A brief history of finance
The history of the world correlates with the development of financial markets, which successively led to the establishment of cities and eventually the rise of civilization.
We refer to financial markets as a physical or digital platform where securities trading occurs. Financial markets provide a place for investors- persons who have capital but lack business ideas to invest in promising projects that can eventually facilitate a financial return to them. Similarly, financial markets provide people who lack capital but have visionary business ideas as an opportunity to start a business. Eventually, these business ideas turn into successful corporations that contribute to the productivity and welfare of civilization. As Goetzmann argues, finance has not solely been a by-product of the rise of civilizations but has often been the principal contributor.
Many Economic theorists talk about how, during medieval times, access to capital allowed kings and queens to finance wars. These wars were often exorbitant but offered the potential to expand their empires. Historically, finance has also allowed for grandiose ventures, such as the age of exploration, to commence. For instance, Christopher Columbus needed financing to embark on his quest to discover an alternative path to the East Indies, which ultimately led to America’s discovery. Sailing across the high seas was quite excruciating and risky business during those times, and uncertainty prevailed. One needs to remember that the GPS or the Radio did not exist back then, and it could take months or even years for investors to know whether they would get an ROI i.e. whether the ship would return home.
Sea traveling was dangerous, but potentially also profitable. The Netherlands and Great Britain came up with a revolutionizing invention that proved crucial in motivating investors to finance exploration: the modern corporation. In 1600, Great Britain set up its English East India Company, and in 1602, the Netherlands found the Dutch East India Company. Although, it’s under some debate when the founding of these corporations was most likely. They played contributing factors to the Netherlands and Great Britain becoming vital powers of the world in the following centuries- with vast economic and naval warfare resources at their disposal. The corporations allowed for the pooling of investor money, which made sea exploration substantially less risky for any single shareholder and eventually resulted in the Netherlands and Great Britain dominating trade routes across the globe.
Post second world war, the United States has arguably been an economic power globally, and the center of finance focused on capitalistic free markets. It has provided incentives for entrepreneurs to take on tremendous risks associated with starting new companies. It has resulted in many of the largest corporations in the world being American. Think of companies such as Microsoft, Apple, Tesla, and Amazon. These companies all have their origins in a young person with only an idea of a business or product and have later, partly with the aid of financial and capital markets, developed into enormously successful and profitable companies revolutionizing the world in extraordinary ways, what we refer to as modern finance today emerged in the 1950s when Harry Markowitz came up with the portfolio theory, which used mathematics to identify the optimal portfolio.
As Goetzmann points out, portfolio theory — based on the hypothesis of efficient markets, i.e. the hypothesis stating that all relevant information about a company is already reflected in its stock price radically differed from other fundamental approaches deployed for valuing companies. It made the process more scientific and mathematical than ever before. It also created the basis for modern-day index funds; passively managed highly diversified funds with low costs. As we have seen in the past decades, index funds have been almost impossible for professional investors to beat in the long run.
As civilizations developed, so did financial markets. Stock markets have made it possible for an increasing share of the global population to save and invest for the future. An important development in finance in recent centuries has been the globalization of the equity and debt market and the emergence of financial instruments such as mutual funds and exchange-traded funds (ETFs). These instruments have made it possible for investors to own assets in different markets and different countries. That's all for today!
