Multiplying Money

7. The Rise of Trust

Land and sea trade routes combined with standardized coinage were the principal catalysts for the growth of markets. Without some form of money, exchange depended on the double coincidence of barter trade – finding buyers and sellers who both offered something the other was willing to buy in exchange. With the introduction of money, the probability of concluding a transaction rose exponentially, since it was sufficient that the buyer wanted what the seller had to offer and possessed money to be given in exchange. Money worked exactly like a chemical catalyst, moving from buyer to seller until the seller found something to purchase with it, moving on from one transaction to another unchanged by the process. The value of the money to the seller arose solely from the fact that it could later be redeemed for other desirable goods and services. The money itself was only a mechanism for recording the transfer of purchasing power, a symbol for the goods sold by the seller which empowered him to acquire other goods later on in exchange. The real value of that money was only as great as the availability of goods for which it could be redeemed. In other words, the value of money was always founded on the productive capacity of the underlying economy, never on its own intrinsic value. This remains true to the present day. That is why countries devastated by social unrest, political instability or civil war often find the value of their currency dramatically reduced.

Commercial revolution eventually spread from the Levant to Southern Europe during the 13th century, where it took root in Italy and along the Adriatic, then gradually spread across Western Europe, laying the economic foundations for the Italian Renaissance and the mercantile empires of Venice and Dubrovnik, forerunners of the great colonial empires of the following centuries. The rigidity of a coin-based money supply was one of the major constraints to medieval business, which was overcome by a variety of creative innovations. While the Greco-Roman economy had been driven by minted coins, unstinting credit became the great lubricant of commerce in Italy.13 The rise of Italian merchant bankers marked a significant new phase in the evolution of money from coinage to bills of exchange and other forms of money based on credit and trust. Italian merchants exporting goods by sea to distant markets in Western Europe introduced bills of exchange as a form of promissory note in which the buyer agreed to pay for the goods at some future point in time. Often these notes were backed by the guarantee of another person or local institution of notable wealth in the buyer’s country. Although the guarantor usually did not participate in the transaction, he was able to leverage his reputation as a catalyst to facilitate trade. Eventually, the use of bills of exchange spread throughout Europe.

This practice marked a transition from commodity money based on the value of the metal of which it was composed to credit money based on trust between individuals and institutions. Each time a transaction was successfully carried out between a buyer and seller, the trust between them increased and their willingness to transact business grew. Successful transactions progressively shifted the basis of trust from the underlying commodity or the transaction to the buyers and sellers engaged in those transactions. With increasing frequency, buyers and sellers extended credit to one another to increase the volume of their trade. Reputable traders and trading houses found that they could carry out transactions based on the confidence and trust which other buyers and sellers placed in them. This gave rise to the emergence of the original merchant-bankers, which facilitated trade by transferring charges and credits in the accounts of their clients. The annual cycle of Champagne Fairs of France during the 12th and 13th centuries relied almost exclusively on credit instruments known as fair letters. These fairs became the financial clearinghouses for long-distance trade between north and south.14, 15 No longer was the creation of money dependent on an underlying commodity. Credit money could be created in the marketplace based on trust in those involved in trade, that is, in their capacity to complete transactions.

We still tend to think of economics solely or primarily as a matter of production. Production in the absence of markets may have use value, but it has no economic value. Market is a creative social institution which is creative of money. Market is a social organization designed to promote mutually beneficial relationships between people. The growth of wealth is a measure of humanity’s capacity to integrate myriad points of production and consumption within an ever widening, increasingly interconnected and complex network of trust. Each step in expansion of the network, multiplication of its interlinkages and increase in the trust underlying the relationships is directly productive of greater wealth and greater social power.

The growth of credit money has passed through many stages since then. Today credit money generated by banks to commercial and individual customers and by companies to their corporate and individual customers represents one of the major sources of money. Keynes considered money on account, money that comes into existence along with debt contracts for deferred payment, as the primary form of money.16 Indeed some monetary scholars argue that all money, even commodity based money, is based on the creation of credits and debts, which constitute the two sides of every credit transaction.17

In earlier centuries, only a relatively few individuals, mostly from the aristocratic class, had access to what we now refer to as consumer credit. Since then the power of money creation has moved from banks, merchants, governments and a few wealthy individuals to the common man. Today the power of money creation is once again getting personal, but this time on a global scale. Consumer credit now represents a major source of money creation. In the USA alone it represents upwards of $2.7 trillion.18 This is roughly equivalent to the total value of US currency notes in circulation.

The rapid expansion of the global credit card industry represents an unprecedented stage in which the power of creating credit money has shifted to individual consumers in the form of outstanding charges on their credit cards. Banks set credit limits, but it is the individual who decides how much to use, when to use it and when to pay it back. In most cases, the underlying asset securing this money is simply trust in the credit-worthiness of the borrower based on past credit history. Visa, the world’s largest retail electronic payments system, links nearly 15,000 retail banks in more than 200 countries around the world with millions of merchants and about two billion card holders in a seamlessly integrated system involving 80 billion transactions valued at more than $6 trillion annually.* The development of a highly sophisticated global system for distributing the power of money creation to millions of individuals marks a new stage in the evolution of money. Individual trust has been institutionalized as a social system.

8. Money as Social Power

Monetarists regard money as a measurable quantity of financial instruments – currency notes, deposits, debt obligations, etc. – that can be tabulated by various measures of the total money supply, M0, M1, M2, etc. In contrast, this article focuses on money as a force that accomplishes work in society. That force is best measured by the results it generates, not merely by the quantity in circulation in various forms.

The value of a chemical catalyst cannot be adequately measured by its physical weight. Its value derives from its power to drive chemical reactions. Given the right temperature and pressure, a catalyst makes possible reactions that might otherwise take years to occur or never occur at all. The power of the catalyst is inseparable from the context in which it functions.

The same applies to the physics of money. The primary aim of money is wealth creation. The power of money to create or multiply wealth depends on many factors. Most notable is the speed or velocity with which it is utilized, the number of transactions it catalyzes during a period of time. The higher the velocity with which transactions are completed, the higher the productivity and effective power of money. Therefore, examining various measurements of the money supply is insufficient to comprehend the extent to which the power of money has multiplied in recent centuries.

Another important determinate is the purpose for which money is applied. Money invested in production of beneficial goods and services possesses power to promote human welfare. Money applied for speculation in commodities, land, and financial instruments may multiply rapidly, but serve no useful social purpose. On the contrary, it may, as recently demonstrated, undermine the normal functioning of the real economy. In recent years, major corporations on every continent have been flush with funds. Often that money is being redirected for speculative purposes, even in countries where there is a serious shortage of capital for infrastructure development or other productive investments. The same applies to the utilization of money on activities that destroy or deplete the environment or threaten the security of other people by war or terrorism. A mere quantitative increase in the volume of money in circulation tells us very little about its overall contribution to human welfare or its untapped potential for catalyzing social development. Managing a society by the numbers is nothing less than speculation. The power of money is too great and important to be left to technical specialists, any more than we would leave the choice of our marriage partners to geneticists breeding for certain desirable traits.

Before the advent of the Industrial Revolution more than 50% of economically productive activity in the Western world was self-production for self-consumption or barter, i.e. it did not involve monetary exchange. Since 1800 monetarization has spread rapidly to encompass a much larger portion of the world economy. From then to now, total world GDP has increased about 100 fold in real terms. During the same period, real income has grown about 15 fold in per capita terms, in spite of a seven fold increase in world population.19 Scholars most commonly attribute this incredible achievement to the development and application of technology since the dawn of the Industrial Revolution. But this is an oversimplification. The development of new industrial technologies was accompanied by a corresponding and equally radical development of new social technologies, including new types of markets, new types of institutions and new ways to create money. It was also a period in which human rights and democratic freedoms have been widely distributed and education has spread rapidly. Without these corresponding changes in social organization, the results of technological innovation would have been far lesser. Indeed, the first rudimentary steam engine can be traced back to the 1st century AD Alexandria, some 1600 years before James Watts’ invention in 1775. So it is evident that technology alone does not generate development. The extended use of money as a social organization played an important part in the democratization of political, economic and social rights.

9. The Psychological Evolution of Money

We have so far traced the psychological evolution of money from commodities to transactions to the people and firms undertaking those transactions and eventually to banking institutions specialized in the financing of trade, public expenditure, war and other activities. Psychologically this marked a movement from informal types of money or credit employed locally to impersonal, institutionalized forms of money operating over an extended geographical area. The physical chronology of different forms of money differs widely from place to place, but the progressive evolution from informal to institutional money is universally valid.

Until the 20th century, the most common form of paper currency used in Europe was the ‘banknote’, a promissory note issued by a state or commercial bank. The first European bank notes were introduced in Sweden during the 17th century. In England, the trust once placed in the goldsmith bankers of London who held gold bullion on deposit was gradually extended to a wider range of banking institutions holding public deposits of precious metals and other assets as backing for the notes they issued. The demand for more and cheaper money culminated in establishment of the Bank of England in 1694 and the Bank of Scotland the following year, which began issuing banknotes backed by their governments, which soon replaced the goldsmiths’ receipts as the principal paper in circulation. By the time Adam Smith published his famous book The Wealth of Nations in 1776, bank money exceeded metallic money, a milestone in world monetary history.20

For much of the 19th century, banknotes were the principal source of currency circulated in the USA. In 1789 the US Congress chartered the First Bank of the United States to issue banknotes. After the bank closed in 1811, the Second Bank of the United States was chartered until 1836. After the Civil War, national banknotes issued by federally chartered commercial banks and backed by deposits in the US Treasury came into vogue. At one time nearly 10,000 different kinds of banknotes in addition to more than 5000 counterfeit varieties were in circulation in the US, some accepted only locally and others over a much wider area depending on the reputation and perceived trustworthiness of each institution.21 Privately issued banknotes remained in circulation until 1936, when they were replaced by Federal Reserve Bank Notes, which in turn were later replaced by Federal Reserve Notes backed by the assets of the Federal Reserve Banks.

10. The Supremacy of the State

The generation of money as a medium of exchange in trade is only one origin of money. By a parallel route money also has been created by government fiat as a means to pay for services rendered to maintain the security and welfare of the state. Adam Smith explained the rationale for this form of money creation, “A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money; even though the term of its final discharge and redemption should depend altogether on the will of the prince.”22

The theory of Chartalism holds that tax debt has always been the principal basis for the creation of money, even in ancient times. Even when coins were the dominant form of money in ancient Greece, power of coinage was rigorously controlled by the state. According to Keynes, the issuance of fiat money in the form of government-issued tokens such as engraved clay tablets, copper or carved wooden sticks, is at least four thousand years old.23 The state used these tokens to pay for goods and services and accepted them as legal tender for the payment of taxes.

Today we tend to look with suspicion at the idea that governments can create fiat money out of thin air without the backing of gold or silver, simply by declaring money as a legal tender for payment of taxes. The very idea that government can print money at will often evokes horrific visions of profligacy and impending financial crisis. The current Euro crisis is cited as evidence that the capacity of governments to spend must be strictly curtailed. The truth is quite different. One of the main reasons for the Euro-crisis is that the countries of the Eurozone have renounced their right to print money at the national level without creating an all-European institution with the power to take over the responsibility for ensuring the availability of sufficient money for a full employment economy.

Viewed historically, public debt is a remarkable evolutionary innovation. When the Roman Empire went bankrupt it did so without owing money to anyone, because the very concept of public debt had not yet been conceived. Given the vast resources of the Empire, the precipitous plunge into the Dark Ages may have been prevented, had it known what we know today. The invention of public debt was to play a central role in the development of the nation-state.

China introduced the first paper currency during the 10th century. Its value was linked to the value of precious metals but was not convertible. The English monarchy introduced a unique form of money in the 12th century known as the tally stick, which was akin to a wooden bill of exchange. Tallies were notched sticks representing specific amounts of taxes payable to the King. The monarchy issued tallies to pay for its expenditures in advance of tax receipts and then accepted them back as payment of taxes in lieu of gold. For 700 years tallies were employed as a convenient method of payment by merchants for private transactions, thus becoming an earlier form of government-issued money. As the value of tallies grew to exceed the amount of taxes due to the throne during the present year, they came to constitute a form of public debt advanced by the people to the government to be repaid from future tax revenues. Over time the value of tallies in circulation continued to grow based on public confidence in the strength of the monarchy and the prosperity of the country. Thus, money was created based on trust in the government and the economy over which it presided.24, 25

The psychological history of money reveals the evolution of a remarkable social invention. What began as a proxy representing things of material utility for human survival gradually evolved into a symbol representing trust in the ability and integrity of a person or organization to complete commercial transactions. From there the symbol generalized itself to reflect the trustworthiness and reliability of the institution issuing the money, be it a company, commodity exchange, merchant banker, commercial bank, central bank or government. The capacity of the state to create money required for governance, defense and public welfare is one of the essential conditions for the emergence of modern nation states.

At each stage of its development, the foundations of money became less material and dependent on specific persons, things or events, more subtle and dependent on the capacity of an institution or an economic system to fulfill an ever-widening array of human wants. As is always the case, the more subtle the forms it developed, the more powerful money has become.

The psychological basis of money was dramatically illustrated during the US banking panic of 1932. Banking panics had been a periodic occurrence throughout American history, with major occurrences in 1818, 1837, 1857, 1873, 1893, 1907, 1930, and 1931. When rumors spread that a bank was about to fail, depositors rushed to the bank to withdraw their deposits. Not even the financially soundest bank could withstand a panic, since most of its assets were lent to borrowers and could not suddenly be withdrawn to pay depositors.

The greatest panic of them all occurred in successive waves from 1930 to March 1933, resulting in the failure of 2444 commercial banks, compared with just 73 during the previous panic of 1907.26 On assuming office as President that month, Franklin Roosevelt went on the radio to deliver the first of what would become known as his fireside chats. FDR appealed to the American people to halt the panic by reminding them that America still possessed the rich natural resources, industrious people and huge industrial capacity that had generated so much prosperity. He promised to immediately introduce legislation to guarantee the security of bank deposits and regulate the banking industry. When the banks reopened the following week, long lines of people formed to redeposit their hard earned money and the panic ended.

What began as a loss of faith in individual institutions of the financial system was reversed by a restoration of trust generated by faith in the national government, which represented the wealth, people and productive capacities of the nation as a whole. Faith in America became the foundation for the American monetary and financial system. Since 1957 every US currency note proclaims that faith by the motto “In God We Trust”.

11. The Ultimate Search Engine

Originally valued for the things that could be obtained with it, money has gradually come to be valued as a thing in itself, valuable not only because of what it can buy, but also because the mere possession of it signifies an accumulation of social power and capacity that can be applied for both economic and non-economic purposes.

For the individual who acquired or possessed it, money became a means to obtain political patronage, social influence, military power, religious indulgences, recreation and entertainment, and virtually every other form of social benefit. It became a measure of a person’s marriageability and romantic desirability. Those who obtained it in large quantity came to be regarded as superior in intelligence, ability, and courage. They were accorded respect and deferential treatment, itself a form of power that opened up opportunities unavailable to the rest of humanity. Money became a symbol embodying all that human beings value and aspire for on earth and in society.

For the society that evolved the appropriate organization to generate and utilize it, money became a catalyst for awakening people’s aspirations for the finer things of life, for releasing their energy and initiative for risky enterprise and ceaseless labor, for raising production and productivity to ever higher levels, for spurring continuous innovation and new invention. Once that energy was released, money also became the organizational means for channeling that energy effectively for productive purposes.

The remarkable role of money as a networking instrument to match needs and capacities has not been adequately recognized. Without the advent of accurate indexed search engines such as Google run by complex algorithms, trying to find information among more than 14 billion pages of the World Wide Web today would be quite like searching for a needle among millions of proverbial haystacks. Money plays a comparable role in matching buyers and sellers in the world of commerce as well as matching economic with non-economic needs and capacities in global society. Money is the ultimate search engine. For while Google is still confined largely to searching the cyberspace of virtual information and transactions, money extends its domain of power to all planes of human existence – material, social, mental, psychological and even spiritual. Money not only facilitates the free exchange of economic goods and services. It plays a similar role in the interconversion of all varieties of socially desirable ‘goods’, such as education, health care, culture, popularity, social status and political power. Rightly applied, money has the power to promote peace and security, save lives, educate youth, improve health, and foster understanding and the development of culture.

Money is not only a powerful catalyst. It is also a great transformer. Like the secret formula for converting lead into gold sought after by the alchemists, money facilitates the conversion of any type and form of social power into any other type – conversion of scientific knowledge into power for greater production, conversion of political power into health and education.

Money is a great transformer. Like a dam across a raging river, it helps channel and direct the raw energy and productive potential of society so that it can be harnessed for useful work. Like the turbines of a hydroelectric project that transform the kinetic energy of the river into power that can be distributed to power a city, money transforms every variety of power for application in all fields of social activity.

12. Money as Human Capital

Money has evolved from a material thing to a symbol that represents material things, a symbol representing trust in commercial transactions and in the people and institutions that participate in them. From there it has evolved further to represent trust in the national government that issues currency and regulates the economy, which is founded on trust and confidence in the nation itself. There is no reason to conclude that the process will stop at this point. Given the inherent instability and inequality resulting from the current dollar-dominated global system, it seems inevitable that further efforts will be made to expand the concept of monetary union geographically from national governments and nation states to regional groupings, and ultimately beyond. A global currency was advocated by Keynes and the British government as an alternative to the Bretton Woods system in 1944. FDR directed his secretary of the treasury, Henry Morgenthau Jr., to also develop plans for a world currency, though the US subsequently withdrew support for domestic political reasons.27

In another direction, the psychological evolution of money is moving from things, institutions and governments to its ultimate source – the individual human being. The human being is the source of all resources. For all things become a resource only when they are recognized as such by the human mind. Converting sand into bricks, glass or silicon chips or decayed organic matter into fuel, synthetic fabrics and pharmaceuticals are strictly human activities. In that sense Human Capital has always been and will always be the real source of wealth creation, human welfare and well-being.

The power of any society to create money ultimately resides in the psychological values and capacities of its people. The willingness of individuals to honor obligations and commitments is the basis for the creation of credit money. The willingness of society to extend and disseminate the power of money to all citizens is the true basis of democratic economy. This trend is illustrated by the unprecedented extension of consumer credit to cover the vast majority of people in USA. About three quarters of Americas now have access to credit card money, including about 45% of low income families.28, 29 This has been made possible not only by the development of a very sophisticated credit delivery and monitoring system, but also by the willingness of individuals to accept, utilize and repay the credit. Banks may allocate the right to create credit card money, but it is only the individual card holder who can decide to exercise that right and actually create it.

The individual becomes the ultimate issuer of money based on the trust society places in him, which is founded on his own trustworthiness and trust in himself. In spite of four years of economic slowdown, in 2011-12, only 2-4% of US credit card holders were more than 60 days late in making payments. This reflects the psychological capacity of the people to create money and the willingness of the society to extend it to all who exhibit that capacity. Extending that capacity further to reach the entire American population and eventually to all humanity is a line of evolution that will mark a fuller recognition of the value of the individual human being and the essential role of the individual in the development of global society.

We conclude, as we began, with the observation that the world already possesses the capacity to promote the welfare of all human beings. To do so will require many changes in law, public policy and institutional functioning. It will also require a fundamental reconsideration of the nature and role of money in human development and a willingness to reorient values, attitudes and policies to unleash the full potential of this remarkable human invention for the welfare and well-being of all.

* See
13. Lopez, The Commercial Revolution of the Middle Ages, 72.
14. Lopez, The Commercial Revolution of the Middle Ages, 90.
15. Edwin Hunt and James M. Murray, A History of Business in Medieval Europe 1200-1550 (Cambridge: Cambridge University Press, 1999), 29, 63.
16. Wray, Understanding Modern Money, 29.
17. David Graeber, Debt: The First 5000 Years (New York: Melville House, 2011).
18. “Federal reserve statistical release” February 2013, Board of Governors of the Federal Reserve System
19. Ivo Šlaus and Garry Jacobs, “Human Capital and Sustainability,” Sustainability 3(2011): 97-154.
20. Davies, A History of Money, 238.
21. Wray, Understanding Modern Money, 64.
22. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations.
23. Wray, Understanding Modern Money, 30.
24. Hunt and Murray, A History of Business in Medieval Europe, 66-67.
25. Davies, A History of Money, 147-51, 252.
26. Elmus Wicker, “Banking Panics in the US: 1873-1933” edited by Robert Whaples EH.Net Encyclopedia September 4, 2001
27. Robert Mundell, “The Case for a World Currency,” Journal of Policy Modeling 27, no.4 (2005): 465-475.
28. The Gallup Poll: Public Opinion 2004 (Lanham: Rowman and Littlefield publishers, 2006).
29. Louis Hyman, Debtor Nation: The History of America in Red Ink (Princeton: Princeton University Press, 2011).

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