Money Monday: A Quick History Of BondsOctober 22nd, 2012 by Aaron Koo
I wrote a little about them a while ago and realized that there was much more left to say. When I was a chef, I always encouraged my cooks to read history books. There was no better way to understand French cuisine than by understanding the French Revolution, which gave birth–for the most part–to what we know today as French food. Thus, I feel to really understand money and finance, it’s imperative to understand where it all came from.
Tribal Leaders Had It Rough
It’s a few thousand years in the past. You’re the leader of a tribe. You don’t have the farmland and the Walmarts like your technologically advanced descendants. How do you keep your village going? You’ve been at the top, and there’s no way you’re giving up the fame, power, and women. As far as survival goes, there really isn’t much room for what we would consider by today’s standards as the sensible values of “violence is never the answer”. It really came down to wiping out your neighbor’s village and taking what they had to survive.
Why Would Anyone Put Their Neck Out For You?
Sure. You got money and you got power, which ultimately lead to women. But why would the young strong men of your village risk their lives for you? So as a tribal leader, you’ve got to bite the bullet and pay someone enough money to risk dying. And if you’re wondering how much that is, it’s not cheap. Just ask anyone that’s served in the armed forces.
Even with the promise of money, it’s still tough to convince people to fight. In the 1400s, Italy was at war with itself. The provinces of Italy were fought for almost a century. People around this time were thinking to themselves that they didn’t really feel like dying for someone they’ve never met before. So, it came down to hiring mercenaries who made the vast majority of the fighting forces. Don’t mercenaries cost money? You bet they do! How do you pay for mercenaries year after year?
Bonds… Government Bonds
Around this time provincial officials had a great idea: “Let’s get money from our citizens.” If they could get enough money, they could win the war. If they won the war, they could pillage and take whatever they wanted. If they could pillage and take whatever they wanted, they could not only pay back the people that lent them the money, but also earn a bit on top since, let’s face it, no one’s going to put their money in harm’s way without getting something in return. And thus you have a bond. Essentially an IOU, bonds truly had a massive role in the way our world is today.
So What Does All This Mean For You?
While Pisa was issuing bonds, so was Florence. The ability to pay back the bonds relied soley on winning the war. If it was a war between two sides, there’s essentially a 50% chance you’ll get your money and a 50% chance you’re going to be taken over. One of the many reasons this is important to know is that while famed for being secure, bonds never were and never will be guaranteed. Just have a look at what is happening in Europe. Bonds are defaulting everywhere. They may have a higher likelihood of paying out than shares in a stock, but all that means for most investors is that the event of a default is only going to catch them off guard even more so.
The performance of bonds has much to do with the health of an economy and the buying strength behind the dollar that’s issuing it. As all monetary currencies around the world inflate and eventually collapse, where does that leave the bond market? It’s an interesting question and a great story… But that’s for another post.
Filed under Money.