A brief history of money

The following is an extract from the unpublished book:

Peoplons, Charmons and the Strange One: the uncertain science of economics

by C. S. Adams, Illustrated by Cohenbaum.

Tokens of exchange:

In the economist’s book of myths and legends, money was invented to solve the “double coincidence-of-wants” problem in a pair-wise economic exchange. Paul the baker wants a beer, but Mary the brewer already has a loaf of bread. Instead Paul gives Mary some gold coins or tokens which are exchangeable for something else later on. Problem solved.

The key property of a coin is not its intrinsic value – over time, gold was replaced by cheaper metals or pieces of paper. The key property is that the token is likely to be accepted as a unit of exchange for subsequent transactions. As Adam Smith writes in the Wealth of Nations, Book I, Chapter 4, Of the origin and use of money:

 … every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in a such a manner as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.

Smith goes on to explain why metals are a convenient substance for this exchangeable commodity:

Metals can not only be kept with as little loss as any other commodity, scarce anything being less perishable that they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be reunited again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation.

Although metals are a ‘convenient’ representation of the unit of exchange they are not necessary. In fact, it makes no sense to limit economic activity to the availability of a particular metal whose supply is limited. The double-coincidence-of-wants problem could just as easily be solved using any accepted token (see e.g. David Graeber‘s brilliant Debt: the first five thousand years). In the medieval era, when Paul the baker is served a beer and does not have anything to offer in exchange, he signed Mary’s book of accounts, or made a mark on a tally stick. After the beer is brewed and consumed, all that remains is a mark on a stick which records who made the beer and who drank it – a collective memory of credit and debt. The stick is split in two – a stock and a foil – such that both Paul and Mary have matching records. As they are a record of a debt, they acquire a value and may be accepted in exchange by a third party if everyone believes that one day Paul will pay. At the end of the year, Paul and Mary and everyone else tally up their stocks. By storing information about an unbalanced exchange, the tally sticks – something readily available with no prior value – become valuable, they become money.

A sculptural tribute to the historical significant of tally sticks can be found on the gates of the UK National Archive in Kew, near London. The tally stick model illustrates how money functions as information about an unbalanced pair-wise exchange where a good only went one way.  Money is simply a collective memory recording the fact that the balance of the origin pair-wise remains to be restored – it is a collective memory of a credit-debt relationship. Although this simple model can function at the level of a village where everyone knows Paul, scaling up to a whole country requires some additional structure. Fiat money is the modern equivalent of tally sticks – based on computers rather than pieces of wood and with an extra layer of institutional organisation. But just like tally sticks, fiat money has no intrinsic value – it’s utility is based on belief.

From tally sticks to Sovereign money:

At various points in history, the Sovereign took a particular interest in money in order to further their goals such as the conquest of new lands.

With assistance from the smartest guys in the room, the Sovereign concocted a money circuit to finance overseas adventures. In its simplest form the story goes like this: First, the Sovereign mints metal coins – Sovereign money – with the King or Queens head embossed on one side. This Sovereign money is used to pay soldiers that participate in the military campaign. In return for protecting citizens from foreign invaders, the Sovereign demands a tax to be paid in Sovereign money. The soldiers are the key link in the circuit. Someone in the family or community has to go and fight to ensure that the community has enough Sovereign money – effectively a tax credit – to pay the Sovereign’s man. When a soldier returns from war and offers a Sovereign coin in exchange for Mary’s beer or Paul’s bread they are more than pleased to accept, knowing that one day the tax man will call.

The invention of Sovereign money – the government’s spend and tax circuit – sold itself on the basis of security. It is not that different today. For the Sovereign’s spend and tax circuit to work, it needs to be carefully controlled –  alternative circuits break the loop and could undermine the value of Sovereign money. To function effectively there needs to be monopoly control of the money system. Although, the Sovereign’s Exchequer initially accepted payment in the form of tally sticks this creates complications – if taxes are paid in tally sticks there is no incentive to join the army and the primary money circuit is undermined. Their use was eventually banned in 1826. As part of Pitt the Younger‘s reforms of the money system, the office of the Exchequer was abolished on October 10th, 1834. Six days later government officials, decided to burn their stock of tally sticks and set fire to the Houses of Parliament. This event is recorded in two paintings by Joseph Mallord William Turner (London 1775–London 1851) that epitomise the Turner style. If you happen to be in Cleveland or Philadelphia you can see the originals.

From gold to fiat:

Throughout history there was a feeling that money should be linked to something substantial and durable, for example, a precious metal. At various times, a gold exchange standard was adopted and then abandoned.* After the second world war, the Bretton Woods system pegged most major currencies to the dollar which in turn was exchangeable for a particular quantity of gold – 35 US dollars per ounce. The gold standard locks national economies to a fixed exchange rate which can become too restrictive as their economic paths diverge. The gold standard was temporarily suspended by Nixon in 1971 and collapsed completely in 1973. Over the longer term it makes no sense to link the quantity of money to the quantity of any particular metal, or to tie different economies to a fixed exchange rate. After 1973, all money became fiat (let it be) money, whose value is based on confidence alone. Modern fiat money is like tally sticks except now the state has monopoly control over the creation of new money.

There is no particular evidence that either commodity money or fiat money has a particularly strong influence on trend growth, however, the switch from a gold standard to fiat money is fundamental, and part of the turmoil of the 1970s was a coming to terms with this. In the post Bretton Wood era, there is nothing to limit money creation apart from maintaining confidence in the unit of exchange – the belief that money is as ‘good as gold’. Even though the world changed dramatically in 1973, the perception of money remained the same, and at the microscopic level nothing appeared to change. Both gold and ‘let it be’ money only have the value we believe them to have, but whereas we cannot create unlimited amounts of gold we could create unlimited amounts of fiat money. To prevent this happening all money is created in the form of  debt, such that the amount of money is linked to future activity. However, a debt-based system of money is also not without problems but that’s another story.

*  For a history of the gold standard era between 1919 and 1937, see End of an Epoch: Britain’s Withdrawal from the Gold Standard, Michael Kitson, June 2012. pdf

Economics 101

One of the core aims of  Progressive Pulse is to increase economic literacy and in particular macroeconomic literacy. To help in this you may have noticed that some posts are being labelled “Economics 101”. you simply need to click on the “Economics 101” tag at the top left of this post (under my mugshot and date) to get the full list of posts. Eventually the hope is to put an Economics 101 tag on the main menu.

Many years ago I was very interested in economics and an avid reader of for example books by John Kenneth Galbraith and thought Keynesian economics made very good sense.

Around the time I was finishing my PhD however neoliberalism somehow took over. I was in the US at the time at the Harvard Smithsonian Centre for Astrophysics, desperately hoping Ronald Regan would not get elected. He seemed to me at least a complete fraud and would put corporations ahead of people. I gave “Trickle down Economics” for example almost zero chance of working. Sadly Regan got elected as president  and indeed Thatcher became PM in the UK. Between them they brought about a neoliberal revolution. Countries are like supertankers and I can’t help but worry that the rudder has been trimmed incorrectly over much of the last 40 years in both the US and UK.   Indeed I pretty much lost interest in neoliberal economics  and economics in general as it felt somehow repellent.

Thatcher and others however have been very adept at pushing for example the “household model” which is completely inappropriate for a macro economy.  Indeed the level of economic literacy (and in particular macroeconomic literacy) seems to have decreased rather than increased over the past 40 years. Someone of a suspicious mind would be forgiven for thinking this “dumbing down” was deliberate.

If the economy were doing well possibly the specific economic theory in use would not matter so much. Since 2008 however the UK economy has been growing very slowly (growth rate is the neoliberal benchmark)  well below its 3%  trend. It would be interesting to calculate that if you removed the effect of immigration (a very strong positive) and the top 1%, whether there has been any growth at all.

Thomas  Clark of the blogspot Another Angry Voice identifies ten questions to put to the general public:

  1. What is a fiat currency?
  2. How is money created?
  3. What is the difference between a debt and a deficit?
  4. What is the difference between fiscal and monetary policy?
  5. What are capital controls?
  6. What is a transfer pricing strategy?
  7. What does fiscal multiplication mean?
  8. What is a derivative?
  9. What is a “naked” trade?
  10. What is Quantitative Easing?

He is of the opinion that less than 5% of the UK population could answer four of these with any depth of knowledge, let alone all ten of them. Sadly I can’t say he is wrong.

I’m not sure I fully understand Quantitative Easing for example. There seems to be a bit too much “smoke and mirrors”.

How many of these do you understand fully?  Are the other questions which are equally or more important?

We intend to answer these and other questions over the next few months. Indeed some of these have been already addressed but possibly it is worth addressing these questions directly?



Wonders to Perform

It must have started with Adam Smith’s ‘invisible hand’.

As Conventional religion has gradually declined, the Economy seems to have risen to a greater and greater importance and taken its place.

Fortunately, most of us can still feel good because the Economy has most of the ingredients of a religion: jargon, ‘high priest’ specialists, holy books which people argue about, splits and non conformists, orthodoxy, prophesies, ideas about money, and of course it contains a value system.

Continue reading “Wonders to Perform”

Follow the money

There is one simple rule that most economists agree on:

prosperity = productivity

The Chancellor understands this – productivity was mentioned 10 times in his recent Spring Budget speech. He said:

Simply put, higher productivity means higher pay.

and went on to say that Britain’s problem is a productivity problem

We are 35% behind Germany and 18% behind the G7 average. And the gap is not closing.

So what is going wrong and who is to blame? Is it the 99% or the 0.1%? I would say the latter. Let me explain why.

Continue reading “Follow the money”

What is the deficit?

In my previous post on government spending (How are we going to pay for it?), I wrote that unless people choose to save it, then extra government spending all comes back as extra tax. If this were true, then what does not come back, the deficit, must be equal to private sector savings? We can test this by plotting data available in the Quarterly National Accounts provided by the ONS. Continue reading “What is the deficit?”

How are we going to pay for it?

When you listen to all the discussion about balancing the budget, about how any increase in spending needs to be matched by an increase in tax, why does no one mention that an increase in spending automatically generates extra tax?
There is no need to raise tax rates!

Continue reading “How are we going to pay for it?”