I recently re-read Peter L. Bernstein’s 1992 book, Capital Ideas, and can recommend it for anyone who wants a history of (a) how economics and finance first began to interact and (b) some of the “good guys” in the history of Wall Street.
As in his later classic, Against the Gods, Bernstein’s work clearly on the side of those individuals (all men, interestingly) who pushed Wall Street away from the “great men” model of oracular investment managers and toward the cold, hard world of quantitative finance that dominates the markets today.
Bernstein begins his story of economics innovation in 1900 with the visionary work of Frenchman Louis Bachelier on the random nature of markets, and he then progresses through the mid-20th Century, finally ending in analyses of the work of Merton, Modigliani, Black, Fama, Scholes, Markowitz, and others. Throughout the book, Bernstein seems to highlight not just the most brilliant thinkers and their work but also those who could have focused their intellect on wealth but did not. Bernstein himself was both an investment manager as well as scholar, but he seems to admire most those who loved the pure problem solving and intellectual challenges posed by financial markets.
Re-reading the book in our Wall Street created, post-Great Recession world, I was struck both by Bernstein’s optimism that in the end Wall Street and the capitalist system it represents are a force for good and the irony that the more rigorous investment theory becomes the more random the markets themselves also become. In other words, the more quantitative analysis that was applied to investment theory in the 20th Century, the clearer it became that beating the market over time was an impossible task for most investors and that over time technology would step-by-step eliminate whatever arbitrage opportunities the market did present from time to time. Bernstein, who died in 2009, pretty much predicted that eventually the computers would get so fast that it would be impossible for the average human investor to keep up, and that is precisely what has happened in today’s wold of high-frequency trading. In today’s Wall Street, information asymmetry edges are measured in milliseconds not days or even hours.
This is a very good book for anyone wants to understand where today’s HFT world was born, and why we are never putting the genie back in the bottle. Lastly, in a time when most of what one reads about Wall Street is negative, it was nice to think back to someone who viewed markets as necessary and good aspects of our society. Bernstein’s own words at the close of Capital Ideas say it best:
If the final product of the efforts of the financial theorists was only an assemblage of abstractions, those abstractions are the essential insights into how people do act and how people should act as they engage in the competitive battle. Mere abstractions cannot tell investors whether to buy or sell — in the end, that secret remains hidden from us — but they can tell us how to manage our affairs so that the uncertainties of human existence do not defeat us.
But there is more. If we join the theorists in their fascination with free markets, we will find that they not only help is to appreciate what we have. They can also help us to make our system better.
This last sentence that is the most relevant of the book, and it’s this thought that all of us engaged in the capitalist system — by force or choice — should take to heart.