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16 - The Capitalist Creed

MONEY HAS BEEN ESSENTIAL BOTH FOR building empires and for promoting science. But is money the ultimate goal of these undertakings, or perhaps just a dangerous necessity?

It is not easy to grasp the true role of economics in modern history. Whole volumes have been written about how money founded states and ruined them, opened new horizons and enslaved millions, moved the wheels of industry and drove hundreds of species into extinction. Yet to understand modern economic history, you really need to understand just a single word. The word is growth. For better or worse, in sickness and in health, the modern economy has been growing like a hormone-soused teenager. It eats up everything it can find and puts on inches faster than you can count.

For most of history the economy stayed much the same size. Yes, global production increased, but this was due mostly to demographic expansion and the settlement of new lands. Per capita production remained static. But all that changed in the modern age. In 1500, global production of goods and services was equal to about $250 billion; today it hovers around $60 trillion. More importantly, in 1500, annual per capita production averaged $550, while today every man, woman and child produces, on the average, $8,800 a year.1 What accounts for this stupendous growth?

Economics is a notoriously complicated subject. To make things easier, let’s imagine a simple example.

Samuel Greedy, a shrewd financier, founds a bank in El Dorado, California.

A. A. Stone, an up-and-coming contractor in El Dorado, finishes his first big job, receiving payment in cash to the tune of $1 million. He deposits this sum in Mr Greedy’s bank. The bank now has $1 million in capital.

In the meantime, Jane McDoughnut, an experienced but impecunious El Dorado chef, thinks she sees a business opportunity – there’s no really good bakery in her part of town. But she doesn’t have enough money of her own to buy a proper facility complete with industrial ovens, sinks, knives and pots. She goes to the bank, presents her business plan to Greedy, and persuades him that it’s a worthwhile investment. He issues her a $1 million loan, by crediting her account in the bank with that sum.

McDoughnut now hires Stone, the contractor, to build and furnish her bakery. His price is $1,000,000.

When she pays him, with a cheque drawn on her account, Stone deposits it in his account in the Greedy bank.

So how much money does Stone have in his bank account? Right, $2 million.

How much money, cash, is actually located in the bank’s safe? Yes, $1 million.

It doesn’t stop there. As contractors are wont to do, two months into the job Stone informs McDoughnut that, due to unforeseen problems and expenses, the bill for constructing the bakery will actually be $2 million. Mrs McDoughnut is not pleased, but she can hardly stop the job in the middle. So she pays another visit to the bank, convinces Mr Greedy to give her an additional loan, and he puts another $1 million in her account. She transfers the money to the contractor’s account.

How much money does Stone have in his account now? He’s got $3 million.

But how much money is actually sitting in the bank? Still just $1 million. In fact, the same $1 million that’s been in the bank all along.

Current US banking law permits the bank to repeat this exercise seven more times. The contractor would eventually have $10 million in his account, even though the bank still has but $1 million in its vaults. Banks are allowed to loan $10 for every dollar they actually possess, which means that 90 per cent of all the money in our bank accounts is not covered by actual coins and notes.2 If all of the account holders at Barclays Bank suddenly demand their money, Barclays will promptly collapse (unless the government steps in to save it). The same is true of Lloyds, Deutsche Bank, Citibank, and all other banks in the world.

It sounds like a giant Ponzi scheme, doesn’t it? But if it’s a fraud, then the entire modern economy is a fraud. The fact is, it’s not a deception, but rather a tribute to the amazing abilities of the human imagination. What enables banks – and the entire economy – to survive and flourish is our trust in the future. This trust is the sole backing for most of the money in the world.

In the bakery example, the discrepancy between the contractor’s account statement and the amount of money actually in the bank is Mrs McDoughnut’s bakery. Mr Greedy has put the bank’s money into the asset, trusting that one day it would be profitable. The bakery hasn’t baked a loaf of bread yet, but McDoughnut and Greedy anticipate that a year hence it will be selling thousands of loaves, rolls, cakes and cookies each day, at a handsome profit. Mrs McDoughnut will then be able to repay her loan, with interest. If at that point Mr Stone decides to withdraw his savings, Greedy will be able to come up with the cash. The entire enterprise is thus founded on trust in an imaginary future – the trust that the entrepreneur and the banker have in the bakery of their dreams, along with the contractor’s trust in the future solvency of the bank.

We’ve already seen that money is an astounding thing because it can represent myriad different objects and convert anything into almost anything else. However, before the modern era this ability was limited. In most cases, money could represent and convert only things that actually existed in the present. This imposed a severe limitation on growth, since it made it very hard to finance new enterprises.

Consider our bakery again. Could McDoughnut get it built if money could represent only tangible objects? No. In the present, she has a lot of dreams, but no tangible resources. The only way she could get her bakery built would be to find a contractor willing to work today and receive payment in a few years’ time, if and when the bakery starts making money. Alas, such contractors are rare breeds. So our entrepreneur is in a bind. Without a bakery, she can’t bake cakes. Without cakes, she can’t make money. Without money, she can’t hire a contractor. Without a contractor, she has no bakery.

Humankind was trapped in this predicament for thousands of years. As a result, economies remained frozen. The way out of the trap was discovered only in the modern era, with the appearance of a new system based on trust in the future. In it, people agreed to represent imaginary goods – goods that do not exist in the present – with a special kind of money they called ‘credit’. Credit enables us to build the present at the expense of the future. It’s founded on the assumption that our future resources are sure to be far more abundant than our present resources. A host of new and wonderful opportunities open up if we can build things in the present using future income.

If credit is such a wonderful thing, why did nobody think of it earlier? Of course they did. Credit arrangements of one kind or another have existed in all known human cultures, going back at least to ancient Sumer. The problem in previous eras was not that no one had the idea or knew how to use it. It was that people seldom wanted to extend much credit because they didn’t trust that the future would be better than the present. They generally believed that times past had been better than their own times and that the future would be worse, or at best much the same. To put that in economic terms, they believed that the total amount of wealth was limited, if not dwindling. People therefore considered it a bad bet to assume that they personally, or their kingdom, or the entire world, would be producing more wealth ten years down the line. Business looked like a zero-sum game. Of course, the profits of one particular bakery might rise, but only at the expense of the bakery next door. Venice might flourish, but only by impoverishing Genoa. The king of England might enrich himself, but only by robbing the king of France. You could cut the pie in many different ways, but it never got any bigger.

That’s why many cultures concluded that making bundles of money was sinful. As Jesus said, ‘It is easier for a camel to pass through the eye of a needle than for a rich man to enter into the kingdom of God’ (Matthew 19:24). If the pie is static, and I have a big part of it, then I must have taken somebody else’s slice. The rich were obliged to do penance for their evil deeds by giving some of their surplus wealth to charity.

If the global pie stayed the same size, there was no margin for credit. Credit is the difference between today’s pie and tomorrows pie. If the pie stays the same, why extend credit? It would be an unacceptable risk unless you believed that the baker or king asking for your money might be able to steal a slice from a competitor. So it was hard to get a loan in the premodern world, and when you got one it was usually small, short-term, and subject to high interest rates. Upstart entrepreneurs thus found it difficult to open new bakeries and great kings who wanted to build palaces or wage wars had no choice but to raise the necessary funds through high taxes and tariffs.

That was fine for kings (as long as their subjects remained docile), but a scullery maid who had a great idea for a bakery and wanted to move up in the world generally could only dream of wealth while scrubbing down the royal kitchens floors.

It was lose-lose. Because credit was limited, people had trouble financing new businesses. Because there were few new businesses, the economy did not grow. Because it did not grow, people assumed it never would, and those who had capital were wary of extending credit. The expectation of stagnation fulfilled itself.

A Growing Pie

Then came the Scientific Revolution and the idea of progress. The idea of progress is built on the notion that if we admit our ignorance and invest resources in research, things can improve. This idea was soon translated into economic terms. Whoever believes in progress believes that geographical discoveries, technological inventions and organisational developments can increase the sum total of human production, trade and wealth. New trade routes in the Atlantic could flourish without ruining old routes in the Indian Ocean. New goods could be produced without reducing the production of old ones. For instance, one could open a new bakery specialising in chocolate cakes and croissants without causing bakeries specialising in bread to go bust. Everybody would simply develop new tastes and eat more. I can be wealthy without your becoming poor; I can be obese without your dying of hunger. The entire global pie can grow.

Over the last 500 years the idea of progress convinced people to put more and more trust in the future. This trust created credit; credit brought real economic growth; and growth strengthened the trust in the future and opened the way for even more credit. It didn’t happen overnight – the economy behaved more like a roller coaster than a balloon. But over the long run, with the bumps evened out, the general direction was unmistakable. Today, there is so much credit in the world that governments, business corporations and private individuals easily obtain large, long-term and low-interest loans that far exceed current income.

The belief in the growing global pie eventually turned revolutionary. In 1776 the Scottish economist Adam Smith published The Wealth of Nations, probably the most important economics manifesto of all time. In the eighth chapter of its first volume, Smith made the following novel argument: when a landlord, a weaver, or a shoemaker has greater profits than he needs to maintain his own family, he uses the surplus to employ more assistants, in order to further increase his profits. The more profits he has, the more assistants he can employ. It follows that an increase in the profits of private entrepreneurs is the basis for the increase in collective wealth and prosperity.

This may not strike you as very original, because we all live in a capitalist world that takes Smith’s argument for granted. We hear variations on this theme every day in the news. Yet Smith’s claim that the selfish human urge to increase private profits is the basis for collective wealth is one of the most revolutionary ideas in human history – revolutionary not just from an economic perspective, but even more so from a moral and political perspective. What Smith says is, in fact, that greed is good, and that by becoming richer I benefit everybody, not just myself. Egoism is altruism.

Smith taught people to think about the economy as a ‘win-win situation’, in which my profits are also your profits. Not only can we both enjoy a bigger slice of pie at the same time, but the increase in your slice depends upon the increase in my slice. If I am poor, you too will be poor since I cannot buy your products or services. If I am rich, you too will be enriched since you can now sell me something. Smith denied the traditional contradiction between wealth and morality, and threw open the gates of heaven for the rich. Being rich meant being moral. In Smiths story, people become rich not by despoiling their neighbours, but by increasing the overall size of the pie. And when the pie grows, everyone benefits. The rich are accordingly the most useful and benevolent people in society, because they turn the wheels of growth for everyone’s advantage.

All this depends, however, on the rich using their profits to open new factories and hire new employees, rather than wasting them on non-productive activities. Smith therefore repeated like a mantra the maxim that ‘When profits increase, the landlord or weaver will employ more assistants’ and not ‘When profits increase, Scrooge will hoard his money in a chest and take it out only to count his coins.’ A crucial part of the modern capitalist economy was the emergence of a new ethic, according to which profits ought to be reinvested in production. This brings about more profits, which are again reinvested in production, which brings more profits, et cetera ad infinitum. Investments can be made in many ways: enlarging the factory, conducting scientific research, developing new products. Yet all these investments must somehow increase production and translate into larger profits. In the new capitalist creed, the first and most sacred commandment is: ‘The profits of production must be reinvested in increasing production.’ That’s why capitalism is called ‘capitalism’. Capitalism distinguishes ‘capital’ from mere ‘wealth’. Capital consists of money, goods and resources that are invested in production. Wealth, on the other hand, is buried in the ground or wasted on unproductive activities. A pharaoh who pours resources into a non-productive pyramid is not a capitalist. A pirate who loots a Spanish treasure fleet and buries a chest full of glittering coins on the beach of some Caribbean island is not a capitalist. But a hard-working factory hand who reinvests part of his income in the stock market is.

The idea that ‘The profits of production must be reinvested in increasing production’ sounds trivial. Yet it was alien to most people throughout history. In premodern times, people believed that production was more or less constant. So why reinvest your profits if production won’t increase by much, no matter what you do? Thus medieval noblemen espoused an ethic of generosity and conspicuous consumption. They spent their revenues on tournaments, banquets, palaces and wars, and on charity and monumental cathedrals. Few tried to reinvest profits in increasing their manors’ output, developing better kinds of wheat, or looking for new markets.

In the modern era, the nobility has been overtaken by a new elite whose members are true believers in the capitalist creed. The new capitalist elite is made up not of dukes and marquises, but of board chairmen, stock traders and industrialists. These magnates are far richer than the medieval nobility, but they are far less interested in extravagant consumption, and they spend a much smaller part of their profits on non-productive activities.

Medieval noblemen wore colourful robes of gold and silk, and devoted much of their time to attending banquets, carnivals and glamorous tournaments. In comparison, modern CEOs don dreary uniforms called suits that afford them all the panache of a flock of crows, and they have little time for festivities. The typical venture capitalist rushes from one business meeting to another, trying to figure out where to invest his capital and following the ups and downs of the stocks and bonds he owns. True, his suits might be Versace and he might get to travel in a private jet, but these expenses are nothing compared to what he invests in increasing human production.

It’s not just Versace-clad business moguls who invest to increase productivity. Ordinary folk and government agencies think along similar lines. How many dinner conversations in modest neighbourhoods sooner or later bog down in interminable debate about whether it is better to invest one’s savings in the stock market, bonds or property? Governments too strive to invest their tax revenues in productive enterprises that will increase future income – for example, building a new port could make it easier for factories to export their products, enabling them to make more taxable income, thereby increasing the government’s future revenues. Another government might prefer to invest in education, on the grounds that educated people form the basis for the lucrative high-tech industries, which pay lots of taxes without needing extensive port facilities.

Capitalism began as a theory about how the economy functions. It was both descriptive and prescriptive – it offered an account of how money worked and promoted the idea that reinvesting profits in production leads to fast economic growth. But capitalism gradually became far more than just an economic doctrine. It now encompasses an ethic – a set of teachings about how people should behave, educate their children and even think. Its principal tenet is that economic growth is the supreme good, or at least a proxy for the supreme good, because justice, freedom and even happiness all depend on economic growth. Ask a capitalist how to bring justice and political freedom to a place like Zimbabwe or Afghanistan, and you are likely to get a lecture on how economic affluence and a thriving middle class are essential for stable democratic institutions, and about the need therefore to inculcate Afghan tribesmen in the values of free enterprise, thrift and self-reliance.

This new religion has had a decisive influence on the development of modern science, too. Scientific research is usually funded by either governments or private businesses. When capitalist governments and businesses consider investing in a particular scientific project, the first questions are usually, ‘Will this project enable us to increase production and profits? Will it produce economic growth?’ A project that can’t clear these hurdles has little chance of finding a sponsor. No history of modern science can leave capitalism out of the picture.

Conversely, the history of capitalism is unintelligible without taking science into account. Capitalisms belief in perpetual economic growth flies in the face of almost everything we know about the universe. A society of wolves would be extremely foolish to believe that the supply of sheep would keep on growing indefinitely. The human economy has nevertheless managed to grow exponentially throughout the modern era, thanks only to the fact that scientists come up with another discovery or gadget every few years – such as the continent of America, the internal combustion engine, or genetically engineered sheep. Banks and governments print money, but ultimately, it is the scientists who foot the bill.

Over the last few years, banks and governments have been frenziedly printing money. Everybody is terrified that the current economic crisis may stop the growth of the economy. So they are creating trillions of dollars, euros and yen out of thin air, pumping cheap credit into the system, and hoping that the scientists, technicians and engineers will manage to come up with something really big, before the bubble bursts. Everything depends on the people in the labs. New discoveries in fields such as biotechnology and nanotechnology could create entire new industries, whose profits could back the trillions of make-believe money that the banks and governments have created since 2008. If the labs do not fulfil these expectations before the bubble bursts, we are heading towards very rough times.

Columbus Searches for an Investor

Capitalism played a decisive role not only in the rise of modern science, but also in the emergence of European imperialism. And it was European imperialism that created the capitalist credit system in the first place. Of course, credit was not invented in modern Europe. It existed in almost all agricultural societies, and in the early modern period the emergence of European capitalism was closely linked to economic developments in Asia. Remember, too, that until the late eighteenth century, Asia was the world’s economic powerhouse, meaning that Europeans had far less capital at their disposal than the Chinese, Muslims or Indians.

However, in the sociopolitical systems of China, India and the Muslim world, credit played only a secondary role. Merchants and bankers in the markets of Istanbul, Isfahan, Delhi and Beijing may have thought along capitalist lines, but the kings and generals in the palaces and forts tended to despise merchants and mercantile thinking. Most non-European empires of the early modern era were established by great conquerors such as Nurhaci and Nader Shah, or by bureaucratic and military elites as in the Qing and Ottoman empires. Financing wars through taxes and plunder (without making fine distinctions between the two), they owed little to credit systems, and they cared even less about the interests of bankers and investors.

In Europe, on the other hand, kings and generals gradually adopted the mercantile way of thinking, until merchants and bankers became the ruling elite. The European conquest of the world was increasingly financed through credit rather than taxes, and was increasingly directed by capitalists whose main ambition was to receive maximum returns on their investments. The empires built by bankers and merchants in frock coats and top hats defeated the empires built by kings and noblemen in gold clothes and shining armour. The mercantile empires were simply much shrewder in financing their conquests. Nobody wants to pay taxes, but everyone is happy to invest.

In 1484 Christopher Columbus approached the king of Portugal with the proposal that he finance a fleet that would sail westward to find a new trade route to East Asia. Such explorations were a very risky and costly business. A lot of money was needed in order to build ships, buy supplies, and pay sailors and soldiers – and there was no guarantee that the investment would yield a return. The king of Portugal declined.

Like a present-day start-up entrepreneur, Columbus did not give up. He pitched his idea to other potential investors in Italy, France, England, and again in Portugal. Each time he was rejected. He then tried his luck with Ferdinand and Isabella, rulers of newly united Spain. He took on some experienced lobbyists, and with their help he managed to convince Queen Isabella to invest. As every school-child knows, Isabella hit the jackpot. Columbus’ discoveries enabled the Spaniards to conquer America, where they established gold and silver mines as well as sugar and tobacco plantations that enriched the Spanish kings, bankers and merchants beyond their wildest dreams.

A hundred years later, princes and bankers were willing to extend far more credit to Columbus’ successors, and they had more capital at their disposal, thanks to the treasures reaped from America. Equally important, princes and bankers had far more trust in the potential of exploration, and were more willing to part with their money. This was the magic circle of imperial capitalism: credit financed new discoveries; discoveries led to colonies; colonies provided profits; profits built trust; and trust translated into more credit. Nurhaci and Nader Shah ran out of fuel after a few thousand kilometres. Capitalist entrepreneurs only increased their financial momentum from conquest to conquest.

But these expeditions remained chancy affairs, so credit markets nevertheless remained quite cautious. Many expeditions returned to Europe empty-handed, having discovered nothing of value. The English, for instance, wasted a lot of capital in fruitless attempts to discover a north-western passage to Asia through the Arctic. Many other expeditions didn’t return at all. Ships hit icebergs, foundered in tropical storms, or fell victim to pirates. In order to increase the number of potential investors and reduce the risk they incurred, Europeans turned to limited liability joint-stock companies. Instead of a single investor betting all his money on a single rickety ship, the joint-stock company collected money from a large number of investors, each risking only a small portion of his capital. The risks were thereby curtailed, but no cap was placed on the profits. Even a small investment in the right ship could turn you into a millionaire.

Decade by decade, western Europe witnessed the development of a sophisticated financial system that could raise large amounts of credit on short notice and put it at the disposal of private entrepreneurs and governments. This system could finance explorations and conquests far more efficiently than any kingdom or empire. The new-found power of credit can be seen in the bitter struggle between Spain and the Netherlands. In the sixteenth century, Spain was the most powerful state in Europe, holding sway over a vast global empire. It ruled much of Europe, huge chunks of North and South America, the Philippine Islands, and a string of bases along the coasts of Africa and Asia. Every year, fleets heavy with American and Asian treasures returned to the ports of Seville and Cadiz. The Netherlands was a small and windy swamp, devoid of natural resources, a small corner of the king of Spain’s dominions.

In 1568 the Dutch, who were mainly Protestant, revolted against their Catholic Spanish overlord. At first the rebels seemed to play the role of Don Quixote, courageously tilting at invincible windmills. Yet within eighty years the Dutch had not only secured their independence from Spain, but had managed to replace the Spaniards and their Portuguese allies as masters of the ocean highways, build a global Dutch empire, and become the richest state in Europe.

The secret of Dutch success was credit. The Dutch burghers, who had little taste for combat on land, hired mercenary armies to fight the Spanish for them. The Dutch themselves meanwhile took to the sea in ever-larger fleets. Mercenary armies and cannon-brandishing fleets cost a fortune, but the Dutch were able to finance their military expeditions more easily than the mighty Spanish Empire because they secured the trust of the burgeoning European financial system at a time when the Spanish king was carelessly eroding its trust in him. Financiers extended the Dutch enough credit to set up armies and fleets, and these armies and fleets gave the Dutch control of world trade routes, which in turn yielded handsome profits. The profits allowed the Dutch to repay the loans, which strengthened the trust of the financiers. Amsterdam was fast becoming not only one of the most important ports of Europe, but also the continent’s financial Mecca.

How exactly did the Dutch win the trust of the financial system? Firstly, they were sticklers about repaying their loans on time and in full, making the extension of credit less risky for lenders. Secondly, their country’s judicial system enjoyed independence and protected private rights – in particular private property rights. Capital trickles away from dictatorial states that fail to defend private individuals and their property. Instead, it flows into states upholding the rule of law and private property.

Imagine that you are the son of a solid family of German financiers. Your father sees an opportunity to expand the business by opening branches in major European cities. He sends you to Amsterdam and your younger brother to Madrid, giving you each 10,000 gold coins to invest. Your brother lends his start-up capital at interest to the king of Spain, who needs it to raise an army to fight the king of France. You decide to lend yours to a Dutch merchant, who wants to invest in scrubland on the southern end of a desolate island called Manhattan, certain that property values there will skyrocket as the Hudson River turns into a major trade artery. Both loans are to be repaid within a year.

The year passes. The Dutch merchant sells the land he’s bought at a handsome markup and repays your money with the interest he promised. Your father is pleased. But your little brother in Madrid is getting nervous. The war with France ended well for the king of Spain, but he has now embroiled himself in a conflict with the Turks. He needs every penny to finance the new war, and thinks this is far more important than repaying old debts. Your brother sends letters to the palace and asks friends with connections at court to intercede, but to no avail. Not only has your brother not earned the promised interest – he’s lost the principal. Your father is not pleased.

Now, to make matters worse, the king sends a treasury official to your brother to tell him, in no uncertain terms, that he expects to receive another loan of the same size, forthwith. Your brother has no money to lend. He writes home to Dad, trying to persuade him that this time the king will come through. The paterfamilias has a soft spot for his youngest, and agrees with a heavy heart. Another 10,000 gold coins disappear into the Spanish treasury, never to be seen again. Meanwhile in Amsterdam, things are looking bright. You make more and more loans to enterprising Dutch merchants, who repay them promptly and in full. But your luck does not hold indefinitely. One of your usual clients has a hunch that wooden clogs are going to be the next fashion craze in Paris, and asks you for a loan to set up a footwear emporium in the French capital. You lend him the money, but unfortunately the clogs don’t catch on with the French ladies, and the disgruntled merchant refuses to repay the loan.

Your father is furious, and tells both of you it is time to unleash the lawyers. Your brother files suit in Madrid against the Spanish monarch, while you file suit in Amsterdam against the erstwhile wooden-shoe wizard. In Spain, the law courts are subservient to the king – the judges serve at his pleasure and fear punishment if they do not do his will. In the Netherlands, the courts are a separate branch of government, not dependent on the country’s burghers and princes. The court in Madrid throws out your brother’s suit, while the court in Amsterdam finds in your favour and puts a lien on the clog-merchant’s assets to force him to pay up. Your father has learned his lesson. Better to do business with merchants than with kings, and better to do it in Holland than in Madrid.

And your brother’s travails are not over. The king of Spain desperately needs more money to pay his army. He’s sure that your father has cash to spare. So he brings trumped-up treason charges against your brother. If he doesn’t come up with 20,000 gold coins forthwith, he’ll get cast into a dungeon and rot there until he dies.

Your father has had enough. He pays the ransom for his beloved son, but swears never to do business in Spain again. He closes his Madrid branch and relocates your brother to Rotterdam. Two branches in Holland now look like a really good idea. He hears that even Spanish capitalists are smuggling their fortunes out of their country. They, too, realise that if they want to keep their money and use it to gain more wealth, they are better off investing it where the rule of law prevails and where private property is respected – in the Netherlands, for example.

In such ways did the king of Spain squander the trust of investors at the same time that Dutch merchants gained their confidence. And it was the Dutch merchants – not the Dutch state – who built the Dutch Empire. The king of Spain kept on trying to finance and maintain his conquests by raising unpopular taxes from a disgruntled populace. The Dutch merchants financed conquest by getting loans, and increasingly also by selling shares in their companies that entitled their holders to receive a portion of the company’s profits. Cautious investors who would never have given their money to the king of Spain, and who would have thought twice before extending credit to the Dutch government, happily invested fortunes in the Dutch joint-stock companies that were the mainstay of the new empire.

If you thought a company was going to make a big profit but it had already sold all its shares, you could buy some from people who owned them, probably for a higher price than they originally paid. If you bought shares and later discovered that the company was in dire straits, you could try to unload your stock for a lower price. The resulting trade in company shares led to the establishment in most major European cities of stock exchanges, places where the shares of companies were traded.

The most famous Dutch joint-stock company, the Vereenigde Oostindische Compagnie, or VOC for short, was chartered in 1602, just as the Dutch were throwing off Spanish rule and the boom of Spanish artillery could still be heard not far from Amsterdam’s ramparts. VOC used the money it raised from selling shares to build ships, send them to Asia, and bring back Chinese, Indian and Indonesian goods. It also financed military actions taken by company ships against competitors and pirates. Eventually VOC money financed the conquest of Indonesia.

Indonesia is the world’s biggest archipelago. Its thousands upon thousands of islands were ruled in the early seventeenth century by hundreds of kingdoms, principalities, sultanates and tribes. When VOC merchants first arrived in Indonesia in 1603, their aims were strictly commercial. However, in order to secure their commercial interests and maximise the profits of the shareholders, VOC merchants began to fight against local potentates who charged inflated tariffs, as well as against European competitors. VOC armed its merchant ships with cannons; it recruited European, Japanese, Indian and Indonesian mercenaries; and it built forts and conducted full-scale battles and sieges. This enterprise may sound a little strange to us, but in the early modern age it was common for private companies to hire not only soldiers, but also generals and admirals, cannons and ships, and even entire off-the-shelf armies. The international community took this for granted and didn’t raise an eyebrow when a private company established an empire.

Island after island fell to VOC mercenaries and a large part of Indonesia became a VOC colony. VOC ruled Indonesia for close to 200 years. Only in 1800 did the Dutch state assume control of Indonesia, making it a Dutch national colony for the following 150 years. Today some people warn that twenty-first-century corporations are accumulating too much power. Early modern history shows just how far that can go if businesses are allowed to pursue their self-interest unchecked.

While VOC operated in the Indian Ocean, the Dutch West Indies Company, or WIC, plied the Atlantic. In order to control trade on the important Hudson River, WIC built a settlement called New Amsterdam on an island at the river’s mouth. The colony was threatened by Indians and repeatedly attacked by the British, who eventually captured it in 1664. The British changed its name to New York. The remains of the wall built by WIC to defend its colony against Indians and British are today paved over by the world’s most famous street – Wall Street.

As the seventeenth century wound to an end, complacency and costly continental wars caused the Dutch to lose not only New York, but also their place as Europe’s financial and imperial engine. The vacancy was hotly contested by France and Britain. At first France seemed to be in a far stronger position. It was bigger than Britain, richer, more populous, and it possessed a larger and more experienced army. Yet Britain managed to win the trust of the financial system whereas France proved itself unworthy. The behaviour of the French crown was particularly notorious during what was called the Mississippi Bubble, the largest financial crisis of eighteenth-century Europe. That story also begins with an empire-building joint-stock company.

In 1717 the Mississippi Company, chartered in France, set out to colonise the lower Mississippi valley, establishing the city of New Orleans in the process. To finance its ambitious plans, the company, which had good connections at the court of King Louis XV, sold shares on the Paris stock exchange. John Law, the company’s director, was also the governor of the central bank of France. Furthermore, the king had appointed him controller-general of finances, an office roughly equivalent to that of a modern finance minister. In 1717 the lower Mississippi valley offered few attractions besides swamps and alligators, yet the Mississippi Company spread tales of fabulous riches and boundless opportunities. French aristocrats, businessmen and the stolid members of the urban bourgeoisie fell for these fantasies, and Mississippi share prices skyrocketed. Initially, shares were offered at 500 livres apiece. On 1 August 1719, shares traded at 2,750 livres. By 30 August, they were worth 4,100 livres, and on 4 September, they reached 5,000 livres. On 2 December the price of a Mississippi share crossed the threshold of 10,000 livres. Euphoria swept the streets of Paris. People sold all their possessions and took huge loans in order to buy Mississippi shares. Everybody believed they’d discovered the easy way to riches.

A few days later, the panic began. Some speculators realised that the share prices were totally unrealistic and unsustainable. They figured that they had better sell while stock prices were at their peak. As the supply of shares available rose, their price declined. When other investors saw the price going down, they also wanted to get out quick. The stock price plummeted further, setting off an avalanche. In order to stabilise prices, the central bank of France – at the direction of its governor, John Law – bought up Mississippi shares, but it could not do so for ever. Eventually it ran out of money. When this happened, the controller-general of finances, the same John Law, authorised the printing of more money in order to buy additional shares. This placed the entire French financial system inside the bubble. And not even this financial wizardry could save the day. The price of Mississippi shares dropped from 10,000 livres back to 1,000 livres, and then collapsed completely, and the shares lost every sou of their worth. By now, the central bank and the royal treasury owned a huge amount of worthless stock and had no money. The big speculators emerged largely unscathed – they had sold in time. Small investors lost everything, and many committed suicide.

The Mississippi Bubble was one of history’s most spectacular financial crashes. The royal French financial system never recuperated fully from the blow. The way in which the Mississippi Company used its political clout to manipulate share prices and fuel the buying frenzy caused the public to lose faith in the French banking system and in the financial wisdom of the French king. Louis XV found it more and more difficult to raise credit. This became one of the chief reasons that the overseas French Empire fell into British hands. While the British could borrow money easily and at low interest rates, France had difficulties securing loans, and had to pay high interest on them. In order to finance his growing debts, the king of France borrowed more and more money at higher and higher interest rates. Eventually, in the 1780s, Louis XVI, who had ascended to the throne on his grandfather’s death, realised that half his annual budget was tied to servicing the interest on his loans, and that he was heading towards bankruptcy. Reluctantly, in 1789, Louis XVI convened the Estates General, the French parliament that had not met for a century and a half, in order to find a solution to the crisis. Thus began the French Revolution.

While the French overseas empire was crumbling, the British Empire was expanding rapidly. Like the Dutch Empire before it, the British Empire was established and run largely by private joint-stock companies based in the London stock exchange. The first English settlements in North America were established in the early seventeenth century by joint-stock companies such as the London Company, the Plymouth Company, the Dorchester Company and the Massachusetts Company.

The Indian subcontinent too was conquered not by the British state, but by the mercenary army of the British East India Company. This company outperformed even the VOC. From its headquarters in Leadenhall Street, London, it ruled a mighty Indian empire for about a century, maintaining a huge military force of up to 350,000 soldiers, considerably outnumbering the armed forces of the British monarchy. Only in 1858 did the British crown nationalise India along with the company’s private army. Napoleon made fun of the British, calling them a nation of shopkeepers. Yet these shopkeepers defeated Napoleon himself, and their empire was the largest the world has ever seen.

In the Name of Capital

The nationalisation of Indonesia by the Dutch crown (1800) and of India by the British crown (1858) hardly ended the embrace of capitalism and empire. On the contrary, the connection only grew stronger during the nineteenth century. Joint-stock companies no longer needed to establish and govern private colonies – their managers and large shareholders now pulled the strings of power in London, Amsterdam and Paris, and they could count on the state to look after their interests. As Marx and other social critics quipped, Western governments were becoming a capitalist trade union.

The most notorious example of how governments did the bidding of big money was the First Opium War, fought between Britain and China (1840–42). In the first half of the nineteenth century, the British East India Company and sundry British business people made fortunes by exporting drugs, particularly opium, to China. Millions of Chinese became addicts, debilitating the country both economically and socially. In the late 1830s the Chinese government issued a ban on drug trafficking, but British drug merchants simply ignored the law. Chinese authorities began to confiscate and destroy drug cargos. The drug cartels had close connections in Westminster and Downing Street – many MPs and Cabinet ministers in fact held stock in the drug companies – so they pressured the government to take action.

In 1840 Britain duly declared war on China in the name of ‘free trade’. It was a walkover. The overconfident Chinese were no match for Britain’s new wonder weapons – steamboats, heavy artillery, rockets and rapid-fire rifles. Under the subsequent peace treaty, China agreed not to constrain the activities of British drug merchants and to compensate them for damages inflicted by the Chinese police. Furthermore, the British demanded and received control of Hong Kong, which they proceeded to use as a secure base for drug trafficking (Hong Kong remained in British hands until 1997). In the late nineteenth century, about 40 million Chinese, a tenth of the country’s population, were opium addicts.3 Egypt, too, learned to respect the long arm of British capitalism. During the nineteenth century, French and British investors lent huge sums to the rulers of Egypt, first in order to finance the Suez Canal project, and later to fund far less successful enterprises. Egyptian debt swelled, and European creditors increasingly meddled in Egyptian affairs. In 1881 Egyptian nationalists had had enough and rebelled. They declared a unilateral abrogation of all foreign debt. Queen Victoria was not amused. A year later she dispatched her army and navy to the Nile and Egypt remained a British protectorate until after World War Two.

These were hardly the only wars fought in the interests of investors. In fact, war itself could become a commodity, just like opium. In 1821 the Greeks rebelled against the Ottoman Empire. The uprising aroused great sympathy in liberal and romantic circles in Britain – Lord Byron, the poet, even went to Greece to fight alongside the insurgents. But London financiers saw an opportunity as well. They proposed to the rebel leaders the issue of tradable Greek Rebellion Bonds on the London stock exchange. The Greeks would promise to repay the bonds, plus interest, if and when they won their independence. Private investors bought bonds to make a profit, or out of sympathy for the Greek cause, or both. The value of Greek Rebellion Bonds rose and fell on the London stock exchange in tempo with military successes and failures on the battlefields of Hellas. The Turks gradually gained the upper hand. With a rebel defeat imminent, the bondholders faced the prospect of losing their trousers. The bondholders’ interest was the national interest, so the British organised an international fleet that, in 1827, sank the main Ottoman flotilla in the Battle of Navarino. After centuries of subjugation, Greece was finally free. But freedom came with a huge debt that the new country had no way of repaying. The Greek economy was mortgaged to British creditors for decades to come.

The bear hug between capital and politics has had far-reaching implications for the credit market. The amount of credit in an economy is determined not only by purely economic factors such as the discovery of a new oil field or the invention of a new machine, but also by political events such as regime changes or more ambitious foreign policies. After the Battle of Navarino, British capitalists were more willing to invest their money in risky overseas deals. They had seen that if a foreign debtor refused to repay loans, Her Majesty’s army would get their money back.

This is why today a country’s credit rating is far more important to its economic well-being than are its natural resources. Credit ratings indicate the probability that a country will pay its debts. In addition to purely economic data, they take into account political, social and even cultural factors. An oil-rich country cursed with a despotic government, endemic warfare and a corrupt judicial system will usually receive a low credit rating. As a result, it is likely to remain relatively poor since it will not be able to raise the necessary capital to make the most of its oil bounty. A country devoid of natural resources, but which enjoys peace, a fair judicial system and a free government is likely to receive a high credit rating. As such, it may be able to raise enough cheap capital to support a good education system and foster a flourishing high-tech industry.

The Cult of the Free Market

Capital and politics influence each other to such an extent that their relations are hotly debated by economists, politicians and the general public alike. Ardent capitalists tend to argue that capital should be free to influence politics, but politics should not be allowed to influence capital. They argue that when governments interfere in the markets, political interests cause them to make unwise investments that result in slower growth. For example, a government may impose heavy taxation on industrialists and use the money to give lavish unemployment benefits, which are popular with voters. In the view of many business people, it would be far better if the government left the money with them. They would use it, they claim, to open new factories and hire the unemployed.

In this view, the wisest economic policy is to keep politics out of the economy, reduce taxation and government regulation to a minimum, and allow market forces free rein to take their course. Private investors, unencumbered by political considerations, will invest their money where they can get the most profit, so the way to ensure the most economic growth – which will benefit everyone, industrialists and workers – is for the government to do as little as possible. This free-market doctrine is today the most common and influential variant of the capitalist creed. The most enthusiastic advocates of the free market criticise military adventures abroad with as much zeal as welfare programmes at home. They offer governments the same advice that Zen masters offer initiates: just do nothing.

But in its extreme form, belief in the free market is as naïve as belief in Santa Claus. There simply is no such thing as a market free of all political bias. The most important economic resource is trust in the future, and this resource is constantly threatened by thieves and charlatans. Markets by themselves offer no protection against fraud, theft and violence. It is the job of political systems to ensure trust by legislating sanctions against cheats and to establish and support police forces, courts and jails which will enforce the law. When kings fail to do their jobs and regulate the markets properly, it leads to loss of trust, dwindling credit and economic depression. That was the lesson taught by the Mississippi Bubble of 1719, and anyone who forgot it was reminded by the US housing bubble of 2007, and the ensuing credit crunch and recession.

The Capitalist Hell

There is an even more fundamental reason why it’s dangerous to give markets a completely free rein. Adam Smith taught that the shoemaker would use his surplus to employ more assistants. This implies that egoistic greed is beneficial for all, since profits are utilised to expand production and hire more employees.

Yet what happens if the greedy shoemaker increases his profits by paying employees less and increasing their work hours? The standard answer is that the free market would protect the employees. If our shoemaker pays too little and demands too much, the best employees would naturally abandon him and go to work for his competitors. The tyrant shoemaker would find himself left with the worst labourers, or with no labourers at all. He would have to mend his ways or go out of business. His own greed would compel him to treat his employees well.

This sounds bulletproof in theory, but in practice the bullets get through all too easily. In a completely free market, unsupervised by kings and priests, avaricious capitalists can establish monopolies or collude against their workforces. If there is a single corporation controlling all shoe factories in a country, or if all factory owners conspire to reduce wages simultaneously, then the labourers are no longer able to protect themselves by switching jobs.

Even worse, greedy bosses might curtail the workers’ freedom of movement through debt peonage or slavery. At the end of the Middle Ages, slavery was almost unknown in Christian Europe. During the early modern period, the rise of European capitalism went hand in hand with the rise of the Atlantic slave trade. Unrestrained market forces, rather than tyrannical kings or racist ideologues, were responsible for this calamity.

When the Europeans conquered America, they opened gold and silver mines and established sugar, tobacco and cotton plantations. These mines and plantations became the mainstay of American production and export. The sugar plantations were particularly important. In the Middle Ages, sugar was a rare luxury in Europe. It was imported from the Middle East at prohibitive prices and used sparingly as a secret ingredient in delicacies and snake-oil medicines. After large sugar plantations were established in America, ever-increasing amounts of sugar began to reach Europe. The price of sugar dropped and Europe developed an insatiable sweet tooth. Entrepreneurs met this need by producing huge quantities of sweets: cakes, cookies, chocolate, candy, and sweetened beverages such as cocoa, coffee and tea. The annual sugar intake of the average Englishman rose from near zero in the early seventeenth century to around eight kilograms in the early nineteenth century.

However, growing cane and extracting its sugar was a labour-intensive business. Few people wanted to work long hours in malaria-infested sugar fields under a tropical sun. Contract labourers would have produced a commodity too expensive for mass consumption. Sensitive to market forces, and greedy for profits and economic growth, European plantation owners switched to slaves.

From the sixteenth to the nineteenth centuries, about 10 million African slaves were imported to America. About 70 per cent of them worked on the sugar plantations. Labour conditions were abominable. Most slaves lived a short and miserable life, and millions more died during wars waged to capture slaves or during the long voyage from inner Africa to the shores of America. All this so that Europeans could enjoy their sweet tea and candy – and sugar barons could enjoy huge profits.

The slave trade was not controlled by any state or government. It was a purely economic enterprise, organised and financed by the free market according to the laws of supply and demand. Private slave-trading companies sold shares on the Amsterdam, London and Paris stock exchanges. Middle-class Europeans looking for a good investment bought these shares. Relying on this money, the companies bought ships, hired sailors and soldiers, purchased slaves in Africa, and transported them to America. There they sold the slaves to the plantation owners, using the proceeds to purchase plantation products such as sugar, cocoa, coffee, tobacco, cotton and rum. They returned to Europe, sold the sugar and cotton for a good price, and then sailed to Africa to begin another round. The shareholders were very pleased with this arrangement. Throughout the eighteenth century the yield on slave-trade investments was about 6 per cent a year – they were extremely profitable, as any modern consultant would be quick to admit.

This is the fly in the ointment of free-market capitalism. It cannot ensure that profits are gained in a fair way, or distributed in a fair manner. On the contrary, the craving to increase profits and production blinds people to anything that might stand in the way. When growth becomes a supreme good, unrestricted by any other ethical considerations, it can easily lead to catastrophe. Some religions, such as Christianity and Nazism, have killed millions out of burning hatred. Capitalism has killed millions out of cold indifference coupled with greed. The Atlantic slave trade did not stem from racist hatred towards Africans. The individuals who bought the shares, the brokers who sold them, and the managers of the slave-trade companies rarely thought about the Africans. Nor did the owners of the sugar plantations. Many owners lived far from their plantations, and the only information they demanded were neat ledgers of profits and losses.

It is important to remember that the Atlantic slave trade was not a single aberration in an otherwise spotless record. The Great Bengal Famine, discussed in the previous chapter, was caused by a similar dynamic – the British East India Company cared more about its profits than about the lives of 10 million Bengalis. VOC’s military campaigns in Indonesia were financed by upstanding Dutch burghers who loved their children, gave to charity, and enjoyed good music and fine art, but had no regard for the suffering of the inhabitants of Java, Sumatra and Malacca. Countless other crimes and misdemeanours accompanied the growth of the modern economy in other parts of the planet.

The nineteenth century brought no improvement in the ethics of capitalism. The Industrial Revolution that swept through Europe enriched the bankers and capital-owners, but condemned millions of workers to a life of abject poverty. In the European colonies things were even worse. In 1876, King Leopold II of Belgium set up a nongovernmental humanitarian organisation with the declared aim of exploring Central Africa and fighting the slave trade along the Congo River. It was also charged with improving conditions for the inhabitants of the region by building roads, schools and hospitals. In 1885 the European powers agreed to give this organisation control of 2.3 million square kilometres in the Congo basin. This territory, seventy-five times the size of Belgium, was henceforth known as the Congo Free State. Nobody asked the opinion of the territory’s 20–30 million inhabitants.

Within a short time the humanitarian organisation became a business enterprise whose real aim was growth and profit. The schools and hospitals were forgotten, and the Congo basin was instead filled with mines and plantations, run by mostly Belgian officials who ruthlessly exploited the local population. The rubber industry was particularly notorious. Rubber was fast becoming an industrial staple, and rubber export was the Congo’s most important source of income. The African villagers who collected the rubber were required to provide higher and higher quotas. Those who failed to deliver their quota were punished brutally for their ‘laziness’. Their arms were chopped off and occasionally entire villages were massacred. According to the most moderate estimates, between 1885 and 1908 the pursuit of growth and profits cost the lives of 6 million individuals (at least 20 per cent of the Congo’s population). Some estimates reach up to 10 million deaths.4 After 1908, and especially after 1945, capitalist greed was somewhat reined in, not least due to the fear of Communism. Yet inequities are still rampant. The economic pie of 2014 is far larger than the pie of 1500, but it is distributed so unevenly that many African peasants and Indonesian labourers return home after a hard day’s work with less food than did their ancestors 500 years ago. Much like the Agricultural Revolution, so too the growth of the modern economy might turn out to be a colossal fraud. The human species and the global economy may well keep growing, but many more individuals may live in hunger and want.

Capitalism has two answers to this criticism. First, capitalism has created a world that nobody but a capitalist is capable of running. The only serious attempt to manage the world differently – Communism – was so much worse in almost every conceivable way that nobody has the stomach to try again. In 8500 BC one could cry bitter tears over the Agricultural Revolution, but it was too late to give up agriculture. Similarly, we may not like capitalism, but we cannot live without it.

The second answer is that we just need more patience – paradise, the capitalists promise, is right around the corner. True, mistakes have been made, such as the Atlantic slave trade and the exploitation of the European working class. But we have learned our lesson, and if we just wait a little longer and allow the pie to grow a little bigger, everybody will receive a fatter slice. The division of spoils will never be equitable, but there will be enough to satisfy every man, woman and child – even in the Congo.

There are, indeed, some positive signs. At least when we use purely material criteria – such as life expectancy, child mortality and calorie intake – the standard of living of the average human in 2014 is significantly higher than it was in 1914, despite the exponential growth in the number of humans.

Yet can the economic pie grow indefinitely? Every pie requires raw materials and energy. Prophets of doom warn that sooner or later Homo sapiens will exhaust the raw materials and energy of planet Earth. And what will happen then?

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