Look closely at what do we all have in common. No matter what corner of the world we live in, we need food water shelter, and money. Half of every transaction involves money. Money is the artery of the economy. It is so integral to our society and our global economy that its true nature remains a mystery to most. It's a technology that's older than the wheel. It's as old as fire. This series of blogs is the story of money, perhaps the end of money as we know it.
At a point in time, businesses jumped into new profitable markets ignoring risk. Housing prices rattled and the major bank went insolvent. Rumors spread more bad news. Investors and businesses made a run on the other banks demanding their cash deposits. The largest financial institutions in the center of the modern world were frozen and assets were seized. Banks foreclosed a credit crunch, threatening the entire world economy.
Then finally the government stepped in. The largest bank bailout ever by the head of state had saved the day.
Remember that? No, I am not talking about the global financial crisis. History may not repeat itself but it certainly rhymes.
This happened two thousand years ago in Rome around 33 a.d. It recorded the first liquidity crisis and government bailout in history. The largest empire the world had ever seen was brought to its knees by a banking disaster. Emperor Tiberius used money from the National Treasury to bail out the country's troubled banks and companies.
The story of money is as old as civilization itself. When we lived in small tribes, keeping track of debt was easy. People owed things like firewood and piece of meat to each other. Credits and debits were kept in the head. It was more like a mental ledger. But when people wanted to trade outside their tribe or village, they needed something everyone could agree had value, something scalable.
There were many kinds but each had to embody the same five characteristics. Commodity money is relatively scarce, easily recognizable, can be cut into smaller pieces, one can substitute one piece for another of equal value and can carry it around without too much trouble.
In ancient Rome it was salt. The Aztecs used cacao beans. Shells were used in Africa. Anything that had the five characteristics of commodity money, someone probably used it as currency. But commodities that aren't durable are a lousy store of value. A bad cacao crop or a huge new salt discovery can throw the currency and economy into turmoil. A more stable system was needed.
About 2500 years ago, the first metal coins were minted in China. These coins shared the same five Characteristics as commodity money and were also very durable. Also, these coins were made of gold and silver which is relatively scarce and cannot be created, and easily recognizable.
Coins were an objective and universal unit of account and they allowed people to buy and sell Goods. The wu zhu coin in china retained its value for 500 years. Constantinople, capital of Rome, the solidus lasted for 700 years.
The coins worked but only if people trusted that the king or emperor who issued them wasn't cheating on the metal content. Using coins also meant that authority now controlled the supply of the currency. Money and political power were inextricably linked. Centralized minting coins steadily and predictably allowed economic growth and stability. Soon royal mints were substituting cheaper metals for silver and gold. This is called debasement. And Europe's kings made a habit of it. The currency of France was debased every 20 months For 200 years.
But If no one can trust the gold or silver content of your coins, how can one trade with other countries? International merchants found a solution. They recognize that one person's debt has value. It can be traded or transferred. This is when IOUs came into use,
An IOU, a phonetic acronym of the words "I owe you," is a document that acknowledges the existence of a debt. When those IOUs came from reputable sources, they could be used as a form of money- Paper money. This money was not based on hard commodities or metal but instead on someone's promise to pay.
It worked like this: an English trader ordered a shipment of Italian cloth from a merchant family for 100 gold coins. His promise to pay the family was put on Paper. Meanwhile, the family owed 100 gold Coins to another trading partner for the Delivery of wine from France. The parties didn't go to the expense of transporting and exchanging gold coins. Instead, the paper was transferred. Everyone agreed that the paper had a value of 100 gold coins but only because everyone trusted the merchant family as solvent middlemen.
Power corrupts, and absolute power corrupts absolutely. People used to hold their gold with themselves or used to keep it with the goldsmiths. Goldsmiths wanted to come into power too. They noticed over a period that some of the coins they were storing for people were gathering dust. The people who owned them didn't need them right now.
Goldsmiths started lending out some of these gold coins and then later they realized that people don't even actually want the gold coins. They just want the piece of paper that says the gold coins are in the bank or with the goldsmith. So now they could make a loan with these pieces of paper and whatever they write on a piece of paper would be trustable as long as people would have faith in the goldsmiths. This is how the idea of lending and borrowing developed over a while.
For centuries, European countries would take turns building massive fleets and waging war on each other to rule the World. The government wanted to take the people's money to finance its wars.
Money and warfare go together. War is expensive. One year's income taxes Simply aren't enough. Kings and queens Had to borrow money against Future taxes. They needed a groundbreaking financial innovation- Government bonds.
The loans came from Rich merchant families and goldsmiths who by now had become powerful financiers and bankers. Sovereign debt and deficit spending had been born. In 1694, the bank of England was established to fund a war against France. England's central bank was privately owned and granted the monopoly to issue banknotes paper that could be redeemed for an equal amount of gold from the government. This is how the concept of government bonds grew.
As far as capital is concerned people don’t want predictability, they want stability. In 1913 in the US, bankers and politicians decided that it was in the country's best interest and theirs to have a permanent Central Bank. They created the Federal Reserve. Among Its jobs to expand or contract the supply of a single national currency, the Federal Reserve's note, the Dollar, was tied to gold and strategic control of it would avoid booms that lead to busts. At least that was the plan.
In the next blog of this series, I would throw some light on Federal Reserve and how Dollar became an acceptable currency worldwide. See you then :)
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