When you are growing up there are some questions you never think to ask. Hopefully not because an authority figure was resistant to questioning but because you believed the question was already answered. That’s part of the human experience. I view it as a derivative of the peekaboo games I play with my son to teach him the idea of object permanence. Just because we can’t see dad’s face or fully grasp an idea doesn’t mean it’s not there/true. We need stable assumptions before we go out and explore the world.

I used to think stock ownership was one of those stable assumptions. But the more I read and speak with people the less confident I’ve become. It’s not obvious why we should trust our future to a bunch of green or red numbers floating along the bottom of a newscast. So, why do we own stocks?

The short answer is they provide higher return characteristics within acceptable risk tolerances when properly diversified in a portfolio. Some common terms you may hear in a conversation about a diversified portfolio but with no context are efficient frontier, CAPM, beta, and capital allocation line.

But that’s a cop out answer and as far as many people want to go. It’s like referencing the Holy Trinity but not knowing the underlying debate about Arianism (these guys, not these guys). No, we’re going to go back, way back.

We’ll begin our journey with the origins of credit and debt, but mostly debt, the rise of the bond market, and the origins of the public company and why you should own a piece of it

The First Loans

It was a warm day off the banks of the Euphrates some 5,500 years ago. A successful farmer by the name of Gilgamesh Akkad’tat was admiring his surplus of crops and granaries when a metal craft descended from the heavens with fire and fury. Two beings of exceptional stature exited the craft and motioned for Gilgamesh to join them. For an entire day they talked wonders about making use of productive assets and economic growth. Later that night, after the beings had left, Gilgamesh met with his neighbor who was a good farmer but having a rough year. Gilgamesh offered his neighbor some of the excess grain seed that Gilgamesh wasn’t using in return for 8% of his neighbors crops the following season (incredibly, Gilgamesh didn’t ask for a down payment). The neighbor agreed to the terms and the first loan was made. The rest, as they say, is history.

Removing fun from the story, the financial system started by discovering ways to move money/goods from savers to people who need money/goods for production, while providing the saver now lender with a reasonable rate of return. These informal transactions would eventually be formalized in ancient legal systems like the Code of Hammurabi to set guidelines for lenders and debtors. As society became wealthier a more centralized system developed. Savers began depositing their currency and barterable goods in temples where debtors could apply for loans witnessed by government officials who recorded the transactions on clay tablets with interest rate schedules, maturity dates, and contractual terms. The complexity and human ingenuity involved is fascinating. But what I want to hammer home is these loans were moving money from savers to hopefully responsible debtors. The interest rate would be set for the level of risk involved in the loan and that interest rate would be your return on investment. Excluding the possibility of seizing a debtor’s assets for failing to pay off the loan, interest was the only upside of making a loan, and the transaction was over as soon as the debtor paid off the loan.

The First Government Bonds

It took reading Seapower States for me to see the significance of Venice. The pesky Italian state that made my life miserable when playing Medieval II: Total War as a kid. Venice was one of those unique powers that combined the asymmetric advantages of naval and merchant power (think Phoenicians, Athenians, Carthaginians, and later the Dutch and English). Her innovation would lead to the first government backed bonds.

In the 12th century the Republic of Venice was at war and wanted to fund their army the old fashion way: raising taxes. But there was a twist, Venice said she would pay her citizens back after the war. Unsurprisingly the war didn’t end when it was supposed to and our Italian city-state couldn’t pay her citizens back in full. Instead, it was decided the people would receive 6% interest until the principal was paid back. People liked that arrangement so much that new loans or “prestiti” would be raised over the coming centuries.

Venice would eventually decline due to changing trades routes with India, the New World, and conflict with the Ottoman Empire, but her monetary innovations took hold. Governments such as the Dutch and English would issue bonds in the coming centuries to fund their own wars and adventures. However, though these new bonds were backed by the full faith and credit of their respective governments, they were still constrained by the same stipulations of the loans made in ancient Mesopotamia. Interest was the only upside of these bonds. And the transaction was over as soon as the government paid off the bond.  

The First Public Company

Once again Seapower States had to educate me on the greatness of a small European state. The Dutch have a fascinating history of resisting continental Europe’s imperial rulers by harnessing the power of markets. First it was through the issuing of government bonds but then they’d dominate global trade for over a hundred years with the first public joint stock company: The Dutch East India Company or V.O.C.

In the 1600s the European powers were competing for trade in the Far East. To stay in the game the Dutch government sponsored the creation of a single company that was granted a monopoly over trading in Asia. The Dutch East India Company was soon founded by her first 358 shareholders who put up a total of 6,424,588 Dutch guilders as starting capital. People may not have known it at the time, but this would be revolutionary. The public investor could now be an owner instead of just a lender.

The V.O.C. would go on to have diverse revenue streams such as nutmeg, pepper, raiding Portuguese ships, and slavery. The last one being particularly distasteful. However, for the first time a company would be lasting longer than a single voyage. The upside was more than just the return of principal and interest on a single transaction or profits from a single trading journey. The upside could be perpetual with the ongoing return of dividends and the appreciation of stock depending on public sentiment of the future growth prospects of the V.O.C. since shares could be bought and sold on the Amsterdam exchange. This was a game changer the world wouldn’t forget.

The V.O.C. would eventually disappear and some of her intellectual descendants, such as the Mississippi Company, would be disasters. But the public company would become one of the most dominant inventions of the next hundred years. In Part II we’ll review why investing in these public companies is necessary before concluding in Part III with an overview of the tools and concepts developed to make investing palatable to the average investor.

What I’m Reading and Watching

The Ascent of Money: Great book. Inspired this first post in the series.

Nassim Nicholas Taleb on Christianity: I already had Tom Holland’s Dominion on my reading list so this is a good endorsement and excuse to finally get around to reading it.

Erdmann Housing Tracker: “Rising Home Prices Are Mostly From Rising Rents.” I can’t tell if medical care, education, and housing are naturally tough subjects that need to be addressed by public policy or if public policy makes everything it touches more difficult.

MAGA: Make Argentina Great Again. Pro crypto tips for your next trip?

The Glory of Rome is forever