Liaquat Ahamed on the Railroad Bubble That Crashed the World | #642

[MUSIC] >> Welcome to a special series of the Meb Fabres show on the past, present, future of America. I'm sitting down with some of the most notable historians, thinkers, investors in the US financial history. All tied to my new coffee table book, Investing in America, the rise of a 250 year bull market out to live for us. Meb Fabres, the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria's funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management for its affiliates. For more information, visit Cambriainvestments.com. [MUSIC] >> Welcome back everybody. Today we have an awesome episode. I'm so excited. Today's guest is Leachet Ahmed, the Pulitzer Prize winning author, Lords of Finance, everyone's favorite book. One of the great financial history books ever written. He's out with a new book, 1873, The Rothschilds, The First Great Depression in the Making of the Modern World. It's a prequel in many ways to Lords of Finance, the story of the world's first truly global financial crisis. Leachet, welcome to the show. >> Thank you, Meb. Your first book, most investors had kind of heard about the Great Depression, not as many people that lived through it, still kicking around today. But I feel like that one's steered in the brain. 1873, less probably named familiarity with it. What was in you mentioned? This is kind of one of the first truly global crisis. Talk to us about why the story, why now? >> 1873 was truly a global financial crisis. It affected central Europe, it affected the US, and it affected what were then emerging markets. It had so much resonance with the modern era because of these multiple financial crises. >> Before we get into 1873, which was spent a lot of time on, I thought it would be interesting to lay the foundation because before the crash, and this is true, in many cases, in over history, there was a boom. If you look at the GDP, the four main economies, I think they almost doubled, world trade grew like fivefold, really in this period leading up to kind of 1873. But also, I don't know many people that have heard about that boom. Maybe talk to us a little bit about what came before, why it's overlooked, and what was the hot AI text-docs of the mid-19th century. >> Well, first of all, it was the first era of globalization. So, as you said, well-trade expanded fivefold, went up two and a half times as a percentage of GDP. So, it was truly the first global boom. And it was driven by massive capital flows coming out of Britain and France, which went into developing infrastructure around the world. And it was infrastructure included ports, but most importantly was railroads. And there was a railroad boom in the US, there was a railroad boom in Europe. There was even a railroad boom in places like Argentina. So, it was the first era in which a single factor, the railroads and a single source, global capital was driving the economy. Was part of that because telegraph helped enable the communication, or is that kind of ancillary? That helped, but it really was that in Europe, a new class of savers emerged. And these were upper-middle-class people whose parents had been entrepreneurs in the early part of the 19th century and had built substantial savings. And one of the consequences of the savings was that real interest rates in Europe declined dramatically. So, if you bought a government bond in a British government bond, a guilt, you would only earn 3%. If you bought a French government bond, you would only earn 4%. And savers started looking around for attractive investments. And they had had their fingers badly burnt by investing in equities in the middle of the 19th century. The bear market in equities from 1845, let's say, until the 1850 was the deepest bear market that they'd experienced. And it caused them to shun equities. So, this was a boom built on bond investments and built by investors in bonds. And that's why the Rothschilds figure in the title, because the masters of the universe in that era were the Rothschilds. They had essentially invented the global bond market in the early part of the 19th century and dominated it. After 1850, they and the bearings accounted for 70% of global bondists here and so as underwriters. So, that's sort of the makings of the boom. You have a quote I want to read because I loved it so much. And if you didn't tell people what it was talking about, you say, well, maybe that couldn't be talking about today. When you start to talk about the boom time in Vienna and real estate in Germany and you start, there's all these companies, hundreds and hundreds of companies that were floating on the German stock market. The quote from a journalist says, "Everyone flew into the flame, the shrewd capitalist and the inexperienced petty bourgeois, the general and the waiter, the woman of the world, the poor piano teacher and the market woman, a shower of gold rain down on the drunken city." I mean, this is a long time ago and here we are. Like, you could be talking about, yeah, I feel like you could be talking about today. Talked us a little bit at that time. What was going on? How is everyone getting caught up on this? Unformer stayed bond investors. They're just getting hot and bothered. What was happening? I was writing about the last stages of the boom. And as you know, most booms start very rationally. And then in the last stages, they become something of a mania. And the boom transformed after 1870 for the last three years, transformed into a mania. And the heart of the mania, or one of the hearts that were actually three hearts to the mania, the heart of it was in Germany because in 1870, you had the Franco-Prussian war and France declared war on Germany and then proceeded to lose the war. Germany imposed a fine reparations of a billion dollars. And now to translate sums from that era, multiply by a thousand. So a billion dollars would be a trillion dollars today. And a lot of money, the Rothschilds raised it in two bond issues and then proceeded to inject it into the German economy in two years. Now the German economy was four to five billion dollars in size, injecting a billion dollars in two years, essentially 20% of GDP into the economy, caused a massive stock market bubble. So it was too much foreign investment coming in too quickly. And most of the money went to German states who paid off their debts. So they retired all their government bonds. And the savers who held German government bonds were left with cash. The question was what to do with this cash. And so for the first time, the state burger from Hamburg sort of looked around and said, where should I put my money? And they for the first time in their lives put it into the stock market. And everyone, the guys from Hamburg, the guys from Munich, the middle class investors from Berlin all gravitated to the stock market. And you got a lot of charlatans who realized that there was this massive inflow of money coming into stocks. And so they started forming new companies. And you got, I'm going to get the pronunciation wrong. But you got the Gründer's site, which is stands for the Founders era. And everyone, it was essentially a massive two to three set of IPOs across Germany. And it covered mostly banks, railroads, but all sorts of companies. It truly was the first IPO bubble. I'm a little like the dot com bubble of the 1990s. I'm bubble the 90s of fun time. We all get that. I loved it. I had a great time. It is until it isn't. And you know, the funny thing is particularly as we're, you know, having this amazing run the past 17 years since the GFC, everyone always thinks they can be the one to kind of step aside before the party ends. They can leave the party early, but nobody ever wants to. That's the problem. It feels like an accelerant and fun and right before it ends. Although the smartest people like Jay, you know, JP Morgan, they once asked him, what's the secret to your success? And he said, selling too early. Yeah. That's good advice. Nothing good happens to 2 a.m. y'all. So, you know, as we're leading up to these kind of crazy times, the book is so much fun because we haven't even gotten into it yet, but it's a book of people. It's weaved in the history of the time, but you know, there's a lot of big characters in this book. And the one thing that I think particularly for the young people today that have only existed in a world of kind of fiat currencies, the economic system was very different back then. Maybe tell us a little bit about silver, gold, how kind of currencies worked and created all sorts of both challenges and problems and benefits versus what we have today. The world's banking system, which was essentially based in Europe, I mean, Europe dominated European economy was more than three times the size of the US economy. So Europe was the center of the world. The US was essentially an emerging market. The banking system was built on the foundation that banks had to hold precious metals in order to issue bank notes. And they were all required, certainly the central banks, but most of the even private banks all held a certain percentage of the bank notes they issued in the form of precious metals. What is less well recognized is that the precious metals consisted of both gold and silver. In fact, most of Europe, most of central Europe was built around silver, because of the silver mines of Bohemia and Czechia. A third of the world was based on silver. A third of the world, which is the Britain, Portugal, a couple of other countries were built on gold. And two countries in particular, their banking system was based on a combination. And that was the US and France. And I'll talk a little bit about the US in a minute, but France was to many people surprised. The essential linchpin of the global financial system. It held the largest stock of precious metals in the world, both gold and silver. The bank, the France, acted as a balancing wheel. So that when lots of silver was mined, it absorbed the silver and issued currency based on gold. And when lots of gold was mined, it shifted its focus to silver. And behind the bank, the France stood the Rothschilds, by the way. In this period, the US had the Civil War. And in 1860, the US left abandoned any link with precious metal. So we had a floating currency, a bit like today, the greenback. So from 1860 to 1865, the US had a floating currency. And as a consequence, inflation took off the price level doubled. And in 1865, after when the Civil War was over and the Union at one, the Union government said, we are going to go back to the gold standard. And the question was, how quickly? Should you do it in a few years, should you take 10 years? And initially, they tried to do it very quickly and caused a giant recession in 65 and 66. So at that point, they slowed down and said, look, let's take our time about it. We still want to restore the dollar as a serious currency linked to precious metals, but we're going to do it over a 10-year period. And so they set themselves a target that by 1879, the dollar would be back on gold and silver. Except they forgot silver. It was almost an error of a mission, although there was a belief that there was so much gold in the world that the world would dispense with silver and just power the world economy on the basis of gold because the mass of gold discoveries in California and elsewhere. So this system is got some pros and cons back then. And one of the challenges, of course, is just good old supply and demand. And back in the 19th century, used to have bouts of not just inflation, but also deflation, which we don't see that much, or at least haven't maybe the past 50 years, maybe some disinflation. But talk to us a little bit about this situation, the big blunder, what happened. And yeah, so 1873, we get these booms. And they all culminate in a giant financial crisis. So the first to go is the stock market bubble in central Europe, in Germany and Vienna, bursts. And the major stocks go down 50% in a day. It was quite a surreal scene because the emperor's daughter was getting married at the same time. So you had this surreal scene of the all of the royal families of Europe have all collected in Vienna and were dancing to Strauss balls and had grand dinner parties every night. And meanwhile, just down the road, the stock market was crashing. It was the first era when people who'd lost money supposedly committed suicide, although in Vienna, what it seems to have happened is they pretended to commit suicide by folding their clothes on the side of the canal, throwing themselves in the canal, throwing to the other side and disappearing so that their creditors couldn't find them. A lot of the speculation was on margin. And so that's one of the reasons they all had to try and escape their creditors. But so the stock market crashes. Initially, everyone says this is going to have major repercussions around the world. And then nothing else happens. So everyone says, okay, this was just a one off Vienna got overpriced. We're going to be fine. And then you get a second crash in September. And that is on the New York Stock Exchange. And this one is not as so much a stock market crash as a series of major defaults by railroad companies. And in particular, J. Cook and company, which was the premier investment bank in the country, J. Cook had helped the union government raise $2 billion during the Civil War. Was a friend of the president, was the most well connected investment banker in the world. He suddenly declares in September that he has run out of money and is unable to finance the railroad that he's sponsoring. At that point, everyone says, you know, if J. Cook can't raise money, and in part, he couldn't raise money because Europe was in financial turmoil. And the world was about a third of the capital that had gone into U.S. railroads had been European capital. You get a giant set of defaults on the railroads. And it was a little bit like 2008 here. In the same way that when Lehman went under, it had a massive psychological effect. And suddenly, everyone said, well, if Lehman can't finance itself, maybe Citibank can't, maybe Bank of America can't. So we got a domino effect across railroad companies by the end of the year, a third of the railroad companies had stopped paying interest. Within five years, half the railroad companies had stopped paying interest in the U.S. And then there was the final shoot to fall, which is that during the early 1870s, a lot of countries had raised capital on the London Stock Exchange. And among them were countries like Egypt and Turkey, collectively, Egypt and Turkey had borrowed one and a half billion dollars, which was roughly the same as the U.S. railroads. And the idea that Egypt and Turkey were going to promise a sort of future that the U.S. railroads were going to promise is sort of laughable now, but they managed to raise the capital, they defaulted on their bonds. So you got the sequence of bubbles and excess bond investments hitting at the same time. Now, in a financial crisis, when you get a sort of sequence, you get a scramble for the safe asset. And the safe asset in those days was gold, or it could have been silver. Everyone gravitates towards precious metals. But in 1873, after the Franco-Prussian War, Bismarck, having defeated France on the battlefield, decided to hit it again in its financial system. And he does this by selling all his silver and moving it into gold. And it causes silver prices to collapse, hurting himself, but hurting France even more. And you get this collapse in silver prices. Every country in Europe decides to abandon silver as the basis for its banking system. And you get a domino effect. In a financial crisis, if everyone's, if everyone's, you get a scramble for precious metals, but if silver's collapsing, all of this scramble gets concentrated on gold. And so you get this giant shortage of the safe asset. And that causes a massive tightening of credit. So in '73, prices, wholesale prices for by 30% by the end of the year. And that is the beginning of a 20-year deflation in prices. I feel like people today, like that concept of deflation, it feels very foreign. Maybe talk to us a little bit about it. Economists, you talk to different ones. Some deflation is scarier than inflation in many ways. And some, that's the opposite. But this one lasted a while. And potentially, had some ramifications, not just for economics, but geopolitics and development, societal forces gravitating all around the world as well. Absolutely. So inflation is too much money chasing goods. Deflation is very simply too little money chasing goods. Everyone hates inflation because suddenly everything's more expensive. And people actually have not experienced deflation, but people hate deflation as much. Because suddenly, you're goods are cheaper, but your debts start accumulating. And what you borrowed acts like this giant millstone on your back. So the people who like deflation are people who earn financial assets. And the people who hate deflation are people who've got mortgages, farmers, households who borrowed money. If you went to Japan after the crash in 1990, you borrowed money to buy a house. 30 years later, your house was worth half the price. But your mortgage remained. And you were still paying off that mortgage. It's been a giant millstone around the Japanese economy. And deflation is terrible for people who want to invest. Because suddenly, with these massive debts around their neck, they are not able to summon the resources to invest. And that's one of the big reasons why Japan had a sort of three lost decades. So people actually love stable prices. They hate inflation, but they hate deflation. The other problem and the country most affected by deflation was the US, although every country was, because it actually split the country politically in half. It had just been through this civil war, which had split the north from the south because of race. Now it faced a split between the west and the east based on economics. Because farmers were all in the west, bankers were all in the east. And it split the Republican Party, it split the Democratic Party. And you got this fragmentation of political parties. And as a consequence, you got sort of political stalemate for 20 years. It's interesting as you kind of look back on times like this. And we have the benefit of time, where we can kind of walk forward and say, oh, you know, this looks similar to this, that and the other, the 1920s and 30s, 1970s, 90s, too, that on and on. We look at today. Do you see any things that like kind of feel a little similar? I mean, obviously we got a ton of these big tech companies spend on a ton of money. And we've had a kind of amazing time, particularly in the US, less so XUS on the stock markets for the past nearly 20 years now. But any other lines that you see that might be interesting. I think back on 2008, because I'm not sure when this tech bubble burst, where it leads us. But we have an example that is directly in front of us. And the most people have experienced. Now in 2008, you get a massive housing crash. People were left with mortgages that they could not afford. The banking system looks as if it's about to collapse. The Obama administration and Tim Geidner and Ben Benanke bail out the banks. And that was exactly the right thing to do. The problem was they didn't bail out the homeowners. And it caused a massive outcry between people who owed money and the people who were bailed out. And it fragmented the Democratic Party. You got the rise of on the left to Bernie Sanders and the left wing. And on the right, you got the Tea Party. And you got a whole series of people saying this financial system does not work for me. It works for the insiders and the people who can get bailed out. And we got a similar populist movement after 1873. That after 1873 with prices falling for 20 years, you got a whole lot of people say, look, this system does not work for us. And it is very fertile ground for conspiracy theories. Everyone looks for someone to blame. Because they say, you know, this is not the way it's supposed to work. So in Europe, people blame the Jews. And people who'd lost money in the stock market crash of the 1850s and Germany and Vienna. I mean, it's not a coincidence that we got a revival of anti-semitism in Europe. And it was a different form of anti-semitism before then. It had been religious. This time it was economic. In the US, you got a strange form of conspiracy theory, which is that all the farmers and people out west started blaming the British, British bankers and said, look, you know, which is the one country that has benefited the most from being on gold. We don't have enough adequate credit because we abandoned silver. And it's British bankers who were to blame. So you got this strange phenomenon that there were these conspiracy theories that these very respectable British bankers had come over with a hundred thousand dollars in their pocket and bride members of Congress to abandon silver. It became known as the crime of '73. Unfortunately, it also, it morphed into a darker way because they then looked around the world and said, who's the most prominent British banker in the world? And they latched onto the Rothschilds. Do I remember correctly that there wasn't as much of a Rothschild presence in the US, right, as mostly Europe? There was no Rothschild presence in the US. The Rothschilds had tried to, I thought about establishing a branch in the US in the 1840s, had lost a ton of money in the canal boom had been outraged that because the canal boom had been sponsored by states, had been outraged that the states claimed sovereign immunity so that you couldn't file suit against states and thought this is a crazy system. So we're gonna have nothing to do with the US. In fact, you know, part of the reason is they were so wealthy and they were doing so well in Europe that they saw no reason to abandon these wonderful palaces they had and moved to a country which was still an emerging market. So their representative was a guy by the name of August Belmont who was rumored to be an illegitimate son of a Rothschild. But you know, I don't think there was anything to that rumour but he established himself and he became a very prominent US financier. So the Rothschilds had never been a factor in the US. They, you know, everyone knew that they were very rich but they had never really figured in the US consciousness and towards the 1880s people started saying, you know, it's the British bankers and it's the Rothschilds who have been behind this and that the money that was used to bribe congressman was supplied by the Rothschilds all bogus stories. I mean, there was no truth to it, any of it. But that's the first signs of the populist movement becoming somewhat anti-Semitic. I think you even said anti-Semitism as a phrase was kind of developed at this point. It was developed by a German, Wilhelm Ma in 1879 and he wrote a pamphlet about anti-Semitism. He used it as a term of approbation but it was a good thing that we can't let this alien race infiltrate our financial system. The ironic thing about Wilhelm Ma was that he was married four times, three of which were to Jewish women. So I don't know whether that says something about the state of his marital affairs or to give him his due, he did recad in later life and so I made a giant mistake and he was essentially an opportunist. It's always interesting, like if you look back to Lord's of Finance, now that you did this huge deep diet on this period, is anything with Lord's of Finance like did it change any of the prism which you saw that or looked at it or kind of how you looked at the 20th century period as well or not so much? Yes, the moral of 1873 was that we had a giant boom and bust. But the economy was surprisingly resilient and what really caused the bust to turn into the first great depression was this giant monetary mistake of abandoning silver and going onto the gold standard. The moral of Lord's of Finance was staying on the gold standard when the circumstances had changed was the giant error after the First World War and that caused a shortage of money which then made it almost impossible to deal with the crash and the economic problems that came from that. So there's a sort of through line here. Now the world doesn't depend on gold and silver anymore so it's hard to say that well, going back to the gold, you know, abandoning the gold standard is a relevant factor that's just not affected today. What is a factor is that in a financial crisis, the authorities face a giant dilemma because in a financial crisis, everyone wants safe assets. The supplier of safe assets is the government or the central bank. On the other hand, if in the years leading to the financial crisis, the government or the central bank has been profligate and has allowed inflation to take off, it faces a giant dilemma. Does it try to deal with the inflation problem or does it try to deal with the giant sort of scramble for liquidity? And it's damned if it doesn't, it damned if it doesn't. And, you know, frankly, in the US in the year era after the Civil War, I mean, I have some sympathy for President Grant. He was trying to restore the US to the gold standard, which meant keeping money tight on the other hand, he was hit by the financial crisis, which meant loosening money. And, you know, he was faced with a bill in Congress, which was dubbed the inflation bill, which would have delayed the return to gold and allowed him to expand the supply of greenbacks. And he was damned if he did and damned if he didn't. And so he stayed with tight money, split the Republican Party, caused 20 years of deflation, but the US went back to gold and it became a respectable currency. So you face this tradeoff between the exigencies of the short run and the long run sort of objectives in currency management. And I think, you know, I would not like to be in Chairman Walsh's shoes if we get a stock market stumble. There's so many cross currents between AI, potential unemployment and potential inflation with the high risk a potential supply. I mean, there's just so many things that the modern currency world has really only existed 50 something years. And it feels like an eternity for all of us who've lived it 'cause that's all we've known. But the reality is for a long time before that, it wasn't the way that it set up. Let's say you get a phone call from Washington DC, could be Treasury, it could be the Oval Office and they say Leachock it, heard you on MEP show, awesome podcast, so we read your books, we read some of the work used to do prior to these books. Give us some good ideas. What would you tell us? Policy ideas, thoughts that might make our government and society a little more stable or a little, what do you got for us? What would you say? Well, luckily I have caller ID and I could put it in a way missing. You know, I'm an item right into the English thing. So I haven't the fainters. I mean, I really do think, I mean, the challenge today is not so much the debt problem. It's the stock market. The US stock market is now $80 trillion in a GDP of 30 trillion. That is more than 250% of GDP. We've never been here. In 2000, we got up to, I don't know, we briefly got up to, you know, maybe 120% of GDP. Everyone has said since that, look, the economies managed to go through 2000 quite easily and there was not much of a wealth effect. The problem is stocks are now more than two and a half times as large in the economy. And more people owns equities than ever before. The rise of 401Ks, I mean, I look at my kids' generation, my kids are in their early 40s and they have, all of their 401Ks are in equities and they seem no reason to own a bond. So there is much wider participation in the stock market than we've ever had. And people have developed a taste for speculation, witness speculative bubbles that we've had in meme stocks and crypto and gold. So everyone's looking for something that's gonna go up 10 times. - Leachocket, this has been a blessing I've loved getting the chance to hang out with you today. Listeners, check out his books, 1873, also "Lord's of Finance" which by the way, is only 18 hours on the audible. So if you don't wanna read it, you can just spend not even one day, you can crank it out in a day or if you do what I do and listen to two times speed. That's a pleasant bike ride in the afternoon. Don't be, don't be daunted. It's a really fun story. Leachocket.com. Thanks so much for joining us today. - Great, thank you, Mib. This has been a lot of fun. Podcast listeners, we'll post show notes to today's conversation at mebfavor.com/podcast. If you love the show, if you hate it, shoot us feedback at the mebfavor Show.com. We love to read the reviews. 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