Friday (Isaac) Newton blogging (Monday edition): Isaac solves the subprime mess.
We are in a mess. How bad is it? I don’t know — but when the Fed et al. race to make sure that the most significant housing lenders in this country are less fiscally sound than they were last week, all to pump some extra dollars into the mortgage market, you know it ain’t good.
What to do? Why, suggests Tim over at Balloon Juice, let’s get the right man for the job:
Isaac Newton, of course.
Tim was joking, I think, but in fact Newton would be a more appropriate choice than just about any other physicist I could name. England in the late seventeenth century experienced a financial revolution as well as its more famous scientific one. Newton took part in both.
For example — he was among the great and the good whose advice was sought on what to do about the disappearance of England’s silver coinage in 1695 — along with such luminaries as John Locke, Charles Davenant and Christopher Wren.
Then, beginning the next year, first as Warden and then Master of the Royal Mint, he became a significant, if not the dominant player in the transformation of England’s money system from a silver to a de-facto gold denominated pound.
More to Tim’s point, Isaac Newton took up his role in England’s nascent financial bureaucracy at a time of wild, uncontrolled, truly exuberant financial engineering. This was a time when the English government’s attempts to fund a wildly expensive overseas military adventure (the Nine Years War) stretched to include licensing the issue of tickets that were at once (a) high-interest bonds (what might later be known as junk), backed by a stream of government tax revenue on malt, the key raw ingredient in making beer;* (b) entries in a lottery, offering chances to win up to a 1,000 pounds against a ten pound ticket; and (c) paper money.
As another excessively premature plug — I cover all this in my book on Newton as a currency cop, coming out early next year. But for now the point is that Newton was not only present while all this happened. He was in fact a fairly senior civil servant working for a government struggling to figure out how to fund and foster a transforming economy. He was a pretty smart guy too, I hear, and he thought in some detail about questions of credit, government control, and probity in financial dealings.
He came to a lot of quite sensible conclusions about the new paper instruments, and the proper role of debt and credit: “If interest be not yet low enough for the advantage of trade and designs of setting the poor on work..the only proper way to lower it is more paper credit till by trading and business we can get more money.” Keynes forshadowed, anyone?
And then there is this: “Tis mere opinion that sets a value upon money; we value it because with it we can purchase all sorts of commodities and the same opinion sets a like value upon paper security….All the difference is…that the value of the former is more universal than that of the latter.”**
Interest is certainly heading low enough for the advantages of American export trade. (evanescing dollar, anyone? I’m only complaining as one who just had to wire a fee for a researcher in London). We still have a way to go to set the poor on work, but at least Newton had that as one of his priorities, which is more than I can say for some, on the evidence. And certainly, the interesting times (in the Chinese sense) we are living in confirms the truth of the observation of the relationship of opinion and value.
But even though Newton could see what many others could not about the essentially abstract nature of money, he was not entirely immune to the confusion — or perhaps to baseline human desires — triggered by half-comprehended new notions of finance. His first investment in the South Sea Company paid off, when he sold on the rise.
But even though there could have been no other man in England better placed to grasp the mathematical implications of the unfolding scheme — he still bought back into the madness of the bubble year, 1720.
He lost, by his heirs’ estimate, some 20,000 pounds — a prodigious sum, a fortune.*** It’s hard to gauge what that means across such gaps of time, but using the Parliamentary research service’s estimate of inflation across that time, a rough guesstimate leads to the conclusion that the smartest man in Europe blew the modern equivalent of better than three million pounds on a “greater fool” dynamic of what had become, in the end, a fairly straight forward pump-and-dump stock fraud.
Newton had succumbed to greed, or perhaps the simple impetus of the common mania — but which ever it was, it still overcame both his capacity to think quantitatively (Newton!) and any prudential impulse. After all, he was rich already. He didn’t need to risk much to gain much: when he died, seven years after the bubble year, he still left a fortune of 30,000 pounds, not counting his land in Lincolnshire.
The moral of the story: This is why you need to regulate financial markets. No one, not even the cleverest, is immune to all the familiar temptations of money in flux. No wise man remains wise always; one of the most reliable inducers of folly is the possibility of gains that seem to repeal financial laws of gravity. Rules that are no respecters of persons are there to save even the Isaac Newtons among us from themselves.
*More crucial than you might think given that weak beer was the staple fluid in a society where the water supply looked like this.
**Both quotes taken from Newton’s Mint papers, and published in G. Findlay Shirras and John Craig, “Sir Isaac Newton and the Currency,” in Economic History. Subscription required.
***It’s not quite clear from the record exactly what Newton lost in the bubble. The suggestion is that he lost an investment of 20,000 pounds, but this seems unlikely, given what is known about Newton’s income throughout his career. More likely, and the more popular interpretation among Newton scholars, is that Newton converted into South Sea stock debt instruments with a total, long term future value at that rather grand number. In other words, he didn’t lose tens of thousands in cold cash; rather, he gave up income that could have added up to very satisfying amounts over time. Still a lot of money, but not the stunning out-of-pocket disaster the raw number implies.
Images: Quentin Massys, “Der Goldwäger und seine Frau,” 1591. The reproduction is part of a collection of reproductions compiled by The Yorck Project. The compilation copyright is held by Zenodot Verlagsgesellschaft mbH and licensed under the GNU Free Documentation License. Source: Wikimedia Commons.
South Sea Bubble Card, 1720. Source: Wikimedia Commons.