Economic determinists are wrong to argue that battles are fought for money. Armed conflict creates the demand for finance

One of the hoariest of myths is that it is mainly the love of money that makes the world go round.

The older form of the thesis was the Marxist one that wars were due to rivalry for markets or investment outlets. There are more modern theories coming from the opposite political camp. One example is the belief that economic growth can be relied on to promote democracy. A trivial version is the belief of so many politicians that elections are won or lost by the state of the economy - by which they mean the short term behaviour of indicators like unemployment, real incomes or inflation.

A more highbrow version promulgated by the historian Paul Kennedy in his book The Rise and Fall of the Great Powers is that economic growth is the key to international power, but that too much diversion of resources to military commitments ones can lead to overstretch and thereby prove self-defeating.

Another historian, Niall Ferguson, has performed a service by debunking these beliefs in a new book. (*The Cash Nexus: Money and Power in the Modern World, 1700-2000 Penguin £20) He almost prefers the contrary theory that war is the father of all things, including financial innovation and even parliamentary democracy. "Almost." For like most historians he believes that the world is far too complex for any simple theory of war, economic growth or any other event.

His book originated in a research project, begun during a sabbatical at the Bank of England, on the history of the international bond market. Such a study involves looking at bond yields, which determine the interest rate at which governments are able to borrow. Ferguson does well to nail some moralistic fables. For instance a high government debt to national income ratio does not necessarily raise bond yields, so long as there is confidence that the debt can be serviced. He finds that the key determinants in normal times are such factors as expected inflation and expected economic growth.

But times are not always normal. These hard-boiled considerations can, and often are, overwhelmed by fears of default, whether outright or forced deferments or conversions. Even in the relatively tranquil 45 years before World War One, there were rumours of war, revolutions or political instability. Such alarms are too frequent to be regarded as mere occasional shocks; and they can overwhelm ordinary economic forces.

Earlier on, in the 18th century, French governments had to borrow at much higher rates than British governments even though they ruled over a wealthier country. The proximate cause of high French borrowing rates was that French monarchs often defaulted or resorted to inflation to debase the value of their debts. British Governments had less need to resort to such stratagems. They had a superior administrative machine for collecting taxes. In addition they could borrow from a much better organised bond market - thanks to various innovations, including the founding of the Bank of England, initially not to run the currency but to borrow for the government.

At times Professor Ferguson seems on the verge of saying "It's the bond market, stupid". Of course, many innovations, deriving from the needs of wartime finance, were a great help in developing peacetime capital markets without which modern economic growth would scarcely have been possible.

Yet it is possible to take this line of argument too far. Human beings have a knack of turning to advantage devices thrown up by history. If European monarchs had had the wit not to expend their resources in warfare, the development of capital markets might have come about differently; but it is difficult to believe that they would not have occurred at all. And one financial problem I cannot take seriously is the threat of a Government bond famine if the US Administration repays a lot of its national debt - not that we are likely to see this happen as Republicans and Democrats race each other to spend the fiscal surplus.

There is an analogy here with those who see in warfare the source of the most important technological innovations, such as radar or the peaceful uses of atomic energy. Against this I would argue that Europe would have been far richer if it had remained at peace; and that the real driving force was the growth of modern science - Newton's Principia was hardly a product of wartime needs.

It has to be admitted that Ferguson's arguments sometimes get lost in a welter of detail. I do not think I am alone in finding it difficult to follow lengthy enumerations of facts and figures in prose form. The author is at his most successful in conveying his empirical material in those chapters where he makes greatest use of charts and tables. Something can be learned from Peter Jay's Road to Riches where each chapter starts with an "Epitome"(summary) and then goes on to a "Narrative." The Cash Nexus would have been better if the main part had been shorter and more openly argumentative and the mass of facts and figures thrown up by the author's researches put in appendices or special sections.

Nevertheless, the great merit of the book is that it poses far wider questions than would have been asked by a conventional economist. Not that Professor Ferguson rejects mainstream econometrics. He is if any thing too respectful of it. He even cites one study which claims that inflation is only harmful to growth at above 40 per cent and, at eight per cent, may even be helpful. Any Western government that acted on this finding would be committing suicide.

He also takes too seriously "generational accounting", which is an attempt to work out what present tax and benefit policies imply for the burden on future generations. Yet we knew about European pension problems on the basis of simple projections of benefit entitlements well before this technique came into vogue. The main conclusion is that, in the face of demographic trends, some countries - above all Finland, Portugal and Italy - are going to have great problems in financing the pensions their governments have promised. But the snag in generational accounting is the assumption of unchanged policies. It would only take moderate future increases in taxes, and statutory retirement ages linked to life expectancy, to bring these accounts into balance.

Professor Ferguson uses these pension problems as debating ammunition against his bete noire, European Monetary Union. There are many reasons why the project may founder, but I doubt if the future pensions burden of Portugal - or even Germany - is one of them. Under EU rules, countries are responsible for tackling their own fiscal burdens and there is no realistic way in which they will be able to offload them onto others.

Ferguson's other main point against Emu is that a single currency requires a European government. I have been accustomed to dismiss this argument by reference to the pre-1914 gold standard, which worked as a de facto single currency without any international regulation whatever. But the over-zealous interpretation by Commission bureaucrats of the Growth and Stability Pact to censure the two members of the European Union with the soundest fiscal positions, namely Ireland and the UK - together with the mean-spirited support of its position by euro finance ministers - make me hesitate. Indeed if there was one day in which the British euro referendum was decisively lost - if it is ever held - was last Monday when these events occurred in Brussels.

In conclusion Ferguson moves onto more interesting ground in his theory of "under-stretch". He looks at a world full of rogue states and genocidal regimes. In deliberate contrast to Kennedy, he considers that this world can only be made safe if the US and its allies are prepared to restore defence budgets which have shrunk so much since the end of the Cold War. I wonder. In the Kosovo conflict which the West only won - if it did win - by luck and bluff, it was not the lack of military spending but the refusal to risk a single American casualty which handicapped the campaign.

Yet any temptation I might have to preach to the Americans about this refusal is limited by a further thought going back to the 19th century English statesman, Richard Cobden who was impressed with "how little knowledge we enter upon the task of regulating the concerns of other people". If I had to choose between a greater commitment to humanitarian intervention and a serious effort to ban arms sales to dubious regimes, I would choose the latter.

* The Cash Nexus: Money and Power in the Modern World, 1700-2000 Penguin £20