John Lanchester on Understanding High Finance

You chose these books because they help the layman to understand economics.

Yes - there is a kind of ‘two cultures’ issue between the general literate public and the world of economics. It’s possible, for example, to be a functioning competent, literate, well-educated adult and not know what a bond is. If you listen to people very casually saying, ‘Well, the thing about the interest rate is …’, just those two words - ‘interest rate’ - imply a set of quite complicated linked ideas about the impact on business, the impact on the cost of borrowing, economic growth, employment, house prices, and exchange rates. No one is born knowing that. I think the standard of writing in the world of economics and money is high, but pretty much everything is addressed at people who already ‘speak’ money. It’s very unlike, say, popular science: where the books do walk you through the basics, until the point that you cease being unable to understand, for example, quantum mechanics in the comfort and safety of your own home. There’s a level of discourse about money that’s really interesting, but it does assume you have that competence, and it’s quite striking how few books there are that properly address the general reader. 

Tell me about The Money Game by Adam Smith.

Adam Smith is a pseudonym – he was an extremely successful professional investor called George Goodman, who also wrote a newspaper column. This is a real insider’s account of the way that the money markets and trading works. And the most helpful way of understanding it is as a sort of a game: taken dead seriously, but contentless, in the way that games are. He talks about Keynes’s idea of how investment is intolerably boring to anyone who lacks a gambling trait in their character. It’s very funny, very fluent, very well-written and also a real pro’s view. I don't know why it isn’t famous any more. The first section is called You: Identity, Anxiety, Money, and it’s very good on the way that money touches on things about anxiety. In a way it’s a reassuring book, because it tells you that the ways that the professionals are conflicted and confused actually pretty much exactly mirrors the way that the rest of us are. The professionals have more tools, but they have the same underlying complexities and ambiguities and ambivalences. George Goodman also wrote a very interesting book about counterculture, about transcendental meditation and yoga and so on: he has an unusually wide-ranging mind and set of interests. 

Why did he write this book?

I think he also felt what I was talking about: that there was this sort of gap, that there wasn’t this kind of writing directed at the lay reader and that there should be. It’s so important that people should understand. It’s very obvious now after the blow-up, but this thing goes very deep in terms of how modern society works. There’s also a larger point, I think, which is that democracy implies an informed electorate.

Shall we talk about Liar’s Poker?

The great thing about it is, it’s still a wonderfully entertaining book: an absolutely hilarious, very, very dark, vivid account of how Michael Lewis came out of Princeton and, with basically no qualifications, got a job in the bond trading department of Salmon Brothers. This was in the early 80s, just at the point at which the bond market really started to take off in terms of its size. They had a complete free rein to invent all these new financial products and the Financial Products Division, where Lewis worked, wrote all the CDS, the credit default swaps insurance that ended up taking the system over the edge of a cliff. There really is a direct line in the narrative between them and the great crash, so there’s a real historic interest in the book, as well as anything else. But the big thing about Liar’s Poker is that it’s still one of the very few books that actually describes the psychology of that world from the inside. Lewis actually was one of these guys, and I wouldn’t shy away from using the words genuinely important – it’s genuinely important to hear what they’re thinking and how they’re reacting. Lewis says that it was meant to be a book that completely put people off working in the world of money and made them want to be marine biologists, whereas in fact, as he says now, people just read it as a how-to book. 

Didn’t he realise that it might have that effect?

Well, I think a lot of people who disapprove, or feel they’ve seen through the world of money are very slightly in love with it. There’s something exhilarating about baddies always, and about people who insist on the world as it is rather than on the world as it might be or should be. And the people in these worlds are really like that. There’s something very thrilling about the amorality of it. But, for all that, I think Lewis was also disgusted and had had enough. No doubt he’d always wanted to tell stories, which I think he does superbly well and it got him away from it all.

What is Against the Gods about? 

The package description of it is that it’s a ‘history of risk’ which makes it sound dry, but it’s an absolutely fascinating, for-the-layman account of how humanity mastered risk (in the mathematical sense) and came to understand probability. Bernstein makes the point that, particularly in the Middle Ages, betting on dice was seen as a grievous sin by the church: because God decided everything and chose whether it would come up 6 or 1, so it was a form of blasphemy to do something so frivolous as to play with what God wanted. But what happened was that gamblers got interested in the fact that certain sorts of numbers came up more often, and you had this extraordinary thing of gambling and mathematics walking hand in hand, as people like Fermat and Pascal got interested in how probabilities were created. Effectively, the invention of probability came out of studying dice. Bernstein brilliantly convinces you that it’s a kind of humanist project, it’s an attempt to put into the realm of human understanding things that were once seen as utterly capricious, and probably to do with divine will. Our mathematical understanding of probability and risk is actually saying: ‘No, this is in our domain, we can manage this.’ And that leads through to things like – well, derivatives have a terrible press now, but they’re used, for example, if you’re a farmer when someone gives you a price for your crop for next season, that’s a very important tool in insuring safety and prosperity, and spreading it around, and it’s a way of mastering risk. And then OK, you’ve sold next season’s crop, and then the right to buy that crop is a financial derivative: because it can be sold, traded, and sold on, and its price will fluctuate; even though the coffee is still the coffee, or the corn is still the corn. That’s a really important, genuinely helpful, humanist tool. 

So quite a positive view of derivatives? 

It is a pity, as I say, that they took us over the precipice, but there is a kind of heroic aspect to humanity having worked out how to manage and utilise and exploit risk. The thing that’s really good about Bernstein’s book is that you do get the way in which there’s a tremendous amount of social utility in what humanity’s done with risk and options and derivatives and probability, and also a kind of beauty in the maths of it. I think also it’s easy to forget how extraordinary markets are. There’s a Costcutter down the road and it’s got everything I might want from Parma ham to bleach to Special Brew to thread to today’s FT to Maltesers, and it was markets put them there. I know we’re having a kind of condemnatory moment in general about the operation of the unregulated free market and, in many very specific ways, clearly things went completely wrong, but we mustn’t forget the ways in which markets are extraordinary things and do work.