The Investment Lessons Learned from 1873

Bloomberg Audio Studios.

Podcasts.

Radio. News. You're listening to Bloomberg Business Week with Carol Masser and Tim Stenevek on Bloomberg Radio.

He's the Pulitzer Prize winning author of Lords of Finance, The Bankers Who Broke the World, about what led to the Great Depression. His latest book out earlier this year, 1873. I got it in my hand right here. The Rothschilds, The First Great Depression, and the Making of the Modern World. We got the author. He's a former investment manager. Biaquit Ahmed with us right now. He joins us here in the Bloomberg Interactive Brokers studio. Welcome, welcome.

We're kind of rushing because we're going to be quite honest. We have been talking about your book in the newsroom with different colleagues. We've been kind of thinking about, we do a three-hour show. We just couldn't wait to get to this four o'clock hour because we feel like so much in the book is relatable to kind of where we are. But I guess we kind of want to start with your first book. Congratulations.

Thank you.

A Pulitzer Prize. It was about the 1929 depression and the events leading up to it. And this book is about 1873 and the events leading up to another time where we went from a boom to bust. Why choose this moment in time as your second book?

Well, I was looking for another financial crisis, and this was readily at hand. It was actually the first global financial crisis in and covered both Europe, the U.S., and, in fact, across the world. And it. I started it five years ago, so I had no idea that we were going to be talking about AI and the boom in AI infrastructure.

Well, let's get to that part because you mentioned it. I mean, I couldn't help but, as I was reading the book, to compare what's happening with the AI investment boom right now, the financing of it. Every time I read something about. The frenzy around railroads and railroad financing, not just in the United States, but really throughout the world.

What are the parallels there? Well, many parallels. So start out with there's a new technology, the railroads. Gets people very excited. It's a technology that requires a gigantic amount of capital. So in the U.S., 5% of GDP was devoted to railroad construction, which in today's terms would be $ 1. 5 trillion. So comparable to the amount of money that's going into data centers and AI infrastructure. What was also true then and is beginning to be true now is most of it was debt financed. the equity market was tiny, and 80% of the money that went into railroads was financed through the bond market.

And I feel like, you know, we just take the bond market for granted today. It wasn't, I mean, it was the creation, really, in many ways, of the bond market that we exist in today.

Yes. I mean, it was actually the main financial market.

Yeah.

So equities, in the U.S., the bond market was $ 3 to $ 4 billion. Equities were less than a billion. So it was dominated by the bond market. And I suppose the other parallel, I mean, I could come to all the many parallels, but so the first was you get this construction boom in railroads, and like lots of booms, there's overinvestment. So there's too much money going into the railroads.

As a consequence... the profitability of the railroads starts eroding. So by 1872, only one in five railroads was paying a dividend. So sort of watch out for this AI boom. when profitability starts declining.

Should we be watching out right now? I mean, you write about bubbles in the story, in the book. You write, quote, it does not actually take enormous prescience to spot when a market has entered bubble territory. What is difficult is predicting when exactly it will burst. Are we in an AI bubble right now?

Um, Yes. But getting the timing right of when it's going to burst is the giant challenge. Previous infrastructure booms have taken anywhere from two to four years to play themselves out. So I don't know. We're two years into this one. It could go on for another two years. So, you know, some of them have only lasted two years.

Some of them have lasted as long as four years.

Do they all end badly?

The major ones all end badly.

And this would be a major one?

Yes. And there's a sort of pattern to the way they play out. The first thing is you start getting the erosion of profitability, right?

Like negative cash flow?

Yes.

Just for example. Sorry, keep going.

The second is all the amount of money that goes into it during the boom is so large that it begins to cause interest rates to spike up. So that happened in the 1870s. It happened again in the 1880s. It happened again in the 1920s and the lead up to the Great Depression. It happened again in 1999, 2000.

And it also happened in the lead up to the real estate bubble in 2008. There's a pattern. It causes interest rates will spike up. And that has all sorts of repercussions throughout the economy.

What would, in this environment, cause interest rates to spike?

Well, they already have done.

Like a war and higher energy prices?

But do you.

Consider this a spike that's worthy of something ahead of some sort of unwind?

Real interest rates have gone up by 150 basis points in the last 12 months. And the other thing to remember is this is not just in the U.S., This is a global phenomenon. And everyone's trying to get their hands on as much capital as they can. And at a time when governments are borrowing an enormous amount.

That's the thing. It's multiple layers, right? You have governments with a lot of debt. You have a lot of debt being created because of the AI bill. You have energy infrastructure, which is related to AI. But again, that's another bit. There's just a lot of layers. And that's when it gets a little bit more complicated. And for policymakers, be it monetary policymakers or government, to kind of figure out what is the right policy.

Yeah. I mean, the other thing that typically happens in these booms is inflation starts going up. So in addition to interest rates going up because of inflation, interest rates, real interest rates also start going up. And essentially everyone's competing For the same territory and for the same, you know, so there's crowding out not only in the financial markets, but, you know, everyone's competing for workers.

Right.

Or capital. Everyone's competing for construction spaces. So, and we're seeing some of that go on today.

Right.

We're going to get to more on the parallels between 1873 and the events leading up to 1873 and today. But I want to go back to the invention of the government bond market because the subhead of this book is the Rothschilds, the first great depression and the making of the modern world. You write about how the Rothschilds family invented this government funding mechanism. What's the history of that?

Well, they started out in the Napoleonic Wars as smugglers. So they helped the British government... evade the Napoleonic blockade.

This is Nathaniel. This is Nathaniel, yes. There are a lot of Rothschilds. He was actually the third son of the founders.

He was a founder, five brothers, and he was the most enterprising of all of the sons. And his father had made a lot of money because he was in charge of the Landgrave of Hesse. So there's money. And Hessian soldiers were the British Army employed Hessian soldiers during the American War of Independence. So the father accumulates all this sterling and he sends Nathaniel to Britain to invest it.

And he says, go into the textile business. And Nathaniel's much too enterprising for that. So he goes to, he moves to London and he figures out there's a great opportunity in the smuggling business. And so starts, uh, uh, supervises the, you know, the, uh, helping the British avoid the blockade. And he has four other brothers who then spread across Europe, and they create a network of smugglers, essentially.

And so by the end of the Napoleonic Wars, they're one of the richer families in Europe. Not the richest yet, but they were one of the richest. And then they go into... taking this money and using it to finance, help governments finance the reconstruction after the Napoleonic Wars. Don't forget, the Napoleonic Wars lasted a whole generation. Europe was in terrible shape. And they became the primary financiers for governments from about 1820 until 1850. And that puts them in a league with the royal families of Europe. And they're treated as princes. Unlike the others, they're Jewish. But they're the first and richest Jewish family in the world. By 1850, They are the richest family in the world. By 1873,

if you translated it in today's terms... they would be worth the equivalent of $ 250 billion. Now, you know, in a world of, you know, Musk, that's still small.

$ 250 billion.

It was still a lot of money in terms of their presence in this world. You know, I guess what's interesting, too, is In terms of bonds, like now you were reaching out to everyday people to help finance things, which wasn't the way it used to be. And that's a big change.

Yeah. Well, the Rothschilds really catered to very high net worth individuals. So they actually catered to the high end of the market. The person who democratized... The bond market.

Mr. Cook?

Yes.

Jay Cook.

Jay Cook. And the interesting thing about the Rothschilds is they became the richest family in the world, despite... Avoiding the U.S.

Why did they avoid the U.S.? I mean, there's a great sort of like a emissary agent who comes to the U.S. and you write about him and his son as well.

Belmont.

Belmont and Belmont Stakes, I believe, is the reason why it's called that. He was very into horse racing. Why did they avoid the United States?

Because they they lost a lot of money in the 1840s during the canal boom. And the canal boom was primarily driven by the states, the states in the U.S. And so when that went belly up, the Rothschilds, Nathan and his brothers, decided to try and retrieve this money. And they discovered you couldn't sue states in the United States because they had sovereign immunity. So they thought, this is crazy. I mean, this is sort of a banana republic sort of situation. So they dismissed the US as a banana republic. And they said, we want nothing to do with the United States. And, you know, much to their regret, because the United States became the big economic power during the 19th century. But they did pretty well,

so I don't think they....

I just want to reintroduce Liaquat Ahmed. He's the author of 1873, The Rothschilds, The First Great Depression, and The Making of the Modern World. He joins us here in the Bloomberg Interactive Brokers Studio.

I want to mention, because we asked... viewers and listeners to send in questions. And we do have a loyal viewer and listener, Brendan from Maryland. He asks, for you, they say that history doesn't repeat, but it rhymes. And human nature is what it is. The great financial crisis was also a debt crisis. Why aren't we learning from all of this? We know it will lead to misery.

Does greed drive everything here, or will AI truly and genuinely deliver on its promises? And We have conversations, and we get so much pushback, even when we raise the idea of the circular financing, where NVIDIA's working with this company, and they're buying the chips, and that that's a good thing, that that's them kind of supporting and helping out those companies that maybe aren't as established, if you will. So I don't know. Do we not learn? Oh, no.

We learn. The problem is you can't repeal human nature. So circular financing. What is circular financing? It's essentially a hidden form of borrowing. So it's leverage. And the thing we've learned in crisis after crisis is the thing that kills you is when you borrow a lot of money in a boom, because when it turns around, that thing just bites you on the way down. So circular financing, we all know what it is, and it's great on the way up, and it's terrible on the way down.

You know, there's a part in your book where you talk about kind of the corruption that came into with the railroad build-out. And you say the best documented examples of such schemes were the two deployed by the transcontinental railroad companies, Union Pacific subcontracted... the construction of its line to a dummy corporation, the exotically named Credit Mobilier. Mobilier, yes.

Thank you. Owned by directors and officers of Union Pacific. The majority stake was held by a consortium led by Massachusetts Congressman Oaks Ames, a millionaire who had made his fortune in the shovel business during the California gold rush. It keeps going on and on.

Right.

And one of the things... Amazon doing a special purpose vehicle. I'm not saying there's anything sketchy. Companies do this all the time. But when it starts to get interesting and complicated and layers below... Like maybe off-balance sheet stuff? Or off-balance sheet.

Are we....

Smart to ask questions or start to make some assumptions.

I would draw a distinction between off-balance sheet and hidden borrowing.

Okay.

And pure corruption.

Okay. Fair.

If you remember during the dot-com bubble. there were all sorts of conflicts of interest. I mean, I'm forgetting the names of the people.

Well, the telecom build-out during that, right?

Yes, exactly.

WorldCom and... Exactly.

And those people were... That was real corruption. I mean, they were breaking the law. And we got a whole revamp of securities laws after the dot-com bubble.

But nobody's breaking the law here.

No one's breaking the law today, although we actually don't know. We'll find out at some point whether anyone's been breaking the law. But certainly in the 1870s, They only found out in 1872 when this whole scheme where essentially the sponsors of the railroads were ripping off their own shareholders because they had created this dummy corporation and they were overcharging the railroads to build the.

The U.S. Transcontinental Railroad cost about 70 to 80 million dollars. A third of that was siphoned off in the form of excess profits.

You write about so many of the railroads going bust during the crisis. What ended up happening to that infrastructure that had been placed? And one thing that was just fascinating in here was the land grant that the U.S. government had done and how these companies were able to amass so much land thanks to the U.S. government.

Yeah, yeah. That was actually a pretty well thought out scheme for essentially subsidizing the construction of railroads and providing for a subsidy to settlers because the railroads made no sense. The transcontinental railroads would have made no sense if there weren't people who were settling. So it was a double subsidy.

It went to the railroads, but it allowed them, some of the land was reserved for people to move out and settle in that area. So it was actually a reasonably well thought out scheme. The problem was, after the corruption scandals, In 1872, after this giant construction scandal, Congress said, no more land grants. And Jay Cook and Company had then gotten into, after the Civil War, he had decided he wanted to finance the second transcontinental railroad. And unfortunately, he got into the business just when Congress closed down the spigot of money that was coming his way, which was one of the reasons he got himself into so much trouble.

What I want to ask you, you know, great financial crisis, a lot of things changed, I think, in terms of bank oversight or what they had to make sure that they, you know, didn't get into the predicament and whether it was how much money they had to keep on their balance sheet and to kind of protect reserves and so on and so forth. I wonder, do you believe we have the right market safeguards in place And even when it is with the circular financing, are we doing the due diligence that we need to be doing to understand these relationships and the risks and vulnerabilities or the leverage?

Okay. So, you know, after the 1870s, there was actually not much reform. The real time when we had reform was after the 1929 crash. Do we have enough safeguards? Look, we have Journalists and, you know, everyone's pouring over these companies. So I don't think there's a giant amount of information that we're not getting. So I think, you know, it's quite, we know what NVIDIA is doing. And people like you publicize all of this. So I don't think that is going to be the problem. I think the problem is going to be that we can't predict everything. So in 1873, you know, we have this boom. We then have war breakout in Europe, which causes a giant financial problem for anyone trying to raise money in Europe. And Jay Cook

and company wanted to raise money in Europe, and the European capital markets closed down. So you can't predict the sort of geopolitical events that could sort of change the landscape. in a way that makes the whole system very vulnerable.

Which just makes us think about this year, you know, in terms of the geopolitical events, and most notably, right now, what's going on in the Middle East.

Or the dot-com bubble.

Yeah.

You know, that burst at the beginning of 2000. Right. You know, it was bad, but 9-11 is what really took the whole... Mm-hmm. economy down and that's what caused the uh you know that that's what made the the thing 10 times worse.

I think some people forget it it took like more than a decade for the nasdaq to to recover right and if you look at what the nasdaq has done since let's say 2015 it's just remarkable to to sort of look at a 10-year period of time where after something that wasn't even like a major global financial crisis It was still under pressure.

Well, you put your finger on something that we've never had in a financial crisis before. Until 2000, the size of the equity market was about, it got up to 110% of GDP. Today, the size of the U.S. equity market is $ 85 billion today. in a U.S. economy that's $ 33 billion. So it's about 200... A trillion. Yeah, sorry, 33 trillion.

Yeah.

So the U.S.

Equity market is 250% of GDP.

And on top, in the last 12 months, a trillion dollars... has come into the US equity market from foreigners. So the combination of an over bloated US equity market, and there I'm counting private equities as well as, so people often forget. that public equities is now only 75% of the story. And there's this giant overhang of, you know.

Which we've talked about for the last couple of years, the worries in those markets.

Well, SpaceX... I mean, who was counting on SpaceX and... anthropic and open AI.

Hang on for a second we're going to come back with Liaquat Ahmed we're talking about his book 1873 the Rothschild the first great depression and the making of the modern world we're not done we want to get a little bit into geopolitics and impact on society we're going to continue we're back in a moment.

You're listening to Bloomberg Business Week with Carol Masser and Tim Stenevek on Bloomberg Radio.

I want to get right back to Liaquat Ahmed. He is the author, the Pulitzer Prize winning author of Lords of Finance, The Bankers Who Broke the World.

Who writes their first book and gets a Pulitzer Prize?

Congratulations. Especially after a 25-year investment.

Very impressive. Okay.

Well done, well done. His new book, 1873, The Rothschilds, The First Great Depression and the Making of the Modern World. I want to start with sort of the timing of crises and how this stuff percolates and then suddenly becomes a global issue.

You know, one of the most quoted lines from Hemingway, The Sun Also Rises, was one character asked the other, how did you go bankrupt? And the response was, two ways, slowly, gradually, and then suddenly. And that's actually a perfect description for the way financial crises work. that they take much longer to happen than you thought they would. And everyone's talking about things being overdone, and still the thing keeps going, and still the band keeps playing. And then suddenly, and it all takes place in the space of a few months.

So that was the story in 1873. For two years, everyone had been saying, this thing cannot continue. And they were wrong all the way. And then suddenly they were right.

Wait, was Karl Marx finally right?

You know, a stock clock is right.

Because you write.

In the book, you know, he's been calling for crises for decades and then he finally hit it.

Yeah, I was actually, I developed a lot of affection for Karl Marx. Yeah.

Would AI, if this indeed does become a crisis and the boom goes bust, is it a global crisis? Because is the exposure the same in the U.S. versus China versus Europe?

Well, I think there are two aspects to these crises. One is the boom-bust cycle. And boom-bust cycles are terrible. and they cause a lot of disruption, but they don't actually lead to a massive financial crisis, or don't necessarily. The economy is surprisingly resilient. What really converts a boom-bust cycle into a crisis is a mistake in monetary policy. Hmm.

You know, that's what happened in 1873, and we can talk about that. That's what happened in 1929 when they let the banks go under. That didn't happen in 2008.

You know, we only have a few minutes left with you, and I promised that we'd talk about some of the social elements of the book. There's an entire chapter in here toward the end of the book. It's entitled, in quotes, The Jews Themselves Are to Blame. And I want to talk a little bit about the anti-Semitism and the rise of anti-Semitism in Europe, and we all know what happened in the 1930s in Germany, but how the seeds of that were planted post-1873. So, financial crises are great.

Breeding grounds for conspiracy theories. Because a lot of people get hurt. And then they're looking for someone to blame. And in most financial crises, in the lead up, everyone starts blaming the bankers. And in Europe, what made it worse was after the crisis, bankers did well. So they did well on the way up, and then they did well on the way down. And so they start in Germany, they all pointed the finger at Jewish stockbrokers. You know, totally unfairly. But it's not a coincidence that the word anti-Semitism was coined in 1879 by one of these rabble-rousing journalists who decided to stir up hatred against the Jews.

And he used the word anti-Semitism... as a word of approbation, i.e., this was a good thing, that suddenly the West had woken up to this problem in our midst, which was undermining Western culture, and it was the Jews who caused it all. And, you know, we know where that eventually led. Yeah.

We only have about two minutes left, and I just wonder about the rise of populism that we've seen globally. Is that a response to the great financial crisis where people were really hurt in their livelihoods, generations, kids who grew up in it? Is that the result in why we're seeing kind of political tensions around?

We keep on getting it because, as I said— Bankers were thought to have caused it, but then they did well in the aftermath. If you go back to 2008, who was bailed out? The bankers. Who was not bailed out?

The homeowners.

Homeowners. Homeowners. You talk to Treasury officials, and they spent hours trying to figure out how can we bail out homeowners because there's too many of them, and do we bail out everyone? But it created enormous resentment. And it created resentment both from the right wing, remember the Tea Party, and the left wing, so Bernie Sanders and Occupy Wall Street.

And so you get this unholy coalition of both the right and the left saying this system does not work. And that's sort of... Here we are.

We only have 30 seconds left. If there's one lesson for our investing audience from 1873, what is it?

I think the lesson sort of reveals itself, which is, you know, don't get caught up. in the heat of the moment, you know, think for yourself and think, you know, be Walter Badgett.

Be Walter Badgett, I love that. Liaket, thank you so much all this time. We so, so appreciate it. Liaket Ahmed, the book is 1873, The Rothschild, The First Great Depression and the Making of the Modern World. So appreciate it.

I really appreciate it as well. Thank you.

Really fun for us.

Hey, we're looking forward to your next book too. I know this one only took five years.

Five years we'll give you and then we'll come back to you.

Do come back before then. We appreciate it. Once again, Liaquat Ahmed, author of 1873. The book is out now.

The Investment Lessons Learned from 1873

Kapitelklicken springt direkt hin

Shownotes

Transkriptvom Podcast bereitgestellt · Zeitmarken springen hin