The evolution of money: an outline of six stages
From tradable utilities to a generalized medium of exchange accepted as the final payment, carrying value over time, and used to calculate the equivalence in exchanges… This transition seems logical and unavoidable from the present day perspective, but its historical origin remains disputed. A common explanation projects the present day assessment of the logical necessity of introducing a generalized medium of exchange on the past, which is a dubious procedure. Most scholars propose to consider such approach as ‘conjectural’ explanation. At issue is identifying who might have had an interest in supporting the emerging medium of exchange to assure its persistence through the stages of inevitable rejection or avoidance. People under the exigency of survival would not have resources of time and means of subsistence to engage in transactions with no immediate benefit, thus the basic condition has to be a surplus of goods and the ability to defer the outcome without dire consequences. Beyond that certain kinds of goods must achieve the status of luxuries reserved for the elite in order to be considered rare and valuable. Once these conditions are fulfilled, at issue is the preservation of status quo by the dominant clique who controls access to the surplus. This can only be assured by sharing the valuables with a larger group of warriors. Creating a mercenary force to protect the elite required that the soldiers of fortune were able to actually acquire one, thus they had to participate in the sharing of the spoils of war. But, in the interim period a value without a value had to be created in order to keep the armed men from absconding with their armory. A ‘token’ that had value although it could not be consumed, like a piece of precious metal, could serve this purpose. II.
From nuggets of precious metal to coins…
The payment in ‘tokens’ would have to be accompanied by enforcement of the acceptance by the population, which in turn required official recognition of the value of tokens in circulation manifested by their acceptance in lieu of tributes, i.e. as taxes. Thus, a standing army and taxes were at the origin of the generalized medium – money. The use of tokens with the image of the ruler might suggest protection from violence and create the assurance of acceptability in trade relations, thus coins have become symbols of tyranny that also brought benevolent peace – “king’s peace”. III.
From full-bodied coins to promissory notes confirmed on paper… The history of coins as money stretches from the 7th c. BCE to early 20th c. CE when the coins gave way to paper money and stayed their value only as numismatic items. The leap of faith from auratic pieces of precious metal with an image of the ruler to fiduciary notes took time to happen. The origins of paper obligations with purchasing power reach back to the 13th c. when the growth of commerce prompted the use of notes as a temporary substitute for full-bodied coins. The bills of exchange issued on the basis of goods delivered were subsequently circulated in lieu of payments in coin for two reasons. First, they relieved from the necessity to transport coins that were valuable as such, and second they were used as ruses to avoid prosecution for charging interest on the ground of usury ban. The bills could be denominated in different currencies thus concealing the interest that was de facto charged under the cover of the rate of cambio. Thus, while coins were used to account for value, to store value and to make the final payment, originally during the fairs in Champagne, written promissory notes served as medium of exchange and those who used them functioned as the original financial intermediaries. The amount of notes in circulation was determined by the collateral of commodities that were being traded. Since coins were still the ultimate store of value, their actual physical possession carried the danger of being robbed and consequently there was a benefit to cede the trove to firms that could assure improved safety of deposits. Thus, banks as depository institutions were preceded by bodies with enough political power to assure the safety of the deposits. Italian city-states developed monte – a kind of treasury that guaranteed regular payments in exchange for the deposit. Templars’ banking had the same character. Its fate exemplifies the dependence of the monetary order on politics and the vulnerability of wealth to the impositions of power. The lasting novelty created by monte is the contractual obligation which transcends the mere fact of the possession of value into a sort of guarantee in the future. IV.
From auratic coins to fiat money – bank issued “tokens”… The most decisive turn in the history of money occurred in the mid-16th and early 17th century with the issuance of ‘bank money’. Full-bodied coins were minted under the auspices of a political ruler who had licensed the mint and derived a profit from the seigniorage. Such ‘real’ money served as means of final payment even if notes were accepted as the intermediary means of exchange. The coins were increasingly deposited in banks (the word refers to a mount of coins, like the Italian monte), and were lent at discretion, or under pressure from those with power to exercise credible threat. Initiated in mid 16th century by the Bank of Sweden, the breakthrough took place in 1609 when the Bank of Amsterdam issued tokens in lieu of deposited coins. A token with nominal value replaced full-bodied coins minted by different mints with varying purity of alloys and in various denominations thus relieving the customers from the drudgery of ascertaining the equivalence. When the token bank money gained acceptance and began to circulate it was a small step to issue more of them in order to satisfy the demand for loans, even when they would no longer have the full coverage in full-bodied deposits. The idea was first picked up by the Bank of Hamburg (in 1621) and became a widespread custom. When the Bank of England – created in 1694 – began issuing paper certificates of deposit, the way to their acceptance in lieu of coins was already paved by the use of token bank money. BoE certificates had the additional advantage, or maybe a handicap, that they needed an endorsement by the previous owner on the reverse of the sheet. When the scriveners who conducted the financial matters for the landlords in London were substituted by the country banks, those institutions started issuing their own paper money, which were believed to be backed by the accounts in Bank of England. This manner of banking became widely popular in the United States until the introduction in 1863 of the “greenback” issued by the US Treasury and gradually accepted as the American currency. However, the treasury notes were backed by convertibility into gold, which in 1900 had become the legal monometallic base of currency (to the detriment of silver coins) and thus were considered neither fiat money nor tokens. In fact, convertibility was entirely notional, the greenbacks were fiat money and only their real value purchasing power prevented them from being disregarded as tokens. V.
From tangible paper money to intangible asset money…
Banks operate on a rather disconcerting to a layman notion of “what goes round comes round”. A bank has to accept the money that it issues in payment of interest and re-payment of the principal: in the meantime the “paper” circulates as a means of exchange, that is providing payments and accounting for (economic) value. Since there is no point in borrowing money that will not be accepted in payment, at the starting point of money creation must be a fiduciary relation extended broadly enough to make forsaking barter promising. An account with BoE was enough, apparently, to create trust among the locals in a country bank in England. The Bank had gold in the vaults, after all. It would not be enough, though, for sophisticated financial operators in Great Britain and abroad who knew well that there is not enough gold to cover all “paper” in circulation, and that even gold is not going to do much good when the economy shrinks, and the supply dries up. Bank of England was created to rescue the royal finances by pooling assets to offer the King a loan to be repaid at 8% annually for perpetuity. The Parliament, which might have included some of the King’s new creditors, would vote to authorize such loans in the future. The genius of the arrangement lay in the stipulation that those who had an interest in being repaid, were also able to fix the amount of tax that had to be used to make the payments of interest. This subtle and nuanced balance of interests assured a parallel societal equilibrium that has blessed Britain since. For the purpose of outlining the monetary evolution, it is crucial to notice that the notes of BoE were issued in a certain proportion to full-bodied deposits, but the viability of this procedure depended on the fiscal policy of collecting taxes and spending within budgetary limits. The Bank issued money, which government accepted in payment of taxes, but in the meantime a much larger proportion was used to sustain a vast network of productive social relations. This network was fed with the monetary means of exchange by an intermediary: the banking system. The “original” money, that is the government debt, was stored as the reserve while the ‘real’ money were issued by the banks to those deemed able to produce profits. In due course, the ultimate guarantee was created by the legal decree that established a legal tender: the currency designated by law to be accepted in payment of obligations. Such currency has become a unit of account for calculating the value in exchange as well as of the accumulated assets that could be used in forwarding economic interests. VI.
How money is made…
Minting money out of ingots of precious metal is an intuitively straightforward process that may still have an appeal to those who promote making currency convertible to gold. In comparison, the process of making money within the present monetary system is devilishly complex and seemingly infinite, subject only to the rakish ingenuity of the money men. The main source of confusion is the blurred distinction between money of account and money acceptable as final payment, which extinguishes any further claims between debtor and creditor. While there is no limit to the amount of assets that can be accounted for in monetary units, the amount of money acceptable as the final payment is restricted, at least at any given moment. Money deposited in a bank creates a liability and money loaned constitute banks’ assets. The obligation to return the deposited value is matched by the business of lending it to a prospective payer of interest and principal in installments. Banker’s acumen is located in the ability to entice depositors and select borrowers. A second-order moneymen are the financiers who borrow money in order to deposit them at higher interest rate with each other. People who “make” money, do not make money, but accumulate assets denominated by financial institutions, usually in zero sum games. To “make” money, one has to outwit someone who will lose them. Since depositors do not – as a rule – bring money to banks in order to take them out “next day”, the banks need not keep all deposits ready to be returned on demand. A bank could never simultaneously return the deposits and keep honoring the checks presented by owners of the credit lines. A small portion is held as a reserve and the rest may be loaned at a profit defined by the interest rate. The reserve is originally the “cash” deposited by bank clients, but is not held in this entirely unproductive form: customers (who are the depositors as well as the owners of credit line) write checks rather than withdraw cash in order to pay bills. Checks do not clear instantly giving the bank time to procure needed funds, so in the meantime even the reserve can be put to making a profit. The ultimate guarantor of stability in this system is the Central Bank which steps in with fiat money whenever the situation reaches the tipping point. The banks are always expected to borrow from each other first, although at a rate determined by the CB, in recognition that a bank could only operate in a system of banks which assures the flow of capital. Any time a credit is extended the creditor must consider the debtor a deserving prospect – in cases when money are transferred for different reason, one should not use the term “credit” - if there is a legal obligation to repay, but the borrower is not a prospect, the transfer is simply a “loan”, otherwise it is a “gift”. In this sense loans do not create money, only credits do. A business is a deserving prospect (in essence this is a pleonasm) when it makes a valid promise of bringing profit. Since the amount of money in the economy equals the sum total of credit extended to borrowers, the process is entirely fiduciary – based on the assumption that obligations will be honored. More tangible than clear conscience and reputation incentive to pay back the obligations is created by the relationship between Central Bank and the government. Government collects taxes to discharge its budgetary commitments, and also borrows from individual and corporate bodies to cover the deficit and/or the current needs by selling bills, bonds, and notes. [Venetian and Genoan montes in the 13th c. were the first such arrangements.] Anybody can buy such securities from the Treasury when offered at auction (every few weeks) and then resell to loosen the cash for more opportune investment. Central Bank buys a stipulated amount (determined by a Committee) and pays with its own notes: the dollar bills, and credit lines. If the CB does not buy securities, banks have less money to extend credit lines, if it does buy than it pays in Federal Reserve notes, that is in money (US $$$) which the banks can float further down the line at ever higher interest rate. For example, a mortgagee borrows at 4% the amount that the bank borrowed possibly for as little as 0.25%. When the interest rates are low, the price of the securities is high and vice versa, thus by the logic of the market when the price is low there should be many takers and the price should go up to dampen the demand; when the price is high there should be few takers and the price ought to go down to spur the demand. Consequently, when the interest rates are low (the price is high) there will not be many takers of the securities. For the financial institutions almost any deal will be better than investing in the federal securities. The central bank will sit on its assets while the “banks” do the job of “money-making”, that is ever broader extension of credit for deserving prospects. When the CB keeps buying government securities, then the price is rising, which means the interest rate is dropping: to buy 1 million securities maturing in a year at 1% means delivering $990.00 to the Treasury in order to get $1 million back a year later, i.e. the price of $1 million is $990.00. When the interest rate goes up the price will be less!
A government is a prospect when it is able to collect taxes and control spending. Such government deserves a “bailout” that is a credit line: the Fed buys government securities and thus provides cash to pay for the budgetary spending. Princeton historian Harold James suggested that handling debt can bring political disaster or may become "the strong cement of the union" (Alexander Hamilton). Britain's Glorious Revolution of 1688 was peaceful and wealth-enhancing, while the French Revolution of 1789 was violent and destructive, leaving French society poorer than Britain's for more than a century. In both cases autocratic dynasties were reined in, the decisive difference was how they dealt with debt. Royal government in Britain after 1688 had to submit budgets to a vote in Parliament, which in this manner recognized the liability of the people for the obligations of the government. Those who voted the taxes in Parliament were also holders of debt interested to limit spending on lavish court life and to constrain the scope of military adventures. This arrangement ultimately established the clear axiom that the state would not go bankrupt, in distinction to the private borrowers. In the 18th century France each time the state faced bankruptcy it would impose cuts in interest rates and extension of maturities on the creditors. Financing of the American War of Independence by France created a huge budget hole in 1787, but this did not prevent the government from bailing out investors who had lost money in a speculative share deal. Since tax revenue was way insufficient to afford this intervention, the state confiscated private assets stoking social tensions, while also creating unrealistic expectations of state power among the public. The principle of non-default led to the loss of credibility and triggered the French Revolution. Whereas in Britain the market distinguished between the secure state borrowing and the risky private loans, in France the risks were blurred by the state intervention in the “market”. There is an analogy to the present situation in the euro zone. The German government strives to limit borrowings and spread the risk between itself and private investors in order to sustain governments' credibility. However, the integration was justified by the expected economic benefits to the poorer nations, so the faltering growth exacerbates the conflicts over the distribution of wealth and income between northern and southern Europeans and raises calls for government largesse.
In the 19th c. state licensed banks were issuing a large amount and a great variety of paper money that were accepted, since there was no alternative: there was not enough full-bodied gold dollars, not to mention that those were too valuable to be ‘wasted’ for everyday business needs. [Congress repeatedly authorized circulation of foreign coins…] Nowadays, there seems to be a surfeit of Federal Reserve notes (US $) that makes some anxious to store value denominated in dollars. Strangely, foreign governments do not share the reservations! As computer algorithms make so many tasks easier, they have also been harnessed to the task of making money. Bitcoins and several other algorithmic quasi-currencies compete with each other and with the Federal Reserve for the trust of the (monied) public. The hope that a political process can be supplanted by a computer algorithm belongs to science fiction, which does not mean that this is a fictional expectation.