Under Funny Money, We’re All Living In Vegas

“True investing is not the same as gambling” said Isabella Kaminska in the Financial Times recently. Yet in today’s world, I’m damned if I can spot the difference. Bonds are a one-way bet to losses, the stock market is at levels it should not have reached until 2075, London real estate is at levels it should never have reached at all, and only crypto-currencies appear to offer sound long-term value. Whatever the differences were between investing and gambling, they have disappeared. That reality has unpleasant implications for our future.

Traditionally, investment involved securing a relatively assured and steady income, together with some prospect of capital gain. The wealthy held the bulk of their net worth in farmland, the crops or rent on which fluctuated from year to year, but as population and wealth increased, could be expected to follow a gently upward trend in value. There were risks of income declining or even of a loss in an atypical year but provided the landowner kept some liquidity, these risks could be made up in subsequent years. The big risks, of a war that erupted locally or of a famine that devastated population, were ones one could neither hedge against nor wanted to gamble with.

Starting around 1700, two additional types of investment came along at opposite ends of the risk spectrum. At one end, innovations such as the Bank of England made government bonds truly risk free, enabling people to put their money where there was no risk of income fluctuation and no risk of default. Incomes could decline as bonds were refinanced at lower rates, but that risk was alleviated by the marvelous invention of 3% Consols in 1751.

Through Sampson Gideon’s invention, people could lend to the government at a 5% running yield in wartime by buying Consols at 60% of par. That gave them an investment that was almost completely safe from being refinanced at a lower interest rate, since when peace returned the bonds would simply return to par (they were eventually refinanced at 2½%, but not until 1888 – 137 years is a decent run, and ample for us mere mortals.)

Sophisticated investors and financiers made nice capital gains on the recoveries in Consols prices after major wars, especially that after 1815, but for the ordinary retail investor Consols provided an investment that was less risky than land, had zero management costs, and gave a yield that did not fluctuate, unlike land which depended on harvests and the solvency of tenants.

Ordinary investors quickly demanded government bonds, but they mostly rejected the other major investment innovation of the early 18th century, corporate equities. The South Sea Bubble of 1720 allowed sharp traders like Gideon to make their first fortunes and lucky ministers like Sir Robert Walpole to increase theirs, but it horrified the investing public to the extent that the Bubble Act of 1720 was immediately passed to prevent the incorporation of any new companies except by Royal charter. An immense literature of vilification was produced around the Bubble, asserting that stock investment was pure gambling, with the Exchange consisting of disreputable stock jobbers rather than the better established and better-connected people who ran the West End gaming clubs.