A Brief History of Money: Value, Trust and Power Over the Ages - Part 2
In part 1, we discussed how money was created as a solution to the shortcomings of Barter, and how it evolved from Barley to Metal over time.
In part 2, we’ll delve into the next stages: Coins and Bills.
To recapitulate, our dimensions of analysis will be:
- Where does money’s true value reside?
- How does value respond to the passage of time?
- Which kind of trust does it need to function?
- Who holds power over the system?
Metal was highly convenient but had one shortcoming: weighing it for each transaction. So, why not pre-weight equal amounts and mark them? Those are coins. The first one was created under King Alyattes of Lydia (now Turkey) in 640 BCE. Later, under his son, Croesus, Lydians learned to separate metal ore, so they minted the first separate silver and gold coins. With coins came two new advantages: neither weighing nor assaying were necessary anymore, as the King’s imprint on the coin guaranteed them.
Interestingly, parallel to the Lydians, the Chinese developed coins from base metals. They had a hole for stringing and were issued by the state.
The concept spread rapidly. Eventually the Romans minted their denarius under the emperor’s stamp, who was so powerful that the coin was accepted almost anywhere in the known world. Adoption was helped by the fact that the issuing kings then demanded taxes be paid in coins, making them essential. Eventually, gold and silver coins would become the quintessential money around the world. Today, coins are no longer made of gold or silver, but the fact that they are still around is testament to their convenience for small transactions.
About our Dimensions of Analysis:
- Where does value reside? Being weighted metal, they have intrinsic cultural value.
- How does value respond to time? Similar to weighted metal, with the extra step of minting for supply creation. Coins are impervious to decay, appreciation, and depreciation, but not to inflation/deflation. If the influx of metal is greater than economic growth, inflation will ensue. If it’s smaller, value will deflate. Colonial Spain poses a great example of inflation. After the conquest and plunder of the Aztec and Inca Empires, the influx of gold and silver to Spain was so overwhelming that it led to the “Price Revolution”, a 150-year-long inflationary period!
- Which trust does it require? Systemic trust gains dominance. While you could still weigh the coin yourself, in practice content and quantity were guaranteed by the imprint, which was a systemic validation.
- Who holds power? Minting, as an institutionally controlled activity, increased centralization drastically. To be part of the monetary system, you had to inevitably rely on an institution.
Coins are great, but metal is heavy in large amounts, so transporting many coins was problematic. Luckily, there’s something lighter: paper. Invented by the Chinese, it was only a matter of time before they realized its potential as money. The breakthrough came under the Song Dynasty in 1000 CE, when metal-redeemable banknotes were issued. Though venetian explorer Marco Polo saw the Chinese system by the late 13th century, Europe took longer to implement the concept. In 1661, the Stockholm Bank of Sweden issued the first banknotes, redeemable for copper and silver. By 1694, the newly-opened Bank of England emitted its own.
Interestingly, private banks issued their own banknotes freely, which sometimes led to chaos, like the “Free Banking Era” (1837-63) in the US. 18 states gave freedom to banks, so by 1860 there were 1600 banks, each with around 6 different banknotes. Clearly, this led to transactional complexity and rampant falsification. The National Banking Act of 1863 ended this by establishing federal guidelines for banking and giving banknote printing exclusivity to the Bureau of Engraving and Printing, which printed standardized banknotes when requested by banks.
Over time, gold triumphed as the backing metal, and by 1870 many advanced industrial countries had adopted the “Gold Standard” (1900 for the US). Basically, nations defined an official price for gold with a fixed value of their currency. Then, most countries centralized the emission of banknotes under federal reserves or central banks (1913 Federal Reserve Act in the US).
In 1944, the Allies held the Bretton Woods Conference. They discussed an ongoing problem: countries had been unilaterally devaluing their currencies to boost exports, which slowed the global economy. So, the Bretton Woods System came into effect when WWII ended. Under it, the dollar was fixed at $35/ounce of gold, and all other currencies were backed by it. This established the dollar as an international standard of exchange and extended the Gold Standard to essentially every country. Though this brought a period of stability, by 1971 the US suffered a balance of payments deficit that eventually led to a collapse of the system. By 1972, a system of floating exchange rates, determined by market forces, was established.
About our Dimensions of Analysis:
- Where does value reside? Value wasn’t in the note, but in the redeemable gold, which in turn has intrinsic value. Hence, banknote value is intrinsic-backed extrinsic.
- How does value respond to time? Well-kept paper isn’t vulnerable to decay, appreciation, or depreciation. But paper money is vulnerable to deflation, and even more to inflation. While coins require mining metal, paper requires just trees and a printer. This creates the often-exploited possibility of arbitrary money printing to cover short-term payments. Supply of money could increase explosively due to the whims of military autocrats or populist politicians, resulting in inflation. E.g.: The Song Dynasty is speculated to have printed money carelessly, leading to great inflation, and eventually its downfall.
- Which trust does it require? Systemic trust. As banknotes have no intrinsic value, you have no way of evaluating the value of the instrument given by a counterparty by yourself. Guarantees come from the imprints on the note promising that a bank has redeemable gold safely stored.
- Who holds power? It depends. In periods such as the Era of Free Banks, it was relatively decentralized among tens or hundreds of banks within a country. This is more decentralized than king-issued coins, but still more centralized than other previous stages. On other periods, there were heavily centralized institutions with issuing exclusivity, like the Song Dynasty and the FED after 1913. During the Bretton Woods period, centralization reached an immense level, as essentially every banknote in existence was dollar-backed.
Reserve-backed bills are no more, in their place stands our current system: Fiat. It has reined strong for nearly 5 decades, but a contender may have appeared. In part 3 we will explore the present, and possible future, of money.