the Archduke Franz Ferdinand, was assassinated in the Bosnian capital, Sarajevo. Initially, financial markets shrugged off the news as just another bout of Balkan bloodshed. In reality, the assassination had sparked off a chain reaction in the world’s financial markets. As investors belatedly grasped the likelihood of a full-scale European war, liquidity – the ability to borrow money or sell assets – was sucked out of the world economy as if the bottom had dropped out of a bath. The resulting disruption to international finance shattered globalisation.

It’s absolutely fascinating to follow the outbreak of the First World War through the financial pages of the London Times. It wasn’t until July 22nd, 1914, that anybody appreciated that the assassination of the Archduke Franz Ferdinand in Sarajevo, three weeks before, might have some financial repercussions. Just ten days later, on August 1st, 1914, the Times had to report the closure of the Stock Exchange, and closed it remained until January 4th, 1915. Why were investors so seemingly oblivious to Armageddon just days before the outbreak of world war? Well, the answer is that a combination of financial innovation and global integration had made the world seem reassuringly safe.

The lights in financial markets were flashing green, not red, until the very eve of destruction. There may be a lesson here for our time, too. Financial globalisation mark one took a generation to engineer. But it was blown apart in a matter of days. And it would take more than a generation to repair the damage done by the guns of August 1914.

The First World War had put an end to the first age of globalisation. Until the late 1960s, international finance slumbered. Some even considered it dead.

In 1944, the soon-to-be-victorious Allies gathered to devise a new financial architecture for the world. Trade would be free, but capital movements would be subject to tight regulation. When money did flow across national borders, it would go from government to government.

This new financial order was to have two guardian sisters, established here in Washington DC – the international Monetary Fund and the international Bank for Reconstruction and Development, later known as the World Bank. By the 1970s, however, vast sums of money were being accumulated by the oil exporters of the Middle East. With Western bankers desperate to reinvest the money as loans, the guardian sisters relaxed their grip. Financial globalisation was reborn. The region where the bankers chose to lend the petrodollars seemed to promise the best returns. Not for the first time in financial history, it also posed the biggest risks. In seven years, Latin America quadrupled its borrowings from foreigners to more than $315 billion. Then, in 1982, Mexico declared that it would no longer be able to service its debt. Soon, the entire continent teetered on the verge of bankruptcy. But the days had gone when investors could confidently expect their governments to send a gunboat to get their money back when foreign borrowers misbehaved. Now responsibility for such debt crises fell on the IMF and the World Bank. They didn’t have gunboats. But in return for new loans, they could insist that Latin American governments adopt painful “structural adjustment programmes” – impose fiscal discipline. To American economists, these programmes all made perfect sense. But not everyone agreed.

To the increasingly vocal critics of global finance, the two guardian sisters of the post-war order were being transformed into economic hit men. They were holding a financial gun to the heads of Third World governments… propping up dictators and furthering the interests of Yankee imperialism. And woe betide those who resisted the hit men. Conspiracy theories flourished in the anti-globalisation movement. According to one popular theory, two Latin American leaders – Jaime Roldos of Ecuador and Omar Torrijos of Panama – were actually assassinated for resisting the demands of American imperialism.

And yet there’s something about this story of a World Bank-IMF plot against Third World leaders that doesn’t quite add up. After all, it’s not as if the United States had lent that much money to Ecuador and Panama. In the 1970s, they accounted for just 0.4% of total US grants and loans. Nor were they particularly big customers for the United States. Again, less than 0.4% of total US exports. Now, those just don’t strike me as figures worth killing for.

To say the least, the idea of IMF-sponsored assassinations is a stretch. Nevertheless, this new phase in the story of globalisation did see the emergence of a new and more plausible kind of economic hit man, armed with a financially lethal weapon – the hedge fund. The men who ran the hedge funds were far more intimidating precisely because they didn’t even need to threaten violence to get their way. And their distinctive contribution to globalisation was to speed it up. Whereas the World Bank lends money to countries for periods of years, hedge funds are more likely to put their money in for just weeks, or even days. The grandmaster of the new economic hit men was George Soros. A Hungarian Jew by birth, but educated in London and based in New York, Soros brought to global finance a brand-new theory of economic behaviour that underlined the fallibility of human nature and the instability of financial markets.

[George Soros] Your actions will have unintended consequences, so the outcome will not correspond to your expectations. And that is the way human affairs generally work.

According to Soros’s Theory of Reflexivity, financial markets can’t possibly be perfectly efficient, much less rational, for the simple reason that prices are just the reflection of the ignorance and the biases, mostly completely irrational, of millions of investors. In Soros’s eyes, markets are bound to go through cycles of boom and bust, as surely as the human temperament is prone to bouts of euphoria and despondency.

Soros’s Quantum Fund had made millions from short selling, a type of dealing which borrows stocks or currencies and sells them for future delivery on the calculation that they’ll go down in value. His biggest coups came from being right about losers, not winners. And the greatest of these was among the most momentous speculative hits in all financial history. On September 16th, 1992, with the British pound in big trouble, I watched as Soros put out a contract on the Bank of England.

I became convinced that speculators like Soros were bound to win if it came to a straight showdown with the British Government. It was a matter of simple arithmetic – a trillion dollars of currency traded every day on foreign exchange markets against the meagre hard currency reserves of the UK Treasury.

At that time, the British pound was tightly linked to the German mark through the ERM – the European Exchange Rate Mechanism. As German interest rates rose in the wake of that country’s hugely expensive reunification, Britain’s rates had to rise too, hurting home-owners and businesses. Soros calculated that the British Chancellor, Norman Lamont, would be forced to withdraw from the ERM and devalue the pound. It was the biggest bet of Soros’s life. So sure was he that the pound would drop that he bet $10 billion – more than the entire capital of his fund.

[George Soros] The risk-reward was disproportionate. And therefore it seemed like a good speculation, or investment, if you like, shorting the pound.

I was equally convinced that sterling would have to be be devalued, though all I had to bet was my credibility. That evening, I headed to the opera to see Verdi’s The Force Of Destiny. It proved exceedingly appropriate. At the interval, they announced that Chancellor Norman Lamont had appeared in there, in the Treasury courtyard, to say that Britain was withdrawing from the ERM. How we all cheered.

[George Soros] Today has been an extremely difficult and turbulent day. Massive speculative flows have continued to disrupt the functioning of the Exchange Rate Mechanism.

Soros made a billion dollars that day, and that was only 40% of his fund’s annual profits.

Do you feel… or did you feel a sense of triumph when your prophecy came true and the bet paid off hugely?

Of course. It was like when you’re betting and you win, naturally, you have that satisfaction and also the profit.

Soros owed his success to a kind of gut instinct about the way the “electronic herd” would move. But even his instincts are sometimes wrong. So what if instinct could somehow be replaced by mathematics? What if you could write an algebraic formula that guaranteed double-digit returns? Well, on the other side of the financial galaxy, such a formula had just been devised.

As the new era of globalisation increased trade and growth, it also increased the world economy’s vulnerability to financial shocks that could spread rapidly to the four corners of the Earth. But what if we inhabited another completely different kind of planet? A planet without all the complicating frictions caused by subjective, sometimes irrational human beings. One where the inhabitants instantly absorbed all new information and used it to maximise profits, where amid the turbulence of everyday life all was calm and predictable. In such a perfectly observed, efficiently interconnected world, an unpredicted catastrophic stock market crash would be about as common as an adult shorter than one-and-a-half feet in our own world. It would happen only once in four million years of trading. This was the planet imagined by some of the most brilliant financial economists of modern times. And this is what their planet looked like. In 1993, two mathematical geniuses came to Greenwich, Connecticut, with a big idea. Stanford University’s Myron Scholes had invented a revolutionary new theory of pricing things called “options”. He and Harvard’s Robert Merton were the original “quants” – a new breed of speculators using quantitative mathematics to make money. From this nondescript office they plotted a global financial revolution.

Merton and Scholes’s idea was based on the simple option contract. Take the case of a stock that’s worth $100 today. Now, suppose I think that stock’s going to be worth 200 in a year’s time. Wouldn’t it be nice to have the option to buy it at today’s price in a year’s time? If I’m right, I make a tidy profit of $100. But if I’m wrong, well, who cares? It was only an option. The only cost to me is the price of the option itself. The big question is, what should that price be? $5? $10? The answer was to be found in a magic formula. “Quants” sometimes refer to this formula as a “black box”. Well, let’s look inside the box. The challenge Merton and Scholes faced was how to price an option to buy a particular stock on a particular date in the future, taking into account the unpredictable movement of the price of the stock in the intervening period. Work that option price out accurately, rather than just relying on guesswork, and you truly deserve the title “rocket scientist”. With wonderful mathematical wizardry, the quants reduced the price of the option to this formula.

Feeling a little bit baffled? Finding the algebra rather tricky to follow? Well, that was just fine by the quants. In order to make money from this kind of thing, they needed markets to be full of people who had no idea how to price options.

In its first two years, Merton and Scholes’s company, Long Term Capital Management, made megabucks by selling options that were never exercised because the buyers had guessed wrong and Long Term had got it right. They also made a killing by buying up all kinds of different securities that the rocket scientists thought were mispriced. Greenwich’s luxury car dealers had never had it so good. Admittedly, to generate these huge returns, Long Term had to borrow. This additional “leverage”, or gearing, allowed them to bet more than just their own money. By August 1997, the fund’s capital was just under $7 billion, but the assets funded by borrowing amounted to 126 billion.

You might have thought that a couple of academics like Merton and Scholes would have been scared silly by this enormous pile of debt. But not a bit of it. According to their magical mathematical formula, there wasn’t the slightest risk in being so highly geared. Apart from anything else, Long Term was pursuing multiple, supposedly uncorrelated trading strategies, around a hundred in all, with over 7,600 different positions. One of these might go wrong, or possibly even two. But surely all the bets they’d placed couldn’t possibly go wrong simultaneously.

Long Term was trading in markets all over the world. But the firm’s biggest business was selling options on American and European stock markets… options that would be cashed in if there were big future stock price movements, up or down. At the time, the high prices these options were fetching implied that the markets would become particularly volatile. But Long Term thought this was wrong. According to their calculations, market volatility would actually decline, and that meant the chances of investors exercising their options would be low too. So Long Term piled the options high and sold them cheap. Sounds risky? They estimated their risk of going bust at one in ten to the power of 24. In other words, virtually zero. It was as if they really were on another planet, far from the mundane ups and downs of terrestrial markets. In October 1997, as if to prove that Long Term really was the ultimate Brains Trust, Merton and Scholes were awarded the Nobel Prize in economics.

It seemed as if intellect had triumphed over intuition, as if rocket science had taken over from risk-taking. Equipped with their magical black box, the partners in LTCM seemed poised to make money far beyond the wildest imaginings of even George Soros. And then, in the summer of 1998, when every self-respecting hedge fund manager should have been playing with his yacht, something happened that threatened to blow the lid right off the Nobel Prize-winners’ black box. Reality started to misbehave.

In evolution, big extinctions tend to be caused by outside shocks, like an asteroid hitting the Earth. On Monday August 17th, 1998, a giant asteroid smashed into Planet Finance. And – surprise, surprise – it struck on the other side of the world in an especially flaky emerging market. Weakened by political upheaval, declining oil revenues and a botched privatisation, the ailing Russian financial system collapsed. A desperate Russian government was driven to default on its debts, fuelling the fires of volatility throughout the world’s financial system. Stock markets plunged. Remember all those low-cost options Long Term had sold based on their prediction of low stock market volatility? The ones they thought no-one would ever exercise? Well, now they did. The quants had predicted that Long Term was highly unlikely to lose more than $35 million in a single day. On Friday August 21 st, it lost $550 million – 15% of its entire capital. Now that, according to the Long Term risk models, was next to impossible. The traders in Greenwich stared slack-jawed and glassy-eyed at their screens. It couldn’t be happening. But it was. By the end of the month, Long Term was down 45%. The only chance of survival was to find a financial white knight to rescue them.

And the most powerful knight in town was none other than George Soros. It was the ultimate humiliation – the quants from Planet Finance begging for a bail-out from the prophet of irrational, unquantifiable reflexivity.

That must have been a very tense meeting. Do you remember the atmosphere in the room, or am I…?

I remember he came for breakfast and it wasn’t at all tense, because… Of course, he was tense but I wasn’t because I wasn’t putting in the money.

There was to be no white knight for Long Term.

I felt that it was too dangerous and that I didn’t have enough capital and, in fact, it really required the coordinated actions of all the banks to bail out LTCM.

And that’s precisely what happened. Fearful that Long Term’s failure could trigger a general financial meltdown, the New York Federal Reserve hastily brokered a multi-billion-dollar bail-out by 14 Wall Street banks. What on earth had happened? Why was Soros so right and the giant brains at Long Term so wrong? For one thing, this wasn’t a coolly logical Planet Finance. It was still dear old Planet Earth, inhabited by emotional human beings with a stampede mentality. There was, however, another reason why Long Term failed. Their risk models were working with just five years’ worth of data. If they’d gone back even 11 years, they’d have captured the 1987 stock market crash. And if they’d gone back 80 years, they’d have captured the last great Russian default after the 1917 revolution.

To put it bluntly, the Nobel Prize-winners had known plenty of mathematics, but not enough history. They’d perfectly grasped the beautiful theory of Planet Finance, but not the messy reality of Planet Earth. And that, quite simply, is why Long Term Capital Management turned out to be Short Term Capital Mismanagement. The big question is whether such a crisis could replay itself today, ten years on, only this time involving so many hedge funds, and on such a large scale, that it simply couldn’t be bailed out? Well, the answer to that question lies not on another planet, but on the other side of this one.

To some, financial history is just so much water under the bridge – ancient history, like the history of imperial China. Some young traders don’t even remember the 1997/98 Asian crisis. In fact, if they came into the markets after 2000, they had seven bumper years. Stock markets worldwide boomed. So too did bond markets. So did commodity markets. So did derivatives markets. In fact, every kind of asset market boomed. And so too did the markets for those products that are in demand when the bonuses are big, like vintage Bordeaux and luxury yachts.

But these boom years were also mystery years. For markets soared at a time of rising short-term interest rates, glaring trade imbalances and escalating political risk. The key to this seeming paradox lay here in China. Chongqing, on the banks of the mighty River Yangtze, is deep in the heart of the Middle Kingdom, over a thousand miles from the coastal enterprise zones most Westerners visit. Yet this is the fastest-growing city on the planet.

I’ve travelled all over the world making this series, and I must say, I have never seen anything like this. Welcome to Chongqing, the fastest growing city in the world. It’s construction heaven. If you look over through the fog, you can just about make out one of the 30 bridges they’re currently building, and down there, one of the ten light railways. All around me, there used to be prime farmland, until six months ago, when they started constructing literally millions of square metres of new office space. The aim is to turn Chongqing into the financial capital of western China. Well, if they keep this up, it’ll soon be the financial capital of the world.

Thanks to growth like this, there are now 345,000 dollar millionaires in China and over 100 billionaires. Not only has China left the colonial era far behind, the fastest-growing economy in the world has also managed to avoid the kind of crisis that has periodically blown up in the other emerging markets. One reason for China’s crisis-free ascent has been the fact that most Chinese investment hasn’t been financed by foreigners, but out of China’s own savings. There has been foreign investment, but most of it has been direct investment in the form of things like factories which you can’t easily liquidate and send home in a crisis. Indeed, so enormous have China’s savings become in recent years that they have enabled globalisation to do the most almighty U-turn. Previously, it was the rich English-speakers who lent money to the poor Asian periphery. But now it’s the Chinese who are lending money to rich Americans. Welcome to the strange new hybrid country of China and America. I call it “Chimerica”.

This extraordinary place is the South Western Stock Exchange. It’s where hundreds of Chongqing’s residents come to have lunch, play ping pong and invest – or is it gamble? – their savings on the stock market. This is what defines the Chinese economy today. Increasingly, it’s what defines the world economy. Chinese investors trying to work out what to do with their abundant savings. After years of instability, Chinese households save an unusually high proportion of their rapidly rising incomes, in marked contrast to Americans, who these days save none at all. So plentiful are Chinese savings that for the first time in centuries, the direction of capital flow is not from West to East, but from East to West. And it is a mighty flow.

In 2007, the United States needed to borrow around $800 billion from the rest of the world. That’s more than $4 billion every working day. China, by contrast, ran a current account surplus equivalent to more than a quarter of the US deficit. And a remarkably large proportion of that surplus has ended up being lent to the United States. In effect, the People’s Republic of China has become banker to the United States of America.

It may seem a little bizarre. The average American has an income of around $44,000 a year, whereas the average Chinese, despite this country’s 100-plus billionaires and all the ostentatious signs of new money here in central Chongqing, is on around $2,000. So why would the latter want to lend money to the former who’s roughly 22 times richer? Well, here’s how it works.

Until recently, from China’s point of view, the best way of employing its vast population was through exporting manufactures to the insatiably spendthrift US consumer. To ensure that those exports were irresistibly cheap, China had to stop its currency strengthening against the dollar by buying literally billions of dollars on world markets. And, until recently, this seemed to be to America’s benefit too.

Here in America, the best way to keep the good times rolling in recent years has been to import cheap Chinese goods by the container-load and sell them in out-of-town superstores, like this one. For companies like Wal-Mart, outsourcing to China has been a way of reaping vast profits from cheap Chinese labour. In 2006 alone, Wal-Mart out-sourced no less than $9 billion-worth of goods from China. But at the same time, by selling billions of dollars of bonds to the People’s Bank of China, the United States has been able to enjoy much lower interest rates than would otherwise have been the case. It’s what they call at business school a win-win situation.

This is the wonderful dual country of “Chimerica”, accounting for 33% of the world’s economic output and more than half of all global growth in the past eight years. Chimerica seemed like a marriage made in heaven. The East Chimericans did the saving. The West Chimericans did the spending. But there was a catch. The more China was willing to lend to the United States, the more Americans were willing to borrow. Chimerica, in other words, was the underlying cause of the flood of new bank loans, bond issues and derivative contracts that swept Planet Finance after 2000. That, in turn, was the underlying reason why the US mortgage market was so awash with cash in 2006 that sub-prime mortgages were being sold to people with no income, no job and no assets – Ninjas.

It wasn’t as if the sub-prime mortgage crisis of 2007 was hard to predict. Months before it blew up, I was in Tennessee and in Michigan, seeing for myself how many poorer households were heading for mortgage default and foreclosure. What was much harder to predict was how a small tremor in America’s very own home-grown emerging market would cause a financial earthquake all around the world. Not many people foresaw that defaults on sub-prime mortgages would send such a shockwave around the world that a British bank would suffer the first run since 1866 and end up being nationalised, or that one of the greatest names in American investment banking, Lehman Brothers, would go bust. And not many people saw that as other banks started to write down hundreds of billions of losses, inter-bank lending would simply seize up, driving the US Treasury to propose a $700 billion bail-out for the financial system as a whole.

Certainly, by June 2008. An American recession seemed more or less inevitable. But the end of the world? Looking around the streets of Hong Kong, I don’t see much sign of a recession here. Can it be that the Chinese half of Chimerica has successfully decoupled itself from the American half?

The idea that China can somehow walk away unscathed from the American crisis is certainly seductive. Despite declining exports to the recession-hit West, and a stock market crash, booming domestic demand seems set to keep China’s economy growing at at least 8% a year. But remember, we’ve been here before. A hundred years ago, in the first age of globalisation, many investors thought there was similarly symbiotic relationship between the world’s financial centre, Britain, and Europe’s most dynamic industrial economy. That economy was Germany’s, and the breakdown of that relationship ended in war. As before 1914, there’s a fine line that separates symbiosis from rivalry and conflict. According to one estimate, China’s gross domestic product could exceed that of the United States as early as 2027. By that time some critics of free trade argue that virtually nothing may remain of American manufacturing industry. And the worse things get in the United States, the louder such complaints will grow.

On a day like today, when the Hong Kong stock market is down sharply, it’s tempting to ask whether anything could trigger a comparable breakdown in globalisation like the one that happened in 1914? The obvious answer is some kind of conflict between the United States and China, whether over trade, Taiwan, Tibet, or some other unforeseeable bone of contention.

What starts with competition for Olympic medals could end in a battle over dollars if the Chinese one day decide to cut off their credit line to the American empire. Maybe, as its name suggests, Chimerica is nothing more than a chimera – the mythical beast of ancient legend that was part lion, part goat, part dragon. A Chinese-American conflict may sound implausible, but one of the key points of this series is that the really big crises come just seldom enough to be beyond the living memory of the people who run today’s companies, banks and funds. Just because all the swans you’ve ever seen are white doesn’t mean there are no black swans.

Today’s financial world is the result of four millennia of economic evolution. Yet despite the unprecedented complexity and diversity of the modern financial system, Planet Finance remains as vulnerable as ever to the age-old problem of booms and busts, irrational exuberance and manic depression. Maybe all this complexity has actually increased our vulnerability to crisis.

For 4,000 years, from ancient Mesopotamia to modern China, the ascent of money has been one of the key factors in human progress, an extraordinary story of innovation, intermediation and integration that had done as much as anything to help people escape from the drudgery of subsistence agriculture. And yet Planet Finance can never quite escape from the gravitational force of Planet Earth, because the quants can never take full account of the human factor – our tendency to underestimate the probability of black swans, our propensity to veer from euphoria to despondency, our chronic inability to learn from history. And that’s why the course of financial history – like that most human of emotions, love – never runs smooth, and never will, not even here, on the magical and quite possibly mythical country of Chimerica.

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