A science of money "cannot be attained by hasty generalizations, narrow and distorted views of isolated phenomena, the abuse of statistics to support preconceived prejudices, or excessive dogmatism on questions whose ultimate solution must depend upon the progress and experience of society."1
The development of money to the near-globally accepted and trusted paper media of today is a long and storied one, which could have had quite a different outcome than we see today. Items from beads and cattle to gold, paper, and electronic signals have been used as money, each attempting to guarantee in its own way the transfer of value from one to another as a gift or in exchange. The functions and values imparted to money today, as well as its design and organisation, were not inevitable and naturally to be expected but the result of much time and a long struggle for acceptance.
Initially, men exchanged goods through barter. If a man had raised pigs and wanted a horse, he would have to find in his community those individual who not only raised horses but also wanted pigs. Out of that segment, he would have to find the ones with horses that he found acceptable, perhaps limiting by colour, age, or strength. Finally, he would have to find that one of those individuals considered his pigs acceptable in value to trade, quite a time-consuming proposition and one which encouraged self-sufficiency inasmuch as the expenditure of time required for successful trade could discourage many transactions.
In a small closed agricultural economy, this was a burden; in a larger economy, this quickly approaches impossible. In response to the deficiencies of barter, men began exchanging goods deemed valuable in trade. Certain goods were valuable everywhere and became trading standards.
Animals were a relatively durable and quantifiable measure of value for pre-industrialised communities. Greeks in Homeric times used cattle as a unit of account, which helps explain the massive uproar with the killing of the sun-god Helios' cows. Glaukos' armour was worth 100 oxen but Diomedes' only nine, says Homer.2 To the Romans, herds were equated to riches and counting cattle by the head gave us the modern basis for the word capital. The German word Vieh, signifying a herd, led to the English word fee, as in a salary.3 Other standards have prevailed elsewhere. Iceland used dried fish as a unit of account as late as the 15th century. The phrase "worth his salt" comes from a time when Roman soldiers were paid part of their wages in salt, from which we also derive the word salary.
Cattle, salt, and dried fish were just three examples of goods that could be consumed or used for trade. These commodities had exchange value since they were in demand by others and could be used as bargaining devices with which to procure desired goods, which they derived from their ability to be consumed to provide benefit to their owner and their relatively long shelf life. When the cow was herded to market, its function was money but when it was herded to the firepit, it ceased to be money and became dinner instead.
Using commonly-desired agricultural products was one way to reduce the costs of trade. This did not fully eliminate them, however. Cattle needed fresh pastureland and dried fish took up a lot of space in storehouses. Both were quite bulky for international trade, and thus a great deal of expense was incurred in using them for long-distance transactions. Thus, the use of metals superseded cattle and agricultural products for trade and value when the international scene opened up. Gold and silver were more compact stores of value and did not deteriorate the way commodity monies did. Metallic money replaced commodity money as the preferred money for trading and for hoarding. Metals were much better suited to storing up for the types of expenditures that funded massive empires Though not consumable as food, their ease of transport and acceptance made them a more convenient standard for traders.
The possibility of theft, and the ease with which one could dispose of stolen gold in the world's financial centers gave rise to banking. While cattle could be branded to ascertain ownership, gold bars or coins could be resmelted and reimprinted at some not insurmountable effort to the thief. Metallic money, it has been said, is bloodless; it bears no witness to its previous possessors or transactions, whether virtuous or vice-ridden. The coins which purchased perfume to anoint Jesus' head and the coins which purchased the services of his betrayer were likely indistinguishable. Thus, while animals could be reasonably protected against theft in a honest community, the fungibility of precious metals made theft a greater worry. To protect against this, men turned to the men who made coin, the goldsmiths, and asked them to protect and store their amassed wealth since, dealing in large quantities of precious metals, the goldsmiths had incentives to invest in strong safes and lock-boxes for the express purpose of deterring theft. Thus the goldsmiths became the first bankers, keeping written records of coin and dispensing receipts for the gold placed in storage. These receipts, trusted and honoured in the community in accordance with the goldsmith's reputation, were circulated in place of gold coin, decreasing the weight of mens' purses.
This shift from metallic money with intrinsic value to receipts serving as guarantors of value meant that a new level of trust had to be added, shifting faith from the other party in the transaction to the one who had capacity to exchange these receipts for the specified amount of precious metals. Other guarantors of value followed, including warehouse receipts, IOU's, and personal cheques. Some of these, such as personal cheques, would require faith in both the writer and the bank of redemption. All these, including government issues, were still redeemable money, backed by a commodity of generally-recognised value. Depending upon the level of trust assigned by the recipient to the other parties, these papers might be discounted from their face value to reflect the recipient's assessment of the risk of default he faced from their acceptance.
The combination of trust in goldsmiths for storage and redemption and the ease of transacting with paper notes meant that the paper notes provided value to their users. For the convenience of paper and the security of gold storage, goldsmiths would charge a small fee, which at that time was regrettably not waivable if one signed up for direct deposit. Some individuals would not redeem their notes for gold, trusting the goldsmith and appreciating the relative lightness of paper. As goldsmiths noticed the quantity of gold piling up in the back rooms and the number of individuals requesting redemption decreasing, they realised they could loan out much of the gold on deposit and expect that it would be returned before the original depositor came to withdraw it. Thus was born the concept of fractional reserve, that a small gold base could support a larger paper money supply. To compensate for the value of the service they were providing to borrowers and to guard against the possibility of non-repayment, they charged fees based on the size and duration of the loan. Likewise, to encourage depositors to leave their gold with themselves so they could lend it out elsewhere, the smiths began to pay them small sums at regular intervals. This was the beginning of positive interest as opposed to demurrage, which will be discussed later in greater detail.
The free banking era in the late nineteenth century had many examples of banks abusing these privileges, issuing far more notes than they could ever hope to redeem in a grand confidence game. As long as individuals had confidence in the redeemability of their paper money, they were willing to accept it in circulation, but if the trust on which its acceptance rested was lost, there was rarely enough gold to support demands. Books were published to serve much like today's vaunted Kelly Blue Book, except that they assessed the risk of unsuccessful redemption associated with the accepting of bank notes from various out-of-state banks and suggested rates for discounting which reflected the likelihood of a loss of confidence occurring and stranding depositors. In a sense, these were predecessors to FirstCall and similar investment analysis firms. Major businesses kept a copy of this book near the cash register. It should be noted as an aside that the collapse of banks was not a loss all around; the unplanned losses of depositors who could not redeem their notes must be balanced against the unplanned gains to borrowers, such as mortgagees, who no longer had a bank able to demand repayment from them. Some persons were both depositors and borrowers, and may have come out even in the process. Bank officers too were likely to see financial gains if they could declare the bank closed before paying out all elements of value within. It is to the advantage of an unscrupulous banker to cut his losses by not paying out to any individual trying to redeem their notes, since whether he pays out to half the demanders or none, his local reputation is destroyed and the bank is assured to go out of business by a run on its deposits. Therefore he may believe he has nothing more to lose, and much money to gain, by unethically profiting off the bank's closure.
Eventually men made the final break and money became fully detached from commodities, becoming 'fiat' money, backed by decree of value alone. This step was usually taken by governments, rather than private institutions, as the government could back it by force and guarantee at least to accept it for tax assessments, which would seem to be a backing of sorts given the certainty of taxes; perhaps it has been held that to discharge an obligation is not the same as to receive a good or service upon presentation of the money.4 In either case, if you walk to a bank nowadays and ask to redeem a paper dollar, they will happily take your dollar and hand you another one, exactly the same but for the serial number, in exchange if they understand your request. Bear in mind that this process towards more ethereal money has evolved in parallel in numerous communities at different times; the intelligence of mankind is not limited to one community or time period; it is hardly new to this century. Man has succumbed often to the temptation to overextend the printing presses and churn out more and more fiat money until it eventually becomes worthless from inflation. The only thing which has restrained issuance was a fear of total devaluation of the currency, which historically has been not a strong enough fear to stop most issuers from financing their debts by inflation taxes.
The United States began its steps toward this under Abraham Lincoln. Without a national currency at that time, he faced a dilemma of how to raise funds to finance the Civil War effort. Rather than borrow from bankers to back national expenditure, he ordered the Treasury to spend the paper notes, called greenbacks, without any backing under the legal tender laws of 1862. A controversial issue, this prevented taxpayers from having to foot the bill for interest but may have cost them more in devaluation in the process. For seventeen years, notes Lewis Solomon, "the United States used a fiat monetary standard. In 1879, greenbacks were made convertible into gold."5 The National Banking Acts of 1863 and 1864 chartered national banks that issued currency at par with one another, establishing uniformity in the process of centralising power. To issue currency under this Act, however, the bank would have to purchase government securities, which could be sold in the event of bank failure to redeem its currency but which also created a forced market for federal debt, helping fund the war effort. This last element in combination with legislation mandating reserve requirements for national banks may have been the stick Lincoln used to ensure loyalty from the bankers to whom he gave the carrot of federal charter. In 1865, Lincoln established a 10% tax on the circulation of notes issued by state chartered banks to reward national banks and force the competing state banks to either recharter at the national level or to quit issuing notes, leaving national banks an effective monopoly on note issuance until the tax's repeal in the Tax Reform Act of 1976. State chartered banks continued their existence by backing not in bank notes but by demand deposits.6
As the federal government paid off its debt after the Civil War, it bought back the bonds against which national banks had issued notes. Running up against their reserve requirements and confronted by seasonal agricultural demands for credit, national banks sometimes would restrict their issuance of currency below normal operational levels, which caused speculative currency-holding panics. Clearinghouse loan certificates and the use of Canadian bank notes were two of the ingenious responses of the market to these crunches, as was the use of checks written by reputable individuals for round denominations of common transaction size. Lacking trust in the banks, individuals placed that trust elsewhere until the crunch was past.7
With the Federal Reserve Act in 1913, the government reformed the banking system by making an organisation whose purpose would be to "provide the nation and its banks with emergency currency reserves by acting as a lender of last resort to forestall panics and illiquidity in the banking system." Paper currency came to be a federal monopoly through a small provision in the Banking Act of 1935, whose more visible purpose was to restructure the Federal Reserve in the hopes of preventing a repetition of the Federal Reserve's failures in the 1929 crash and the following bank collapses. Other actions of Franklin Delano Roosevelt to centralise banking power included the Joint Resolution of June 5, 1933 which abolished gold clauses in contracts, and the Gold Reserve Act of 1934, which removed all gold coin from circulation. Under Roosevelt, gold was removed from being a part of the United States monetary system, and was removed from international transactions as well in 1971 under Richard Nixon.8 It was hoped that without a redeemable currency, that monopoly power could use and manipulate the value of circulating currency to meet government objectives of low unemployment coupled with low inflation. Learning how to use these powers for good and restrain the potential evils of fiat currency has been and may continue to be a slow process.
Yet despite the government's best of intentions, it does not retain a monopoly on money creation contrary to popular opinion. What is money nowadays? Men earn and can trade not only dollars but frequent flyer miles, rewards points, vacation time, and numerous other programs. Credit cards, bank loans, and even checking accounts represent money created not by national authority, and computer accounts can transfer vast sums of money in a single packet of data capable of fitting many times over on a standard floppy diskette. As money has been abstracted over history from cattle, fish, and even gold, its ethereal quality has become apparent; now its realities and essence must be clearly understood.
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1 Charles A. Conant, The Principles of Money and Banking (New York : Harper, 1905), 17.
2 Homer, Iliad 6.234-6.
3 Conant, 56-57.
4 Though in each case the exchange of money for either debt cancellation or for gold can be seen as beneficial, it is quite possible that the removal of a negative element may not be equated to the addition of a positive element to one's possessions. Sharp legal scholars have long distinguished between negative rights (rights against the interference of others) and positive rights (rights requiring the intervention of others to be fulfilled). In the same light may this be viewed.
5 Lewis D. Solomon, Rethinking Our Centralized Monetary System: The Case for a System of Local Currencies (Westport, Conn.: Praeger, 1996), 9.
6 Ibid., 9-11, 102-103.
7 Ibid., 11-12.
8 Ibid., 13-14.