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History of Money and Monetary Systems

From ancient Rome to modern world, money has gone through an evolutionary process. For the Roman empire, scarcity of silver and gold meant resorting to debasement to create new money. For the Inca empire, the same silver and gold was sacred precious metals coming from the hand of God. Spanish empire hunted for these precious metals to accumulate power but in truth abundance of silver lowered the value of the metals for which they had unquenchable lust. But over the course of time, the concept of money turned out to be a simple narrative installed in the minds of the people. The truth of the matter is, be it gold or silver or simply a piece of paper or the digits in your mobile wallet, the money has the value only if other people value it the same way. It's a machine driven by trust. The narrative of money has made a significant contribution to the progress of humankind. Although It was often flawed and we are yet to find a perfect system, the concept of money was one of the greatest inventions of human history.  
 

Even though money has changed its nature over the time, fight for autonomy over issuance of money still continues today. The emperors and governments still take the pleasure or burden of controlling the money supply which can be efficient and dangerous at the same time depending on the human beings running the show.

Fevicon-2-01Too Much Money

In 1530, after obtaining royal approval, a Spanish man named Francisco Pizarro sailed to conquer Peru with three ships, twenty seven horses and one hundred and eighty men equipped with guns and mechanical crossbows. He would find his way to confront Incan emperor, Atahualpa who had nearly eighty thousands soldiers with him in the mountains.

Pizarro’s army was most certainly outnumbered but he had some cards to play. He soon came to know that the Inca empire was in the midst of a civil war and inca people’s loyalty was divided between Atahualpa and his half brother Huascar. Pizarro played it in his advantage.

Pizarro soon began recruiting soldiers still loyal to Huascar. After making all the arrangement for a perfect coup, Pizarro invited Atahualpa to a feast framing it as the feast in the honor of the great emperor of the Inca. The emperor consented to attend the feast with only five thousands unarmed men, a easy prey for Pizarro and his men.

After killing Atahualpa’s men, Pizarro made last encounter with the Inca emperor. Atahualpa offered to fill Pizarro’s room with gold and silver. Pizarro accepted the offer gladly but killed the emperor anyway. From there Inca empire was set to decline and the Spanish empire declared this conquered land its new colony which would open the gate for large quantity of silver and gold flowing from America to Europe for years to come.

For the Inca empire gold and silver was shiny objects. They considered the precious metals sacred. For them gold was the sweat of the sun and silver was the tears of the moon. But for the Spanish empire it was the tool to accumulate more power. It was the money people accepted, it was the store of value that everyone put their trust on. In essence, they believed it was the means of acquiring more wealth and resources.

With further expansion in the America, new and more efficient method of mining and minting and establishment of convoy system of sea routes, the Spanish empire would set a treasure fleet of its own which meant uninterrupted supply of gold and silver along with other resources.

For instance, one of the Inca cities called Potosi supplied 60.0% all silver mined in the world during the second half of the 16th century. These supply of Gold and Silver brought new money in the Spain and other parts of Europe.

This silver and gold rush from the new world turned out to be a natural stimulus package for the people of Spain. So much so, such supply of money created something we call today the “Price Revolution”.

With large influx of gold and silver in other words money, people would start spending that new money at a greater rate than the growth in production of goods and services which eventually led to rise in prices of goods. The classic economic case of too much money chasing too few goods.

In that period over 150 years, prices rose on average roughly sixfold. In per year term, that’s inflation of 1-1.5%. In today’s term that inflation seem too little. But given the monetary policy in place where creation of new money meant invading a new area and striking gold or silver, that inflation was a lot.


Price-Revolution

 

With that series of inflationary events, people started getting a new view on money. A lot of silver didn’t necessarily mean more purchasing power. A greater supply of silver compared to growth in production of goods meant reduction in the value of silver or value of money.

Fevicon-2-01Too Few, Too Greedy

Let me take you further back in the history. Roman empire had these coins in circulation. They were made of Gold, Silver and Bronze. They were valued in terms of scarcity. The more scarce, the more valuable they were. The silver coin named denarius which initially had 95-98% purity was most widely used money in the roman empire.

Roman-Empire-Coinage

Naturally, to create this money they had to have deposit of silver. Any time they would invade a new area and find sources of silver, they would be able to create additional supply of money. Roman empire was thriving, especially in the period between 50-150 A.D. To maintain this large empire, they would need additional money to finance government expenses. It was all good as long as new deposit of silver was flowing in the emperor’s vault.

But soon the sources dried up. No new sliver sources were being discovered. The expanding administration, growing army and all the coming wars demanded more money. But money was nowhere to be found. Obviously, the emperors could tax more to increase their revenue, and occasionally they did. But that revenue never caught up with ever increasing expense.

Then the emperors got creative with their monetary tools. They thought they could create more money with same amount of silver by mixing bronze, copper and other cheap metals. So, this process, called debasement began. And soon, there was more money in the system than their deposit of silver. The mix of silver in the coin dropped to 5.0% by 250 AD.

Debasement
Source: Debasement and the decline of Rome by Kevin Butcher
 

Such process of debasement devalued the currency. It might have been a natural process as deposit of sliver declined and value of sliver rose. But the large drop in the silver mix in the later part of the roman empire showed an accelerated devaluation of the currency.

Later denarius was replaced by a new coin which was equivalent to two denarii (plural form of denarius). As people realized that this new coin had lower purity of silver, they started hoarding denarii. Prices would rise as people started realizing that the new coin had lower intrinsic value.

Back then money was viewed as something of an intrinsic value. They were made of some precious metals that people valued. Whenever they realized that the coin they used as currency was losing its purity, they would lose confidence on the currency. Sometimes, the shift would go smooth and sometimes it had inflationary element to it.

As long as commodity money existed, different emperors in different time periods used the process of debasement depending on the level of scarcity of precious metals in their regime. Even long before anyone started using paper money, emperors in China issued world’s first paper currency which they found more efficient than mining the precious metals and storing them in large volumes. This also created inflationary problems later which made the paper money very unpopular and issuance of paper currency was later discontinued in China until whole world were ready to adopt it.

These debasement policies or policies that ensured easy money were executed at the wishes of the emperors. To finance the wars, their lavish lifestyle and manage the administration, they would use their authority to execute monetary tools. Sometimes, it would produce shockwave among the people. People would lose confidence on the currency as they found out that the currency was losing its value. Sometimes, it would take time to restore that confidence on the currency.

Imperfect human beings with vested interest and short-term orientation controlling the money supply that affect everyone involved, the government, the people is a dangerous aspect. These emperors and governments always fought for autonomy and full control over the money supply. And It is still the case today.

Fevicon-2-01Fight for Autonomy Continues

In the course of time commodity money turned into well accepted paper currency. But the evolution of money was still on its path to shift into something different.

In 1971, When Richard Nixon cancelled direct international convertibility of the US dollar to Gold, the monetary authority gained full autonomy over their currency. It turned into fully floating fiat currency, a currency that is not backed by anything.

Prior to this, as per Bretton Woods System, US dollar was declared the world reserve currency which was pegged to gold. The US dollar was convertible to gold at the fixed rate of 35 US dollar per ounce. It meant, with a fixed amount gold in reserve, the central bank had limitations in increasing money supply. If they did increase money supply at a greater rate, the currency would lose value in relation to Gold.

However, US kept increasing money supply to finance its deficit which signaled other foreign nations that US Dollar was getting overvalued. These nations would convert their US dollar reserve into gold which was allowed at that time. Other nations would also made similar attempts looking at the possibility of significant devaluation of US dollar. Some nations would even ask USA to pay them in gold.

Finally, in 1971, Richard Nixon would step up cancelling direct international convertibility of the US dollar to Gold temporarily. By 1976, it became official that the U.S. dollar would no longer be defined by gold.

Fight-for-Autonomy-Continues

It created a new direction for the money as we know today. The currency we use today became a fully floating fiat currency which meant that there remained no systematic limitation in creating additional money.

It may seem a natural course of event because gold deposit was lagging behind in relation to the growth of world economy. So, money turning into a fiat currency would have happened one way or the other.

In a fiat currency world, the government can easily create money for their financing needs. Today, the money creation is much more efficient. From commodity money, to paper money and now digital money. It’s just a fingertip away to create a large sum of money to finance the government’s next large project.

In crisis, it may seem a great solution to printing away the recession with just a simple yes from the monetary authorities. If there is room for real growth in the economy, it seems all good.

But such autonomy and efficiency also pose a threat that the ancient roman empire faced. A country can easily fall prey to the temptation of overspending, meaning greater money supply than economy’s real growth opportunity. And if that temptation lasts for long, people can easily lose confidence on the currency and even the currency can sink into oblivion. The piece of paper that we value so much today can easily be turned into a worthless junk tomorrow depending on who we choose to put on the hot chair of authority. Basically, we are putting our most precious faith on the men and women running the show.

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