Liaquat Ahamed - 1873: The Rothschilds, the First Great Depression, and the Making of the Modern World

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0:21Welcome to A Book With Legs podcast. I'm Cole Smead, CEO and Portfolio Manager here at Smead Capital Management. At our firm, we are readers, and we believe in the power of books to help shape informed investors. In this podcast, we speak to great authors about their writings. The late, great Charlie Munger prescribed using multiple mental models and analysis. We analyze their work through the lens of business, markets, and people. Hosting this episode alongside of me is our chairman, our chief investment officer, and my dad, Bill Smead. Dad, thanks for joining me. Thanks for having me. I'm very excited about talking.

0:56This book is wonderful and good to think about right now. Yeah. For the listeners, we love economic history. We can't get enough of it. There's other books that have floated around this, but I think this is a very big picture, great way of looking at multifacets of, like we said, business markets and people. Today, we will look at the first Great Depression, the crisis of 1873 that began in Vienna, spread in New York and Berlin, and this set the stage for two decades of deflation. We will think about what happens when governments blunder into currency policy, when speculation outruns fundamentals about a banking family that built the largest fortune in history by knowing when to say no.

1:38Joining us is Lee Akit Ahmed to discuss his book, 1873, The Rothschilds, The First Great Depression and the Making of the Modern World. A little background for our listeners, if you're not familiar with Lee Akit. he is one of the most respected financial historians I think you can run into. His first book, Lords of Finance, The Bankers Who Broke the World, won the 2010 Pulitzer Prize for History. He graduated with a degree in economics from Cambridge and Harvard, worked at the World Bank in Washington, and spent 25 years as a professional investment manager in London and New York. What a fun job.

2:13He is a trustee of the Putnam Funds, an advisor to the Rock Creek Group, and chair, more interestingly, of the Sun Valley Writers Conference. Liocit, thank you for joining me today and thank you for being us here. Well, thank you for inviting me. Oh, thank you. I always start out this with authors because, you know, I have certain thoughts and usually when they write 10 books, you can kind of get the seeds of this. But what drew you to tell this story? I mean, you know, you got the 1873. We were talking about 1893 also, which was kind of reverberation of this in some respects. What drew you to 1873 particularly and really the Rothschilds?

2:50So, 1873 was the first truly global financial crisis. Yep. And what struck me was no one had written about it. I mean, there have been plenty of books about 1929, but no one had written about 1873. So, that was the motivation. And the challenge in writing economic history is that you don't want it just with facts and figures and charts. And so I was looking around for someone or a group of people to act as sort of the, to carry the story forward for me. And in Lords of Finance, I had four central bankers who did it. And in this time, I was sort of searching, and one name kept on cropping up, Rothschild.

3:54And they were the wealthiest family in the world at the time. They were bankers, so they'd made all their money not building anything. but acting as intermediaries. Sure. And they built it over a 50-year period and made themselves indispensable to governments and corporations around the world. So I decided to use them as the vehicle for carrying the story. It helped that they had lots of fancy houses. They had a very gramless lifestyle. So that added a certain amount of color to the story. Very entertaining people. I was going to say, the word I think of when you say that is panache. It adds a fun panache to your story.

4:52Right, exactly. So let's kick it off. 1869 was the peak. Okay, the golden spike goes in at Promontory Summit. in May of that year. For those of you that don't know where that is, that's right outside of Salt Lake City. Utah, yeah. It was important at the time. It's not important today. Very funny way to think about it. The Suez Canal goes in in November, 3 ,000 European guests, including Empress Eugenie, Franz Josef. And then the last of those three was Indian linking Bombay to Calcutta the same year. What made that single year feel like the start of something new? In other words, there was an atmosphere and a mood about the world.

5:31Well, a French newspaper cottons on to the fact that these three iconic projects have all been completed, and writes an article saying, you know, you can now go across the world in less than 80 days. and a young French adventure novelist, Jules Fern, stumbles across this article. And by the way, the French newspaper even gave an itinerary for what such a journey would look like. And, you know, a light bulb went on in his head and he said, wouldn't that make a great novel? It would. And so in 1873, around the world in 80 days appears. He actually didn't realize that it would make an even greater fill.

6:27But that was to come. Quite a while later. That was to come. So between 1850 and 1873, the global bond market quintupled in size. Saving rates jumped in Britain, Germany, France, and the US. What made ordinary people willing to hand their money to markets they couldn't see? So in the 1840s, there had been, and most of the savings, by the way, were based in Europe, were British, French, German. Sure, sure. And there'd been a giant bear market caused by the collapse of the British railroad bubble and by revolutions across Europe. And that left everyone very – it had the impact of causing people not to want to invest in equity.

7:29Apprehensive, I think, is the word you're looking for. Right. You know, whenever you have these giant crashes, we had it after 29, you know, people become risk averse. But wait, I got to stop you there real quick. I'm 42 years old. Okay. I got in the business right before 08. So I have seen grown adults do that. But I mean, and like that feeling, how foreign is that of an idea to like the last five years? I mean, because I think one of the things is like what we're going to talk about today is elongated moods of that. Not like, cool, I went through it for 60 days. Or by the way, it was a one-year bad market.

8:09Well, I can help you a little bit on that, Cole, because you think about it. The market was lousy from 69 to 82. And then we had a four-year bull market. And then we have the crash of 87. And all the smart guys were out there saying, well, we're going to have a depression now. And they were thinking that same thing that you're just talking about at that point in time. So how do you, other than reading your book, which obviously people should do, how do you think and discuss that with people that have never seen some of this, you know, looking back, say, 10 years? Right. I think the way to think of it is that you have different types of cycles.

8:49Sure. So you have, the market always has ups and downs. Sure. But once in every two generations, you have a drastic change in the sort of mass psychology. Essentially, Galbraith wrote about this. He said, what it takes is a whole generation to disappear from Wall Street to then sort of recoup confidence. Sure. So 1850, you get this crash, and people wouldn't go back into the equity market for another 25, 30 years. Sure. So we're talking about 25, 30-year cycles. Yeah, which is why people were in the debt market to earn interest. Yeah, initially. Right. Yeah. That's why Willie Sutton robbed banks, right?

9:46Because that's where the money was. Right. Yeah. So then Charles McKay publishes his Extraordinary Popular Delusions and Madness of Crowds in 1841. You suggest he may have exaggerated some tales. The book has never gone out of print. Why does that book still hold up so well? Well, because the things that go on are so crazy. Yeah. I mean, you know, the South Sea bubble and the associated bubble in France, those two combined, you had one company worth 150 % of GDP. Sure. We're still not there yet. Sure. Which was the Mississippi. It was the Mississippi bubble there in France. Right. Yeah. Yeah. But it was always good for government in both those cases.

10:36It was a good ploy for government. You know, I never quite understood those bubbles because all they did was issue equity and then buy government securities. Now, why that was going to be a recipe for a giant, you know, making tons of money, I could never compute. Sure. Well, I mean, like today's – to your point on that, like I think of things like QSBS, for example, on venture companies. Like why do we give tax-free gains on venture companies to people that are very – I mean the government is funding it at some level or subsidizing it. So again, these things are weird, but they still exist. Let's go back to 1848 because you kind of started your story with it almost didn't happen, right?

11:25The Rothschilds nearly went under in 1848. Emergency loans from London and Frankfurt, French government bailed out, saved the Paris and Vienna branches, lost I think a quarter of their capital at the time. Yeah, 40%. How does a family recover from an experience like that? I'm sure some people just died and that's one way to recover in the family. But elsewhere, how do you recoup your capital and begin anew? Because this is a trust business that they're dealing in. Yeah. Look, it helped that you got the passing of a new generation. So the people who lost money in 1848, it was the second generation of the Rothschilds.

12:05And over the next five years, in fact, I forget the precise date, but it was in the early 1850s, three of the brothers, there were five brothers, three of them passed away. So that left the bank in the hands of a whole new generation who were the third generation. And they had a – so they managed to sort of, if you like, avoid hunkering down too much. And the next 25 years, they would go from having a bank with capital of$20,$30 million to a bank with$200 million. Sure. So under James Rothschild, as you just mentioned, the bank makes this big move in capital. I think you noted in the book that they were a third of the capital of the entire European banking system.

13:05Right. What's your takeaway for James? What did you understand about diversification that obviously the prior generations where his father hadn't? Yeah, I mean, in the case of James, he was the youngest of the five. So he was actually the second generation. And he was in business with all his nephews and sons. And, you know, what made him such a great risk taker? I, two things. One is, he knew when to say no. And, you know, he turned down some great opportunities. He turned down investing in the US. But he was, he always, you know, knew his the limitations of what he should invest in. Sure. And secondly, the Rothschilds of that generation were very good about plowing back profits into the business.

14:17Sure. They were making a million dollars a year, and they made sure that that million dollars went back into the business. Sure. So that by the 1870s, they were making$5 to$10 million a year. Sure. Yeah. Wow. The Rothschilds owned 107, 148, 147, 142, and 143 Piccadilly, progressively controlling a stretch of London. Same story with Rue Lafitte in Paris. What does the geographic concentration of family wealth tell us about how great fortunes actually get built? Okay. I mean, I'm not sure that concentrating it in Piccadilly and Rue Lafitte was a great idea, but they owned 40 mansions across both mostly in France and Britain.

15:20Sure. And, you know, to give you a sense of what these mansions look like, you've probably seen one of them. Do you watch Downton Abbey? Have you ever watched Downton Abbey? Yeah, well, I was just in London, and I went by one of these addresses there off of Green Park. Right, right. Yeah, but, you know, that giant mansion belonged to the Rothschild daughter. So it was actually one of the smaller mansions. Sure. And I recently did an event in Newport, Rhode Island, which is the home of the U.S. mansions. And we had a long discussion comparing the Vanderbilt mansions with the Rothschilds mansions.

16:06Yeah, when your mom and I went to Newport and toured those mansions, and that wasn't too much before Bill Gates built his$60 million house on Lake Washington in 1999 at the dead flat top. American companies paid 8 % or 9 % to borrow when Europeans paid 5 % to 6%. Travelers were blackballed from London clubs. the country was viewed as a nation of swindlers. How does a country lose that reputation, and how does it come back? Good, interesting. I didn't think that's a novel question. They got into it because there was a boom in the 1840s, a canal boom, sponsored by the states. and the people like the Rothschilds tried to sue the states to get their money back.

17:10And it turned out all of the U.S. states were able to claim sovereign immunity. So you couldn't sue a state in a court. And that is, in fact, what turned off the Rothschilds from ever investing in the U.S. Sure. Which was a giant era, by the way. Well, I think you mentioned that some of the states did end up paying their interest and principal back. But some states like I think Florida just let them go. Yeah. Yeah. Yeah, because it's funny. I was just having this conversation with someone thinking about the pendulum swings. Like it swung for America. Now it's at the antithesis of that. Like we're the most credit worthy we can borrow even though we spend like drunken sailors on leave.

17:55Right. I was having this conversation with Canada and someone said, well, I personally, I think we personally think that at some point the loony will go back to par with the dollar, which sounds crazy to most people in the world. I'm like, yeah, but just look at the political setup. I mean people are – we're down on Canada, including Canadians in the Trudeau era. Well, commodities have been doing well. But again, that's overshadowed the commodity era we're in. So again, you think about these things. It's not single factor. The politics play a role. Economic growth plays a role. Investor perception plays a role.

18:25and that's what we call interest rate theory, for better or worse. And nothing happens forever. Correct. Exactly. Amen. Thank you for reminding me of that. I was beginning to wonder here. So an interesting person in the Rothschild family is August Belmont. I think you said he's 23 in 1837 at the time. He's on a ship to Havana, learns the prior Rothschild agent in New York has gone under. OK, immediately opportunity strikes. He goes to New York and is effectively trading in the name without the blessing. Is that a fair way of putting it? Yeah, yeah, yeah, completely. And actually shocked James the Rothschild.

19:07He said, you know, who's this who's this guy who's who's pretending to be a Rothschild? I don't know whether the rumor was correct, but it was said that he was the illegitimate son of one of the Rothschilds. But he made a great name for himself in New York, built a great fortune. His problem was he had terrible political instincts. So he threw his lot in with the Democrats. Pre-Civil War. just before the Civil War started. Yeah, because I remember James had thought about sending his son out to go take over. And then I think you said they were making so much money in Europe. It's like, oh, well, we'll let it go.

19:56Is this the Belmont racetrack? Yes. Yeah. Oh, yeah. Yeah. He started the whole business of horse racing in the US. Yeah. Hi, I'm Cole Smead, CEO and portfolio manager here at Smead Capital Management. and host of this podcast. If you enjoy this podcast, I'd like to invite you to check out smeadcap.com. At our firm, we are stock market investors. We advise investors who play the long game with a discipline that has proven success over long periods of time. Learn more about our funds at smeadcap.com. Past performance is not indicative of future results. Investing involves risks, including loss of principle.

20:35Please refer to the prospectus for important information about the investment company, including objectives, risks, charges, and expenses. Read and consider it carefully before investing. Smead funds distributed by Smead Funds Distributors, LLC, not affiliated. The other big character of this story from a U.S. perspective is Jay Cook. He raised over a billion for the union war effort. He, you know, we think of like Chase Bank, Sam and Chase. He was present with Sam and Chase and a lot of the Lincoln cabinet were his, I'll call it friends. I wouldn't go as far as maybe cronies, but you could debate that in the book.

21:13His bank has$10 million in capital when the Rothschilds have$150 million. But he's the largest investment bank in America. He's coming out of the Philadelphia set with the Drexels and other people like that at the time. Is he just an American big name or is this more of a big name on a global stage, do you think? He's an American big name. He's, I don't know, a piker in global terms. So he, but, you know, to give it his due, he took the innovation that the Rothschilds had come up with, which is the bond market and making that a major source of funding for both governments and for companies trying to build railroads, and he democratizes it.

22:12so he sells bonds in denominations of a few hundred dollars each and is able to well he democratized investing the way you're reading it and the way you're describing it he was a bit of a Mike Milken in his era yeah I mean that's one way of looking at it I mean, he didn't have a group of insider traders, but what he did was he was more like Merrill Lynch. He had an army of salesmen who would go around investing in union government bonds. Now, this was during the Civil War. He was able to tap into a great deal of patriotic sentiment. He tried to replicate that in the case of the second transcontinental railroad, the Northern Pacific.

23:20Unfortunately, he got caught in a series of problems, which we could talk about, but it It essentially meant that he wasn't able to complete the Northern Pacific and ended up going under. Well, if I remember correctly, and you tell this in your book, but like the Union Pacific was subsidized more heavily. And so they tried to seek out subsidy from, you know, the administration at the time. And I think they just couldn't get it. I mean, that was part of the issue is they had less subsidy, even though they had land granted to them, you know, to obviously create the second transcontinental. Yeah, the timing wasn't great because he was trying to raise it.

24:03And at that time, a giant scandal hit Congress where it was discovered that 20 or 30 congressmen had taken shares in a company called, had been gifted shares in a company called Credit Mobilier, which sounds very French and sophisticated. Perfect for selling to investors. Was essentially the construction company building the Union Pacific, owned by insiders. And they started giving congressmen free shares in order to get these subsidies from Congress. That gets revealed in 1872, and any hope that Jay Cook had of being provided with subsidized finance through Congress died. Yeah. You mentioned you compared what Jay Cook did to Merrill Lynch.

25:09Our big break in our business was getting on Merrill Lynch's financial advisor platform. So Cole and I immediately hit the road, went to Chicago, went to three offices. And after the third meeting, I said, Cole, I said, we might build our business by basically telling them to do what he said to do, which is put branches and buy stocks in U.S. companies because no one wanted to buy stock in early 2012 because they'd gotten beaten up by breaking up the last bubble before that. Alphonse de Rothschild stays in Paris during the four-month Prussian siege while other bankers flee. He sends his family to London and mans the ramparts himself.

25:51What does that say about how he saw the family franchise? You know, he was, I mean, the Franco-Prussian War for the Rothschilds could have been a disaster. Because it was, you know, they had a branch in Frankfurt, so a German branch, a branch in London, and a branch in Paris, and a branch in Vienna. And, you know, it could have caused the whole company to fall apart if they, you know, because they weren't on the same side. But he managed to make a – he – when the Franco-Prussian war – when France lost, they needed to raise – Prussia imposed a fine of a billion dollars, which would be the equivalent of$1.2 trillion today.

26:52And the Bismarck was on their doorstep. I mean, this wasn't like, oh, we're just going to decide. And they went back and forth. You tell the story of their negotiation and they get nowhere on it. So the billion is what the Bismarck wanted. Yeah. There was no consensus on how much this fine, on what reparations should be. Sure. They end up with reparations of a billion dollars. Big question is, how do you pay this billion dollars? Sure. And they, Alphonse de Rothschild, and it's testament to the power and the sort of breadth of the Rothschild network, that they were able to raise that billion dollars in two bond issues in 1871 and 1872.

27:49Sure. You know, this would be like, I mean, you know, our capital markets are much larger now, but it was an incredible achievement. Sure. Well, yeah, because I mean, to your point, I think it was like selling war bonds. It's just the war's over and you have to pay it off. Right. And the ingenuity that you explain in your book was there was two parts to the agreement. They had to pay the billion. But as I'll call it collateral, they had taken the – would be the eastern part of France in effect controlled it. But if they were ahead of schedule on the payments, that would effectively protect them and cover and so they would have to leave.

28:34And so what they did is they financed out them leaving early is the rough math. Is that a fair statement? Yeah, yeah. I mean, no one expected them to pay it off in two years. They thought the Germans would be there for many years, and the French would be paying off this debt over a long period of time. No one had counted on the power of the Rothschilds. Sure. But we see a pretty common thing come out of that. To your point, they raise all this money. Okay. Money in circulation goes up. Very common when you do a bunch of borrowing like that. Prices. What happens is interest rates go from five to three because demand for money causes money to get cheaper.

29:23Isn't that just a very normal liquidity flow when the government chooses to effectively crowd the market in many cases or overspend on the fiscal side? You know, I mean, borrowing a lot of money. So, I mean, I'm not sure that that caused interest rates to go down. They borrowed a lot of money, but two things happened. One is that because of the war, Paris had closed down as a capital market. It was the second most important capital market in the world. So all the activity got concentrated in London. So anyone who had money took it out of France and put it into London. And that created a series of bubbles, because there was just too much money floating around in London.

30:26So it was because of France having to close down. The second effect was that in paying off the Germans, it involved injecting a billion dollars into Germany, which then had an economy of four to five billion dollars. So this would be like injecting, in today's economy, It would be like injecting$6 trillion into our economy in a space of two years. Which, by the way, we've done over the last five years. Just so we're all the same age. We've done more than that, actually. So we did that. We did that in 2020. We've been doing it since 2020. We're seeing the consequences of that. Well, yeah, we agree.

31:19But beyond meat market, we called it. Because what we've done in this case here in the United States today is rather than doing it in a single issuance, we just spread the maturities out. Right, yeah. We got to let the market swallow it. So let's see. So we're going to come back to that because I think the other thing is like, you know, I always think of bond issuance. You know, when you talk about bond issuance, the more maturities you have, the more you can kind of parse out your maturity schedule. Bond investors like that kind of a ladder effect, if you will. And then the more you issue spreads get tighter, right?

31:48That always happens in bond markets. So we'll come back to that in Vienna's case. But I love this quote. Quote, Meyer Carl in Frankfurt writes to his partners about how hard it was to stay disciplined. He said, quote, others have become millionaires and the public laughs at our constant stupidity. Such a good line. Yeah, it's so hard to say no. Correct. It's a timeless truth in many respects. Why is it that the hardest moment for a great investor to hold his ground? Welcome to our life. Okay. This is a support group for my dad, if you can't tell. Right. Yeah. He and I bonded over this. Franz Joseph tears down the Vienna's medieval walls and auctions of land along the Ringstrasse to private investors.