November 26, 2007

The First Credit Crunch

AS THE CREDIT CRUNCH continues to keep Wall Street mired in a financial morass, it's worth noting that credit crunches -- and the economic contractions that have gone with them -- have been with us for millenia. In the Middle Ages, the Fugger bank was one of just several major banking operations that was thrown for a loss when its risky loans to warmongering princes -- the original subprime loans -- went bad. Before that, the economy of the late Roman Empire was ruined due to runaway inflation. Long before that, the famed archon Solon of Athens threw a giant monkey wrench into the city-state's works when, through governmental fiat, he abolished all debts in the early 6th century BC.

However, interestingly enough, Yale finance professor William Goetzmann has noted perhaps the first recorded instance of a credit crunch in 1788 BC, in no less a place than the ancient city-state of Ur.

In a particularly interesting work (see link), Prof Goetzmann relates the case of the ancient businessman Dumuzi-gamil, who became wealthy through building large bakeries and lending silver at high rates of interest. While the Government at the time had lending caps in place -- interest on loans could not top 20 pc -- enterprising types like Dumuzi-gamil got around this through arranging short-term loans, generally between one and three months in length. But in 1788, Prof Goetzmann notes, it all went down the drain when local warlord Rim-Sin decided to abolish all debts, throwing the once-thriving financial markets of Ur into chaos and pretty much destroying the economic engine of the city.

But wait, you say. Who the devil was this Rim-Sin, king of Larsa? Well, there's a reason no one has ever heard of him: it's because the great Hammurabi, the guy who handed down all the laws (with death being the typical punishment), came along and kicked his ass a couple of decades later. Of course, had Rim-Sin not ruined his local economy, he might have been able to raise the capital to raise an army capable of defeating Hammurabi. But there is little in the historical record that suggests the economy came back to life anytime soon: about all that exists in the record after 1788, as Prof Goetzmann notes, are lawsuits.

It is perhaps a bit harsh to condemn the ancients for their lack of knowledge about economics and finance, as the knowledge we have today of those subjects far outpaces that which they had. For instance, the quantity theory of money -- the basis for understanding inflation -- wasn't first guessed at until the 16th century, when people finally drew the connection between rising prices and all the precious metals coming over from New Spain. The math of probability wasn't really known until the 17th century, which was also when the joint-stock company was formally developed. Price controls have never worked, as Diocletian famously found out back in the third century, yet up until the 1970s the Western world at times seemed to think they were a good idea.

Still, this sad saga from long ago holds many lessons for people today. For instance, the easy way out is not always the best way out. Hopefully, folks will keep that in mind when considering how to address Wall Street's present dilemma.

Posted by Benjamin Kepple at November 26, 2007 12:44 AM | TrackBack
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