History of Money
This short summary of money history includes only the points relevant to the issue at hand - creating a currency based on energy. Will the kilowatt hour be the final step in the path started by the cowrie and followed by wheat, silver, gold, the British Pound and the American Dollar?
Money has taken many forms. Basically anything which is representative of value and can be traded for a wide range of goods can be said to be money. From beads on a string (wampum) to sea shells (cowrie shells) to tokens and coupons and lumps of metal.
Fundamental to all of these gradually evolved or fiat currencies is the belief in the minds of buyers and sellers that they have value. Governments can dictate the value of a currency to a large extent but must make sure the integrity of their currency is maintained by avoiding circulating too much of it. If the currency is based on some content of precious metal like gold or silver, they must maintain that content to avoid “debasing” the currency. For several millennia the success of national or “fiat” currencies have depended on their consistency of precious metal content because people have viewed the value of gold and silver as much more reliable and constant than the “promises” of governments.
Paper money has zero intrinsic value. The first bank notes were printed on paper nearly 1000 years ago in China preceding Europe by 500 years. At first they were used for exchanges between merchants but later the government began to operate the presses. This resulted in the worlds first case of hyperinflation. As a medieval Chinese historian Ma Twan-lin later remarked, “Paper should never be money but only employed as a representative sign of value existing in metals or produce.” Ie commodity based.
“Sound as a pound” came into being as a stock phrase because of the British dedication to maintaining the integrity of their currency (the pound) by keeping the silver content constant. For several centuries, the British pound was “the gold standard” for most of the world.
Gold has been a representation of wealth for many thousands of years and is embedded in most minds as being wealth itself. But it isn’t particularly useful. Golds practical applications are limited and almost 80% of it is used in ornamentation. If the total amount of gold mined were melted into one large cube, it would measure 20 metres on each side. It is attractive but its rarity and the effort to produce it gives it its value.
Gold is a highly stable token of exchange, not a unit of real wealth.
In the middle ages, there was a net outflow of gold from Europe to the Middle East and China to pay for their silk, spices and manufactured goods. This caused scarcity in Europe and continued high gold prices. It wasn’t until the Spanish plunder of the New World that there was actually a decline in the value of gold and silver. So much became available that the metals lost a great deal of their value in the late 1500's.
In most cases of currency debasement, the percentage of precious metal in the coins was decreased and therefore their value declined over time. This “inflation” is basically a tax by the governments to deal with urgent financial shortfalls. The flooding of the gold and silver markets by the Spanish was a rare case of making the metals themselves more plentiful and therefore less precious.
This demonstrates that precious metals are more faith than reality and so limited in supply that any currency based on them today would become highly inflated to the point of restricting the expansion of economic activity.
Precious and rare commodities which have held prominence in peoples minds for millennia have proven to be excellent currency stabilizers. But although they command wealth, they do not constitute wealth themselves.
Cowrie Shell Currency
As fixated as we in the west are on the enduring value of gold and silver, the cowrie shell has been used as an exchange currency longer, by more people and over a greater geographic area than precious metals. The cowrie shell is a product of the Indian Ocean (principal source was the Maldive Islands), comes in various sizes and is attractive to both the eye and the touch. Most importantly it is unique and impossible to counterfeit convincingly. That didn’t stop the Chinese from manufacturing their own cowries in metal when the supply of the real shells grew short. This underlines the concept that the representation of money plus faith equals real money.
The cowrie has been used all over Africa and Asia and has been a staple of trade for so long that its image forms the Chinese pictograph for money. In central Africa it was still possible to pay ones taxes in cowries in the early 1900s and to purchase small items at market well into the 1950s.
Like precious metals, the cowries had few practical uses outside of ornamentation but that and their uniqueness and rarity allowed them to form a practical currency whose use spanned over 4000 years and covered the most populous areas of the world. Their range was from China westward and even to North America as the natives accepted them in trade from European settlers.
Most societies in the world today are used to thinking of gold as a representation of wealth. We can look back upon the cowrie shell as a quaint token used by primitive peoples in a time gone by. But at one time, in a large portion of the world only a fool would give up cowrie shells for gold. They were both rare but at different times in history in different regions one had a history of value and the other did not.
Rare commodities such as precious metals and cowrie shells are little more than tokens of exchange, not embodiments of real wealth.
Commodity Based Currencies
Egypt Wheat Currency
There are extremely few examples of a practical currency actually having intrinsic value. Nails and knives have been used and most Chinese coinage was made from base metals whose intrinsic value constituted most of their face value. But the best example of a commodity based financial system is the Egyptian use of wheat. For much of their recorded history, the ancient Egyptians used wheat and credits based on wheat as the blood of their complex banking and financial system. Because it is a staple food, wheat held high and immediate intrinsic value. There would always be a ready market for this commodity in any location and for a broad scale of transactions.
The wheat based financial system of the Egyptians is the closest to an energy based system in recorded history. Today, energy has a number of advantages being more ubiquitous in the economy, more easily transferable, measurable and with a wider range of scale. But wheat possessed most of the fundamentals, certainly enough to make a financial system work for hundreds and perhaps thousands of years. And there are no recorded instances of bank failures or currency inflation in this period. With fiat money, financial crises are a regular occurrence.
The coin and precious metal currency ambivalent Egyptians had used grain for thousands of years as a crude currency but the system was elevated into a full banking network under the Ptolemies around 330BC who blended the grain base in with Greek banking. The use of grain was made practical by the (relatively) dependable harvest in the Nile valley thanks to the annual floods which replenished the soil. Outside of Asia, this kind of consistency was unknown. Wheat as a currency base was made practical by the unique and dependable soil and water cycle of the Nile Valley which eliminated severe inflationary cycles.
This begs the question of whether there were rice based currencies in Asia. Certainly a wide range of transactions were conducted using rice in feudal Japan and Burma. Japan was clearly closest to establishing a completely rice based currency and banking system but it does not seem to have approached the sophistication of the Egyptian wheat model.
The Egyptian wheat financial system was complete with a central reserve bank and many branches throughout the country. It featured the first use of credit notes and was not surpassed in sophistication until 2000 years later in 18th century Europe. The system could not have reached that level if it had been prone to inflation or currency crises. It was its reliability that allowed such a high degree of development of such a relatively cumbersome currency.
Energy is the most reliable and consistent base available and it’s scalability and ease of transport make it superior to any other commodity as a currency base. It is produced and consumed in lockstep with economic activity and thus will give a true reflection of the wealth creation process. The value of energy does not change and it cannot be debased. This is not to say fraud will not occur in an energy based system but fraud will be easier to identify in system using scientifically defined units.
The first practical “coin” outside of China where and weight and purity of the new currency was accepted without question was stamped in Cappadocia around 2200BC. Since then many currencies have come and gone. Among the most stable and long lived with widespread acceptance have been the Roman solidus , the Italian florin and the British pound sterling (with 22.5 troy grains of silver) which became the most stable currency and the staple of international finance for several hundred years.
Printed money - paper notes - freed currency and those making it from any link to inherent value in the coinage itself. This made it possible to devalue the currency in far more subtle ways so debasement became both easier and less prone to market oversight and public outcry. The results however were more extreme in terms of more regular and absolute failure. The printing press removed several large factors of discipline which had previously moderated the actions of desperate or irresponsible governments.
In the millennia since the implementation of printed money, it has served as a method of exchange, not as a representation of total output of an economy. Until the last century, a large percentage of the real economy was non-monetized, that is, the labour and much of the material that went into real output was not paid for directly. Little of any subsistence economy or womans’ labour was paid for in cash. Trade did not constitute a dominant part of total productive activity.
Over the past 50 years in industrialized countries however, most forms of labour have moved into the realm of the commercial economy so the flow of money is indeed widely viewed as being a full representation of the human portion of the real wealth creation process.
After the second world war, the “almighty” American dollar supplanted the “unshakable” British pound which had been the bedrock of international finance and trade for 200 years and the most stable currency in the world for almost 1200 years. The greenback has been the most dominant currency in world history but it will also have had the shortest run of only 60 years for the usual reason of debasement by an overly creative and loose financial system underwritten by a structural trade deficit that has no end in sight.
Should the dollar be replaced by another fiat currency of any description, the cycle of economic crises will continue. But the perfect currency is out there waiting to write the final chapter in the history of money.
Barter trade was a real goods exchange system with perfect transparency and no residual effects and no distortions.
Commodity based exchanges broadened the trade possibilities with no residual effects or distortions. It was still real goods exchange on both sides of the transaction. The transaction was totally completed at the point of and time of exchange.
Coinage broke the system of real goods exchange on both sides of transactions and made distortions and residual effects possible. As long as the coins had a consistent level of precious metals, the distortions were slow, moderate and more easily absorbed.
Once the coinage could simply be printed, there were no restraints on abuse and no link to real wealth. Crisis are inevitable and have been frequent. Particularly as the majority of the human wealth creation process becomes monetized.
It is important to remember that printed money represents a claim on the real goods in a society but does not at all guarantee that real goods have been produced to meet the full claims of the currency printed.
Energy currency restores a direct link to real goods on both sides of the transaction and minimizes abuse as well as eliminating distortions like currency debasement inflation.
So with the move to energy based currency we will have come full circle from fully transparent real good transactions to faith based transactions and back again. Precious metal based coinage and printed currency accelerated immensely the pace of commercial development. But fiat currency based monetary systems have proven highly opaque and unstable with large cumulative delayed distortions and crisis.
Energy currency takes us back to fully transparent, stable, real goods exchanges with unlimited scale and flexibility. The ultimate form of barter with unlimited scale and complete flexibility.
Source : The Perfect Money
The Gold Standard was a system under which nearly all countries fixed the value of their currencies in terms of a specified amount of gold, or linked their currency to that of a country which did so. Domestic currencies were freely convertible into gold at the fixed price and there was no restriction on the import or export of gold. Gold coins circulated as domestic currency alongside coins of other metals and notes, with the composition varying by country. As each currency was fixed in terms of gold, exchange rates between participating currencies were also fixed.
Central banks had two overriding monetary policy functions under the classical Gold Standard:
Maintaining convertibility of fiat currency into gold at the fixed price and defending the exchange rate.
Speeding up the adjustment process to a balance of payments imbalance, although this was often violated.
The classical Gold Standard existed from the 1870s to the outbreak of the First World War in 1914. In the first part of the 19th century, once the turbulence caused by the Napoleonic Wars had subsided, money consisted of either specie (gold, silver or copper coins) or of specie-backed bank issue notes. However, originally only the UK and some of its colonies were on a Gold Standard, joined by Portugal in 1854. Other countries were usually on a silver or, in some cases, a bimetallic standard.
In 1871, the newly unified Germany, benefiting from reparations paid by France following the Franco-Prussian war of 1870, took steps which essentially put it on a Gold Standard. The impact of Germany’s decision, coupled with the then economic and political dominance of the UK and the attraction of accessing London’s financial markets, was sufficient to encourage other countries to turn to gold. However, this transition to a pure Gold Standard, in some opinions, was more based on changes in the relative supply of silver and gold. Regardless, by 1900 all countries apart from China, and some Central American countries, were on a Gold Standard. This lasted until it was disrupted by the First World War. Periodic attempts to return to a pure classical Gold Standard were made during the inter-war period, but none survived past the 1930s Great Depression.
How the Gold Standard worked:
Under the Gold Standard, a country’s money supply was linked to gold. The necessity of being able to convert fiat money into gold on demand strictly limited the amount of fiat money in circulation to a multiple of the central banks’ gold reserves. Most countries had legal minimum ratios of gold to notes/currency issued or other similar limits. International balance of payments differences were settled in gold. Countries with a balance of payments surplus would receive gold inflows, while countries in deficit would experience an outflow of gold.
In theory, international settlement in gold meant that the international monetary system based on the Gold Standard was self-correcting. Namely, a country running a balance of payments deficit would experience an outflow of gold, a reduction in money supply, a decline in the domestic price level, a rise in competitiveness and, therefore, a correction in the balance of payments deficit. The reverse would be true for countries with a balance of payments surplus. This was the so called ‘price-specie flow mechanism’ set out by 18th century philosopher and economist David Hume.
This was the underlying principle of how the Gold Standard operated, although in practice it was more complex. The adjustment process could be accelerated by central bank operations. The main tool was the discount rate (the rate at which the central bank would lend money to commercial banks or financial institutions) which would in turn influence market interest rates. A rise in interest rates would speed up the adjustment process through two channels. First, it would make borrowing more expensive, reducing investment spending and domestic demand, which in turn would put downward pressure on domestic prices, enhancing competitiveness and stimulating exports. Second, higher interest rates would attract money from abroad, improving the capital account of the balance of payments. A fall in interest rates would have the opposite effect. The central bank could also directly affect the amount of money in circulation by buying or selling domestic assets though this required deep financial markets and so was only done to a significant extent in the UK and, latterly, in Germany.
The use of such methods meant that any correction of an economic imbalance would be accelerated and normally it would not be necessary to wait for the point at which substantial quantities of gold needed to be transported from one country to another.
Rules of the Game:
The ‘rules of the game’ is a phrase attributed to Keynes (who in fact first used it in the 1920s). While the ‘rules’ were not explicitly set out, governments and central banks were implicitly expected to behave in a certain manner during the period of the classical Gold Standard. In addition to setting and maintaining a fixed gold price, freely exchanging gold with other domestic money and permitting free gold imports and exports, central banks were also expected to take steps to facilitate and accelerate the operation of the standard, as described above. It was accepted that the Gold Standard could be temporarily suspended in times of crisis, such as war, but it also was expected that it would be restored again at the same parity as soon as possible afterwards.
In practice, a number of researchers have subsequently shown1 that central banks did not always follow the ‘rules of the game’ and that gold flows were sometimes ‘sterilised’ by offsetting their impact on domestic money supply by buying or selling domestic assets. Central banks could also affect gold flows by influencing the ‘gold points’. The gold points were the difference between the price at which gold could be purchased from a local mint or central bank and the cost of exporting it. They largely reflected the costs of financing, insuring and transporting the gold overseas. If the cost of exporting gold was lower than the exchange rate (i.e. the price that gold could be sold abroad) then it was profitable to export gold and vice versa.
A central bank could manipulate the gold points, using so-called ‘gold devices’ in order to increase or decrease the profitability of exporting gold and therefore the flow of gold. For example, a bank wishing to slow an outflow of gold could raise the cost of financing for gold exporters, increase the price at which it sold gold, refuse to sell gold completely or change the location where the gold could be picked up in order to increase transportation costs.
Nevertheless, provided such violations of the ‘rules’ were limited, provided deviations from the official parity were minor and, above all, provided any suspension was for a clear purpose and strictly temporary, the credibility of the system was not put in doubt. Bordo2 argues that the Gold Standard was above all a ‘commitment’ system which effectively ensured that policy makers were kept honest and maintained a commitment to price stability.
One further factor which helped the maintenance of the standard was a degree of cooperation between central banks. For example, the Bank of England (during the Barings crisis of 1890 and again in 1906-7), the US Treasury (1893), and the German Reichsbank (1898) all received assistance from other central banks.
What were the perceived advantages and disadvantages of the Gold Standard?
In the 19th century after the Napoleonic Wars, societies turned initially to gold, silver or bimetallic standards, and subsequently to the international Gold Standard, in order to reduce the potential for run-away inflation. Throughout history, and with some notable episodes in the 18th century and around 1800 during periods when money was not tied tightly to gold or silver, governments or central banks often printed too much currency, increasing the money supply too fast—reducing the effective value of the currency. By tying paper currency to gold, society linked the ability of a central bank to print money to the amount of gold that it had in its possession or to a multiple thereof. This provided tremendous confidence in the currency; citizens knew that at any point they could redeem their paper currency for gold. Thus, the primary advantage that has been attributed to the Gold Standard is price stability - which provides the conditions for greater economic activity and broader financial stability. During the Gold Standard, prices both rose and fell, but over the long-term they were broadly stable1.
There is also plenty of evidence that cross-border investment flows during the Gold Standard period were substantial2. Confidence that exchange rates would hold facilitated the substantial flows of direct investment that opened up the ‘emerging markets’ of the era, such as the Americas (including the US West), Australia, New Zealand, and South Africa. Global outflows of capital from the core European countries to countries of new settlement were massive during this era and far higher than during most of the 20th century. Only towards the end of the 20th century did international capital flows recover to comparable levels. Arguably, today they are often less stable than during the Gold Standard period (witness the ‘Asian crisis’ of 1997-98) and can be in the ‘wrong’ direction from emerging markets to developed ones.
Indeed the period of the Gold Standard was a highly successful one for the world economy. World trade expanded and most countries benefited from relatively rapid growth and low instability. Experts debate to what extent the Gold Standard enabled this and to what extent it flourished, because of these favourable conditions. Most probably causality flowed in both directions, but it would be hard to deny that the Gold Standard at least helped to facilitate matters.
On the other hand, a major disadvantage of the Gold Standard was that it did not allow policy makers to stimulate the economy through a monetary stimulus —which is the foundation of modern-day Keynesian economics. Furthermore, by tying a nation’s currency to gold, the money supply is instead tied to the global stock of monetary gold, growth in which varies, in particular, with the pace of new mine supply. Thus large discoveries of gold can have the effect of creating a monetary stimulus—which might not be appropriate at that particular time. Conversely, lower growth in gold output during a particular period can limit the expansion of the monetary base, restraining economic growth. Following the Californian and Australian gold discoveries of the late 1840s and the 1850s, there was rapid growth in mine production. This first levelled off and then fell back in the 1870s and 1880s, before surging again with the South African and Klondike discoveries of the 1890s, and improved production techniques.
Further, while the overall picture is one of rising prosperity, there were times of hardship in all countries. The Gold Standard was famously blamed for economic problems in the US. Discontent culminated in William Jennings Bryan’s famous ‘cross of gold’ speech in the 1896 presidential election campaign3. Nevertheless it is not just under a Gold Standard that tensions arise between the desire or need to maintain a fixed exchange rate and the desire to mitigate its adverse impacts on the domestic economy. The history of currency boards and, indeed, the Eurozone crisis of 2010-11 are other examples.
Why did the Gold Standard break down?
The Gold Standard broke down at the outset of the First World War, as countries resorted to inflationary policies to finance the war and, later, reconstruction efforts. In practice, only the US remained on the standard during the war. The reputation of the Gold Standard meant that there was a widespread desire to return to gold afterwards. However, differing inflationary experiences during and after the war – including the German hyperinflation of 1922-24 – meant that a return to pre-war parities was not automatically feasible. A further problem was concern, in the absence of major new gold discoveries after the 1890s, over whether there would be sufficient gold to underpin the standard. These concerns had started to surface in the first decade of the 20th century. The solution was to allow the emergence of a ‘gold exchange standard’ whereby central banks both acquired a higher proportion of the gold stock4, reducing the amount of gold coins in domestic circulation, and also started to hold increasing amounts of their reserves in the form of foreign currency assets, primarily sterling or dollars. On this basis, most countries, with China and the Soviet Union being notable exceptions, returned to a Gold Standard during the 1920s.
But many countries returned at the ‘wrong’ gold price/exchange rate. The UK, for example, returned at its pre- war rate. But a decline in UK competitiveness meant that sterling was now heavily overvalued. France, by contrast, having experienced higher inflation than the UK, returned at a different parity giving itself an undervalued exchange rate. The US did not change its parity but having experienced lower inflation than most countries this also resulted in an effective undervalued exchange rate. This led to large balance of payments imbalances, a situation which was exacerbated by central banks’ unwillingness to co-operate and follow the ‘rules of the game’.
This is something that Federal Reserve Chairman Ben Bernanke commented on in a speech in November 2010. He said: “the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international Gold Standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression. The Gold Standard was meant to ensure economic and financial stability, but failures of international coordination undermined these very goals.” 5
The huge gold outflows that deficit countries were experiencing, most notably the UK, also undermined confidence in convertibility – an absolute necessity for the Gold Standard to function. This led to a run on sterling, eventually forcing the UK off the Gold Standard in 1931. With the widespread deflation and massive unemployment that came with the Great Depression, other countries, wishing to pursue inflationary policies and devalue their currency in a bid to boost competitiveness, gradually followed.
In the US, one of President Franklin D. Roosevelt’s first acts on taking power in 1933 was to take the US off the US$20.64 per ounce parity it had held throughout the First World War and the 1920s. The dollar price of gold was gradually raised until it was fixed at the new parity of US$35 per ounce in early 1934. Most other countries, though, remained on floating or managed exchange rates until the outbreak of the Second World War.
The Bretton Woods system
It was clear during the Second World War that a new international system would be needed to replace the Gold Standard after the war ended. The design for it was drawn up at the Bretton Woods Conference in the US in 1944. US political and economic dominance necessitated the dollar being at the centre of the system. After the chaos of the inter-war period there was a desire for stability, with fixed exchange rates seen as essential for trade, but also for more flexibility than the traditional Gold Standard had provided. The system drawn up fixed the dollar to gold at the existing parity of US$35 per ounce, while all other currencies had fixed, but adjustable, exchange rates to the dollar. Unlike the classical Gold Standard, capital controls were permitted to enable governments to stimulate their economies without suffering from financial market penalties.
During the Bretton Woods era the world economy grew rapidly. Keynesian economic policies enabled governments to dampen economic fluctuations, and recessions were generally minor. However strains started to show in the 1960s. Persistent, albeit low-level, global inflation made the price of gold too low in real terms. A chronic US trade deficit drained US gold reserves, but there was considerable resistance to the idea of devaluing the dollar against gold; in any event this would have required agreement among surplus countries to raise their exchange rates against the dollar to bring about the needed adjustment. Meanwhile, the pace of economic growth meant that the level of international reserves generally became inadequate; the invention of the ‘Special Drawing Right’ (SDR) 1 failed to solve this problem. While capital controls still remained, they were considerably weaker by the end of the 1960s than in the early 1950s, raising prospects of capital flight from, or speculation against, currencies that were perceived as weak.
In 1961 the London Gold Pool was formed. Eight nations pooled their gold reserves to defend the US$35 per ounce peg and prevent the price of gold moving upwards. This worked for a while, but strains started to emerge. In March 1968, a two-tier gold market was introduced with a freely floating private market, and official transactions at the fixed parity. The two-tier system was inherently fragile. The problem of the US deficit remained and intensified. With speculation against the dollar intensifying, other central banks became increasingly reluctant to accept dollars in settlement; the situation became untenable. Finally in August 1971, President Nixon announced that the US would end on-demand convertibility of the dollar into gold for the central banks of other nations. The Bretton Woods system collapsed and gold traded freely on the world’s markets.
1 A new reserve asset, the SDR was created and given the value of 0.888571 gram of fine gold, the same value as the dollar in July 1944.
Source: World Gold Council