Finance as a Bridge: A Metaphor
How can we connect families that save money with entrepreneurs who want to create value for others?
"Ponte Vecchio" by Jo@net is licensed under CC BY 2.0.
I have been a financial journalist for the best part of 30 years now. When I started in the game, way back in the mid-1990s, I was still in the process of moving from old-school socialism to the point where social democrats and liberals can find common ground. As a philosophy graduate and non-fiction geek, I plead guilty to over-thinking the role of financial journalism in society over the course of my career. For many years I have grappled with the question: what is finance for?
The best answer I can come up with is to see finance as a bridge between families that save money and entrepreneurs developing projects that will create value for other people. The bridge in this metaphor is a very specific one. It is the Ponte Vecchio (Old Bridge) in Florence, Italy. There has been a bridge over the Arno river at this point since Roman times. A wooden bridge was built in 1218, but most of it was swept away in 1333. It was rebuilt in 1345. It is the only bridge in Florence to survive World War II.
What makes the Ponte Vecchio a tourist attraction is that a number of buildings and shops have been built on it. This used to be common practice throughout Europe, but is rare today. The bridge used to be dominated by butchers, but a decree in 1565 excluded them from the bridge and handed the buildings on it to goldsmiths and jewellers. The decree is still in effect.
Why is the Ponte Vecchio such a good metaphor for finance? Let’s start with two different banks of a river. On one side, we have families who try to live within their means and save as much money as possible. They want to put their money to work to gain some compound interest. On the other side of the river, we have entrepreneurs with projects that they expect will grow exponentially by creating value for other people. The entrepreneurs will need more capital to successfully execute the project.
In order to get money from hardworking families to ambitious entrepreneurs, we need to build a bridge between both banks of the river. However, there is always a risk of con artists and grifters posing as entrepreneurs in order to steal families’ hard-won savings or thieves mugging them halfway across the bridge. In order to prevent theft, fraud and cons, we need to build some superstructure along the bridge, so that it will end up looking a little like the Ponte Vecchio in Florence.
To facilitate savings, families will need bank accounts. Hard experience shows us that the banks will need to be regulated. Accepting deposits will then allow banks to lend out this money (and more) to other families, as well as to businesses that want to grow, with regulatory oversight on the ratios of deposits to loans. Governments will also need to guarantee bank deposits so that the system works.
Families will also need more sophisticated products to move money from their saving accounts into investment capital. These products can include private pensions or index funds, which will be managed by asset managers. Regulators will need to provide oversight over this area too.
On the other side of the river, let’s imagine an entrepreneur with a project that is fast gaining traction. He or she decides to list on the stock market through an initial public offer (IPO), which offers new shares to asset managers in return for capital to grow the business (primary issuance). The new shares will dilute down existing shareholders, who will end up with a smaller percentage of a bigger company with a better growth trajectory.
In order for the IPO to happen, we will need a well-functioning and regulated stock market, which creates the conditions for liquid investments (being able to easily buy and sell shares). The company that wants to offer new shares will need to be audited, which implies the existence of large accountancy firms, standards to compare different companies and various other laws and regulations, including those facilitating the existence of limited-liability companies. The entrepreneur will need to work with investment banks, law firms and possibly consultancies to make the IPO happen. The entrepreneur’s advisors will need regulations, standards and laws in order to operate successfully.
Looking at the bigger picture, the family, the asset manager, the entrepreneur and the advisors will all need to have a common currency before they can move savings from one side of the river to the other. This implies the existence of a central bank that can use interest rates to manage the ever-present risk of inflation - rising prices can wipe out families’ businesses and discourage entrepreneurs from launching projects.
So, as well as a bridge to link families and entrepreneurs, we will need a fair amount of infrastructure on top of it. We have mentioned banks, regulators, private pensions, asset managers, the stock market, accountancy firms and standards, limited-liability companies, investment banks, law firms, consultancies, governments and a central bank as examples of the infrastructure that can be put on top of the bridge. The independent financial media, where I have spent most of my career, lives here too.
As well as laws, regulations and standards, we need something else to hold everything together. This extra element is best described as social norms. Joseph Henrich, an American professor of human evolutionary biology at Harvard University, has done cutting-edge work that shows that the ability to create and learn social norms should be seen the secret of our species’ success. It allows us to create institutions that are too complicated for any individual to fully understand.
As both Adam Smith and Friedrich Hayek argued long before Erik [Kimbrough, an economist] and me, it’s our automatic norm following - not our self-interest or our cool rational calculation of future consequences - that often makes us do the “right thing” and allows our societies to work. This means that how well a society functions depends on its package of social norms.
In this case, the social norms on one side of the river include working hard, living within your means and saving money, as well as thinking about how to grow your savings for retirement. The social norms on the other side of the river include creating value for others, entrepreneurship and permissionless innovation. The social norms in the middle of the bridge include the need to protect families from financial crime, as well as values like professionalism and avoiding potential conflicts of interest, along with a healthy concern for one’s reputation.
If we accept the metaphor of finance as the Ponte Vecchio, it should be fairly obvious that the bridge between families that save and entrepreneurs who want to create value is the most important part of the setup. The bridge could in theory exist without quite so much superstructure, although it would be less efficient because of the ever-present risk of cons, grifts and fraud. On the other hand, there would be no point whatsoever in building the superstructure on dry land without a bridge.
When the system works as intended, the bridge acts as a feedback loop, sending traffic both ways. Financial institutions help families funnel their savings to companies as capital; and successful companies then pay their employees enough money that they can save some of their salaries and invest in other projects as they plan for their retirement.
Of course, there might be a risk that I am talking my book! I enjoy working as a financial journalist and it pays better than other branches of journalism. Motivated reasoning is real and nobody is immune from it. Are there any natural experiments where we can see what happens when finance is removed from society?
I stumbled on a great example many moons ago when I read Jon Lee Anderson’s masterful biography of Latin American revolutionary Ernesto “Che” Guevara. Did you know the Argentine Marxist was president of the National Bank of Cuba from 1959 to 1961 while also serving as the island’s finance minister? He signalled his distaste at finance by signing the Cuban currency with his nickname, Che, instead of his full name, while also nationalising the banking sector. His experiment to ruin Cuba’s financial sector yielded poor results and the island became dependent on aid from the Soviet Union during the 1960s.
In conclusion to the first half of this essay, finance really does play a role in a well-functioning society, even though it comes with risks as well. These include credit crunches, which can lead to recessions, or excessively complex financial instruments, which can provide cover for fraudsters and bad actors. When both factors combine, as we saw from 2007, it can lead to terrible outcomes for society, particularly in countries like Spain, which have low savings rates.
The first half of this essay might make some of you feel a little queasy. Why? In my metaphor, financiers clearly act as middlemen. Some of them get hideously rich as a result. Economist Thomas Sowell says that middlemen, who seemingly conjure wealth out of thin air, always evoke suspicion and resentment in a way that is different from other wealthy members of society. People who work with their hands are particularly prone to suspicious attitudes to middlemen, something that is particularly true when middlemen are ethnically different from the majority, he argues.
Contrast with crypto
Those of us who have grappled with finance’s role in society often think that much of the crypto world seems to be missing something essential. It is all superstructure, with no bridge beneath it. This point is often made in financial circles, although it is usually hidden underneath jargon, when critics talk about the lack of “use cases.” This is a fancy way of saying that the crypto is good at taking peoples’ savings, but fails to deliver it to entrepreneurs with plans to create value for others.
Crypto prices are also disconnected from the boring fundamentals of finance, which are largely based on projecting cashflows into the future and then comparing different results. Although fear and greed have always driven prices in the short-term, vibes are notable by their absence in the chapters of finance textbooks that deal with how long-term investors should think about pricing assets.
Previous essays on Sharpen Your Axe have discussed how the lack of regulation in the crypto world inevitably leads to widespread fraud; and how the field makes much more sense to those who embrace a conspiratorial mindset than it does to those of us who strive to think critically about conspiracy theories. Cryptocurrencies and tokens are probably best seen as vibes-based pseudo-finance, along with meme stocks.
Having said that, bitcoin is slowly gaining a certain amount of respectability in mainstream financial circles, a trend which has been driving the cryptocurrency’s recent rally. Although the main cryptocurrency lacks real use cases at the moment, its value might not be zero, as its more grumpy critics sometimes claim.
A previous essay described crypto as being an emergent community-based methodology looking for a use case. This is a fancy way of saying that buying crypto can be a little like buying the same lottery ticket as your friends. Spending money on a volatile pseudo-currency might not necessarily be good for society, but who are we to judge how other people choose to spend their money as long as they aren’t actively ripping off suckers?
This modest defence of crypto is probably true up to a point, but if you are interested in getting investing in digital assets, you should do some basic research first. In my opinion, it is worth doing including a previous craze for tulips in the 1630s in the Netherlands in your literature review, as well as seeing how stocks are priced in mainstream finance.It is also worth reading Crytonomicon, a 1999 novel from Neal Stephenson that predicted digital currencies ten years before bitcoin was launched. Please don’t be in a rush to buy financial assets that are unsupported by cashflow as you do the preliminary reading.
The absence of the fundamentals of traditional finance is what makes crypto so exciting for some people. Is one bitcoin worth 80,000 dollars? Or eight dollars? Who knows! The only sensible bet is on volatility. Vibes will change in an unpredictable way; and sometimes lots of people will buy around the same time and sometimes lots of people will sell around the same time. Fun! There is no need to read boring finance books or trouble your brain with old-fashioned cashflow projections if this appeals to you. If the price goes up, you can claim the status of someone who understands finance without having done any of the dull maths homework.
Of course, early entrants to the crypto world, who bought digital assets for next to nothing, have already been able to generate significant wealth as prices have tended to accumulate over the years in a bumpy and volatile way. It is in their interests to protect their newfound status. The best way of doing this is to convince newcomers to buy cryptocurrencies as well, which should in theory keep prices moving upwards, at least on average and over the long term, barring major crashes.
The Financial Times (FT) has reported that crypto lobbyists are building a huge war-chest to fight US politicians who are perceived as having anti-crypto views. Democrat Senator for Massachusetts Elizabeth Warren, who faces an election in November, is likely to feel the brunt of the crypto lobby’s spending. She has called for clearer rules to protect ordinary families from crypto scams. An interesting figure, Warren is well aware of Lord Acton’s famous dictum that power tends to corrupt. This is as true in the corporate and financial world as it is in politics.
Warren is also likely to face strong opposition from tech billionaires. The best way to become a billionaire is to create value for others, as we have discussed before. Unfortunately, though, once a billionaire has successfully built a dominant tech platform, it is perfectly possible for founders to start taking decisions that serve his or her own narrow interests more than those of the platform’s users, as we mentioned in our recent essay on new social network Bluesky.
Writer Cory Doctorow famously describes the conflict of interest at the heart of successful tech projects as “platform decay,” or more colourfully as “enshittification.” As well as seeking to prevent crypto scams, Senator Warren also sees vigorous anti-trust rules as a way of fighting platform decay.
Sadly, though, the defenders of Big Tech and those who want newcomers to keep buying cryptocurrencies to maintain their own wealth will always be prepared to dig deep into their pockets to pay lobbyists to protect their interests. Those of us on the other side are more likely to write articles like this one than we are to give Warren tens of millions of dollars to fight back against her many opponents.
ESG changes access to capital
Finally, I would like to return to the question at the beginning of this essay: what is finance for? Another slightly different answer is possible. Do you remember how the rulers of Florence in the 16th century banned butchers from the Ponte Vecchio and encouraged goldsmiths and jewellers to set up shop instead? Something similar has been happening in finance in the last few years.
Climate change is real. However, the environmental movement is split in two, as previously discussed on this blog. The more pragmatic side has found allies in finance, who are promoting environmental, social and governance (ESG) issues as a key concern when it comes to allocating capital to projects.
ESG proponents want cleaner projects to gain easier access to finance, like the suppliers of expensive metals, diamonds and precious and semi-precious stones who gained access to Florence’s goldsmiths and jewellers when they took over the Ponte Vecchio after 1565. Meanwhile, dirtier industries could suffer the fate of the farmers who used to sell meat to the butchers who dominated the bridge before that date and found themselves excluded from a prime location.
The idea that finance can be used to green the economy has received much hostility from members of the hard right, who think that businesses only need to make profits for shareholders. Conspiracy theories about “the Great Reset,” billionaires George Soros and Bill Gates, and Agenda 2030 do much of the heavy lifting for the people who want to strip finance of any transcendental meaning on a warming planet. Many dirtier industries will also lobby against politicians who support green finance.
If you want to dig deeper into any of this material, you can see plenty of reading matter below, including previous articles on Sharpen Your Axe and a link to Henrich’s excellent book on social norms. You will also find a link to an excellent book by the recently deceased Nobel laureate Daniel Kahneman on why we find intuitive hunches based on vibes much easier to handle than detailed calculations (for example, cashflow projections and pricing multiples). May he rest in peace! The comments are open. See you next week!
Previously on Sharpen Your Axe
Double-loop learning is the core of reflective practice
My journey from the left to the centre
The difference between socialism and social democracy
Compound interest and Franklin’s lesson
Exponential growth and the innovation society
Con artists and grifters
Chesterton’s fence helps us appreciate hard-to-understand institutions
Article on the impact of “la crisis” on Spain
Thinking critically about conspiracy theories
Is crypto an emergent community-based methodology looking for a use case?
A literature review is a basic part of research
The great divide in the environmental movement
Do businesses just need to make profits?
Great Reset, Gates, Soros and Agenda 2030
Further Reading (Articles and Tweets)
FT article on crypto lobbyists [behind a paywall]
Senator Warren on protecting consumers from crypto scams
Wikipedia entry on enshittification
Article on ESG and access to capital
Further Reading (Books)
Che Guevara: A Revolutionary Life by Jon Lee Anderson
The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit by Aswath Damodaran
Tulipomania: The Story of the World’s Most Coveted Flower and the Passions It Aroused by Mike Dash
The Secret of Our Success: How Culture Is Driving Human Evolution, Domesticating Our Species, and Making Us Smarter by Joseph Henrich
Thinking, Fast and Slow by Daniel Kahneman
Cryptonomicon by Neal Stephenson
Are Jews Generic? by Thomas Sowell (available in Black Rednecks & White Liberals)
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