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Economics: Money and Credit

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Figure 1.--.

The history of money and credit is in large measure the history of civilization. This is because civilization began with settled agriculture and the creation of wealth beyond what hunter gathers could accumulate. This also involved a specilization in labor. With the specialization of labor pure bartar was akward leading to the development of money. The development of writing appears to have developed out of a need for accounting records. Early money was metal coins which had intrinsic value. Money was invented in Mesopotamia. The next step was credit. Modern banking traces its origins to the Templars. Christian pilgrims needed a way of transfering money to the far away Middle East and the Templars established a system to do this. It was the Medeci in Florence that established the foundation of modern banking (15th century). Banking was contrained in Europe because of the Church procriotion against paying interest which was consider usurious. For that reason Jews were commonly involved in lending money during the Middle Ages. From early times there has been a populist reaction to money lenders and banks. This was an element in European anti-Semitism. Even the Medici faced a populist uprising led by Savanarola. He is best known for his religious teachings, but populist sentiment was an important factor in the rising against the Medici. Populist sentiment against banking has continued to this day. While populist has generally blamed banks for economic problems, throughout history it has been the lack of an efficent banking system that has impeded economic growth, not the presence of banks. The Dutch took the next step in inventing capitalism which was adopted by the British. An efficent banking and economic system is an important factor in the victory of the English speaking people over Catholic absolutists (Spamush and French), the hegemonic German Empire and 20th Century totalitarians (NAZI and Soviet). Along with money and credit has come economic cycles and financial bubbles. These have included the South Sea Bubble and the Dutch tulip bubble. Bubbles of course are not just historical. Americans are familr with the dot.com bubble (2001) and the credit bubble (2008).

Money

The history of money and credit is in large measure the history of civilization. This is because civilization began with settled agriculture and the creation of wealth beyond what hunter gathers could accumulate. This also involved a specilization in labor. With the specialization of labor pure bartar was akward leading to the development of money. The development of writing appears to have developed out of a need for accounting records. Money was invented in Mesopotamia, but most civilizations had some form of money. Early money was for the most part metal, lafing to metal coins which had intrinsic value. The development of money and finance has been an essential part of thec rise of civilization. One author maintains that financial developments are the real driver of world history. 【Ferguson】

Precious Metals: Gold and Silver

Humans for as long as there were records were enfatuated with gold and silver. The first discoverer of gold is lost in the mists of time. A human, perhaps a child, and probbly before the evolution of modern man. It was found as shiny nugget in a creek, washed down from rocks buried in the eth. This occurred thousands of years ago, and the humanity was immediately attracted to it. Gold is found around the world. Gold was discovered in its natural state, in inumerable streams. Eventualy humanswoukd go up those streams to discover the source of the gold. This occur in the stone age. Gold was surely the first metal known not only to humanity, but to early hominids. Every culture has seen gold as something very special. Every known culture trasured gold in one form or the other. Gold unlike many metls is dispersed widely over the earth's surface. Thus it was discovered by countless different peoples. And all of these societes wgich found it wre awed by it and wanted more. There are various reasons that humans were attracted to gold. There is the alure of the color, luster and sparkle. And the fact that is so stable. Gold is so stable that no compounds are found it nature. And it is easily worked, extrodinrily malable and has a low melting point, an dunlike silver is resistant to tarnishing. Thus it can be worked with the most basic technology. The gold-silver ratio has varied over time. It formally dates back to 3100 B.C. The code of the first pharaoh, Menes, set the ratio at 'one part of gold is equal to 2 1/2 parts silver in value'. The emergence of gold as physical money took place in the form of the Lydian merchants' electrum coins -- 63 percent gold and 27 percent silver (about 700 BC). There are few valubles that have sustained their value for as long as money made out of precious metals have.

Coins

The earliest coin that has been found come from China -- a cast copper coin (11th century BC). It was discovered in a Shang Dynasty tomb. Many Chinese coins had distinctive square cut out centers. This was so they could be held on poles for storage and transport, poles which as a result became very heavy. They were followed by silver coins. Gold coins were also made, but because of the emense vlue were not commonly used in everyday commerce. Bartering goods was very awkward. You had to find people that wanted the goods you had and who had goods you needed. Money greatly facilitated trade. Metal coins had many advantages as a form of money. Metal is durable, difficult to counterfeit (but can be diluted), and has intrinsic value. The big disadvantage is portability. Metal is heavy. An individual can only carry so many coins on them eause they are so heavy. This was a problem for individuals, but it was much greater problen for merchants involved with trade boy only within a country, but for traders in different countries, even across oceans.

Credit

The next step was credit. Modern banking traces its origins to the Templars. Christian pilgrims needed a way of transfering money to the far away Middle East and the Templars established a system to do this. It was the Medeci in Florence that established the foundation of modern banking (14th-15th century). It is no accident that the beginning of the rise of the West occurred in Italy. The Renasissance is intriniskly liked with the rise of credit and banking in Italy. 【Ferguson】 A key factor was the adoption of 'Oriebntal mathematics' (Arabic numerals) which greatly facilitated calculation. Banking was contrained in Europe because of the Church prohibition against paying interest which was consider usurious. For that reason Jews were commonly involved in lending money during the Middle Ages. From early times there has been a populist reaction to money lenders and banks. This was an element in European anti-Semitism. Even the Medici faced a populist uprising led by Savanarola. He is best known for his religious teachings, but populist sentiment was an important factor in the rising against the Medici. Populist sentiment against banking has continued to this day. While populist has generally blamed banks for economic problems, throughout history it has been the lack of an efficent banking system that has impeded economic growth, not the presence of banks. One historian writes, " ... poverty is not the result of rapacious financiers exloiting the poor. It has much more to do with the lack of financial institutions, wih the absence of banks, not their presence." 【Ferguson】

Paper Currency

The Summerians originated thge general idea of paoper currency, but used cklay tablets. Paper is widely believed to have originated in China. This makes sence as it was the Chinese that invented paper. This began with merchants during the Tang Dynasty (618–907 AD). They began to deposit their heavy strings of coins with a trusted agent, who would issue basically promissory notes. This was the same process that led to papermoney in the West dyuring the Remissance. It was especially useful along the Silk Road wghere transporting heavy amons of coins was an impediment to commerce. Credit for the first Government-backed currency usually goes to the Song Dynasty and Emperor Zhenzong (r997–1022 AD). The notes were reortedly made from the bark of mulberry trees and printed in different colors. Marco Polo would note this in his accounts. Considerable information exists on this. The practice would rise and fall with the different dynasties and the paper currency would decliner in value as the different dynasties weakened. 【Pickering】 And the first national inflation with paper money occurred in China. 【Lui】 After Europeans became involved in China, the money supply would be increaingly focus on silver--supplied by the famous Manila Galleons with silver from Mexico And Peru. Chinese paper money does not seem to have influenced the adoption of paper currency in the West. The early European paper currency origuinated during the Crusades and in Renaussance Italy. They were not bank notes as we know today. They were, as in China, promissory notes —- meaning promises to pay specified amounts of gold or silver. They were key steps in the development of banks. As in China, the European experiebce with paper money was frought with difficulties, the most notable even being John Law in France. 【Lande】 And although the U.S. dollar would become the world reserve currency, the experience with the paper 'Continental' at the birth of the country was a disaster (1770s) that the first Treasury Secretary, Alexander Hamilton, would have to deal with. As a result, the Unitedc States would not issue its first dollars bills (Greenbacks) until the Civil War (1860s), nearly a century later. One author writes about modern times, "Banknotes ... are simply promises to pay ..., just like the clay tablets of ancient Babylon four millenia ago. 'In God We Trust' it says on the back of the ten dollar bill. But the person you are really trusting when you accept one of these in paymentis the successor to the man on the front (Alexander hamilton, the first Secretary of the U.S. Treasury), who at the time of writing happens to be ... Henry M. Paulson, Jr. When an American exchanges his goods or his labour fiorv a fistfil of dollars, he is essebntially trusting 'Hank' Paulson (and vby imoplication the Chairman of the Federal Reserve System, Ben Bernanke) niot to reoeat Spain's error and manufacture so many of these things that theyend uopbeing worth no more than they are printed on." 【Ferguson】 Today with the enormous expansion of the money supply by Democratic politicans enchanted with the chimera of Modern Monetary Theory, that seems to be happening in real time.

Interest Rates

Interest rates or the the cost of debt have for several years now been the lowest levels in recorded history. And using a little creative assments, this means going back to the very begnning of civilization in ancient Mesopotamia. And even more syrprising, never has there many so much debt. And this oes not mean just failed states like Veneuela and Zimbabwe. The American national devt has just exceeded the $20 trillion mark. And huge debt exist around the world, including all the major money centers: Britain, the European Union, China, and Japan. And we even have the phemonenon of negative interest eates for the first time with lebders ctually paying govenments to take their money. Two academic have claimed to find a U-shaped interest rate cycle for every major civilization. He finds high interet rate befor a civilization begins to mature. At the top left of the 'U', interest rates begin a downward trnd as avivilzation develops and gains strength. And as interest rates fallm the level of civilization rises. Civilizational heights bring heroic deeds, great achievements, and golden ages. This pattern can be detected with Babylon, Greece, and Rome. The researcher observes 'a progressive decline in interest rates as the nation or culture developed and throve.' Near the turn of the turn of the 20th century, Austrian economist Eugen von Böhm Bawerk glimpsed the same phenomenon. Bawerk declared that the cultural level of a nation is mirrored by its rate of interest: The higher a people's intelligence and moral strength, the lower the rate of interest. Here Bawerk is speaking about real market interest rates and not central banker imposed rates. Then rates start rising off the bottom of the 'U'. The pace of civilization slackens and the flame of achievement fades. Debt is often the the water that douses the civilization flame. Ccivilizations fatten on cheap debt. And when interest rates begin rising, the burden of that debt also rises. At this point, each civilization declins and eventually falls. Civilization rises with falling interest rates. Drunk with debt, civilization falls with rising interest rates. 【Homer amd Sylla】 Interest rates have plunged since their 1981 peak. And the national debt has exploded:

Capitalism

The Dutch took the next step in inventing capitalism which was adopted by the British. And no one adopted capitalism more dervently than America. Two critical developments too place in 1776, both critical steps in the gistory of freedom. We all know tht America declared its independence in 1776--essenilly a declaratiom of political freedom. The other key development was Adam Smith piblishing The wealth of Nations the primer on capitalism or economic freedom. At the time, more than 85 percent of the world's population lived on the equivalent of less than a dollar a day. Today less than 15 percent do. And what is even more startling is that in only a songle generation,a group of countries (the Asian Tigers) reinvented themselves from poor countries to economic powerhouses. At the time the Communists were claining that they had the key to the futur, but chieved only economic stagnation and national poverty. The Aian Tigers on the other hand achieved phenomenaleconomic success. Even Maoist China took note and when they also insytituted market reforms achieved the same results. What was responsible for the enormous spike in material prosperity? Of course science and technology played aole, but the Soviet Union had plenty of sience and technoloy, but little economic success. What is the historic secret of capitalism and the post-World war II market reforms in transforming the starteling increases in living standards. The answer could not be more simple -- the profit motive. Adam Smith wrote in The Wealth of Nations in 1776, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard for their own interest." Contrary to popular thought, the overnment doesn't provide us with food, clothing, shelter, healthcare or Apple Smartphone. Businesses do. And in the process of meeting economic wants and needs, public and privately owned companies develop employee job skills, build careers, support local communities, contribute to charitable organizations, pay billions in taxes and provide financial rewards for owners and shareholders, including labor retirement plans. The Progressive/Socialist argument is that capitalism is all about selfishness, greed, and exploitation and thus a faulty if not evil system. This is not entirely incorrect, except that these are chararacteristics define humanity, at least in oart. Capitalism in essence harnesses human nature and thus the creativity of the human mind. It isn essence economic freedom. Capitalism is about voluntary exchange for mutual benefit. Unlike government, business is about freedom and individual choice, not coercion. If you don't like a particular company or its policies, you don't have to work for them, sell to them, buy from them or own their shares. The results have been astonishing. Americans turned awilderness iinto a beacon od freedom and an ecnomic and scientific powerhouse. An efficent banking and economic system is an important factor in the victory of the English speaking people over Catholic absolutists (Spanish and French), the hegemonic German Empire and 20th Century totalitarians (NAZI and Soviet).

Central Banks


Historical Impact

Money and finance was a deciding factor in many historical events. Major examples are the Athenian discovery of silver during the wars with the Persian Empire (4th century BC). Banking and finabce were a major factor in the Renaissance (15th century AD)). Corporate finance meaning capitalism was a major factor in the ability of the tiny Dutch Republic to maintain its independence from the massive Spanish Empire powered by the huge flow of silver and gold from its American colonines (17th century). Spain itself woul flunder on using that wealth on the purchase of luxuries and the financing of wars. Capitalism and sound financing was a huge factor in Britain's victory over France, a larger and richer country (18th century). America's victory over the great totalitarian powers was largely due to capitalism and the financial instruments associated with it (20th century).

Financial Cycles

Along with money and credit has come economic cycles and financial bubbles. These have included the South Sea Bubble and the Dutch tulip bubble. Modern cycles have been studies in great derail. This is specially true of America because the United States is such an important part of the world economy. Bubbles of course are not just historical. Americans are familiar with the dot.com bubble (2001) and the credit bubble (2008).

Gold Standard

Gold since the dawn of civilzation has been used as the ultimate store of value. This meant that there was an informal gold standard in place. In fact during the Mercantil Era, the central monetary goal of nations became to acquire gold. The Industrial Revolution (mid-1770s) led to a massive expansion of profuction and wealth. For the first time in history, man possessed the means to massively increase the power that could be generated leading to mass productiion and wealth on an unprecedented scale. And large numbers of individuals coul shar in that wealth. This and the teaily increasing volumes of trade meant that uinfiormal methods of accounting and exchanges were no longer practical, especially for internatuiinal trade. Each country had its own currency. There had be a way of establishing exchange rates. The first such formalized system for internatuiinal trade was the Gold Standard. It is a monetary system using gold as the standard economic unit of accounting. Gold became the bench mark. The gold standard in internatiinal trade was the foundationn for the developing international monetary system arising out of the Industrial Revolution. Britain adopted a national gold standard (1844). The Bank of England fully backed its notes with gold. Subsequently almost every country in Western Europe as well as the United States adopted the Gold Standard. It dominated internatinal trade (1870s-1920s). Under the Gold STandard, the value of a currency was defined in terms of gold, for which the currency could be exchanged. It was largely abandoned as an result of the Great Depressiion (1930s). Europe and America tried to reserect it at the end Of World War II with the Brenton-Woods Agreement, but it ultimately collapsed when the United States unilaterally terminated convertibility of the U.S. dollar to gold, effectively ending the system (1971). Some today argue fir aeturn to the gold stndard. Others argue that the world supply of gold is simpoly inadequate for the massive world economy.

Monetarisn

Milton Friedman was the apostle of monetarism. He argued that the supply of money is the key to managing the modern economy.

Monetary History

A monetary system is the mechanisms by which a government provides a means of exchange (money) to facilitate economic activity. In addition to exchange mony can also serve as a store of value and a standard for measuring value. Normal istitutions, are a mint/printing office (bureau of engraving), central bank, and commercial banks. In the modern age new intitutions and exchang mechanisms are seveloping such as bit-coin and fintech. Over time a wide range of items have been used, inclueding skulls, salt, pigs, palm nuts, wapum, shells and much mokre. Different socirties have evaluated various items differently. The Aztecs and other Native Americans greatly valued a green stone (turquoise) which the Spanish were not impressed with. Over time two metals known as bullion (gold and silver) were seen by most sophisticaed cultures as of great value and thus provided a useful mode of exchange--the most common type of commodity money. The first monetary coins were appeared independently during th Iron Age in Anatolia and Archaic Greece, India and China (7th and 6th centuries BC). The use of monetary coins then spread rapidly. Paper bills were first adopted by the Chinese during the important Tang Dynasty (7th-10th century AD). Usage did not become widesread until modern times (late-19th century). Modern systems have used bullion (gold and or silver) and in the 20th century primarily paper bills. Paper money was at first not commoly accepted unless convertavle into gold and silver. Paper currency was, howevet, after the Depression of the 1930s and the end of the gold system was not normally convertable into bullion becoming fiat mony. he money of especially important economies with responsible finncial systems becme accepted as reserve currncies, the British pound stirling in the 19th century abd the American dollar in the 20th century. The Europeans created a common currency which now competes with the dollar, but reckless fiscal policies in both he United States and Europe are destablizing financial markets. China with its growing economy is interested in making its Yuan a reserve currency.

Sources

(von) Böhm Bawerk, Eugne.

Ferguson, Niall. The Ascent of Money.

Homer, Sidney and Richard Eugene Sylla. A History of Interest Rates 4th ed. (Rutgers University Press: 1996), 688p.

Lande, Lawrence, and T. I. M. Congdon. "John Law and the Invention of Paper Money," RSA Journal 139.5414 (1991), pp. 916–28.

Lui, Francis T. "Cagan's Hypothesis and the First Nationwide Inflation of Paper Money in World History," Journal of Political Economy 91:6 (1983): pp. 1067–74.

Pickering, John. "The History of Paper Money in China," Journal of the American Oriental Society 1:2 (1844), pp. 136–42. .









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Created: 2:50 AM 12/26/2008
Last updated: 8:37 AM 9/6/2023