Monday, March 2, 2009
The meaning of money: a historical perspective
Presented to the Club on March 26 2007 by William J. Bartz
In 1965, the United States abandoned a practice that had underpinned human civilization for millennia. The process really began many decades earlier, and technically speaking, the complete disassociation wouldn’t be fully realized until a few years later in 1971. But 1965 signaled to that keen citizen that the nation’s monetary base was severed from a commodity – the age-old, very definition of money. Money had now become ultimately an abstraction. For silver coinage minted for daily economic exchange went extinct, to be replaced by base-metal alloy coins joining fiat paper currency. For most Americans, the change in our currency has given little pause for concern. The economy has had its ups and downs, our politics has wrangled back and forth, but on the whole, our money works well in the marketplace and the United States has enjoyed burgeoning prosperity in the last 40 years, so that now 1 in 11 households is classified with millionaire net-worth status – a mass upper class, so to speak, something unprecedented in history. For others, though, our money, which has become reliant on the control, credit and confidence in the United States Government to underpin its value, causes unease and trepidation about continuous inflation and keeping the whole system functioning without hard money assets. So what did money really mean throughout human history? How is it conceived of today? What does this mean for the future of our country? Tonight, I’ll take you through a broad, sweeping view of money from its beginnings, concentrating especially on its development in the United States and how we arrived at the money we use today.
Money arose out of the universal need for exchange. Primitive societies used barter – the direct swap of goods and services – but that was hardly better than self-sufficiency because it relies on the rare circumstance of perfectly matched trades. It was indirect exchange that permitted an expanding economy, better fulfilled human needs and even made civilization possible through specialization. Under indirect exchange, you sell your product or service not for a good you want directly, but instead for another good that you can, in turn, sell for the good or service that you do want. That intermediate good must have great marketability that you are confident can be resold. In other words, it must function easily as a medium of exchange that is widely recognized and acceptable. Some goods are more widely demanded than others, enhancing marketability: more divisible into smaller units without loss of value, more durable over time and more easily transported and safeguarded. Gradually certain goods will emerge as the most marketable and used as the general medium of exchange. These special goods are called money.
Many different goods have been used as exchange media: copper in ancient Egypt, cattle in ancient Greece, salt in Abyssinia, nails in Scotland, sugar in the West Indies, tobacco in colonial Virginia, and grain, beads, tea, cowrie shells, wampum, fishhooks and furs. But through cumulative development over the centuries, two precious-metal commodities, gold and silver, emerged as the most efficient and universal money. Naturally found gold was used for gold units in Egypt about 3000 BC or BCE, while silver was used in Mesopotamia. But the clear, practical and concrete device that would embody money for millennia were coins.
Gold and silver coinage was first produced in the time of Croesus, the last king of Lydia, in Asia Minor about 550 BC or BCE. A century earlier, the Lydians made coins from electrum, a natural river deposit of gold alloyed with 20 to 45% silver, but later developed the technology to separate the gold from silver and made both kinds of coins called staters, the name for a standard unit of weight. Seagoing merchants spread these coins all over the Greek world. Another ancient Greek unit of weight for monetary purposes was the talentum or talent. Babylonian in origin, the talent had been a weight used on a scale. Interestingly, these days, we use the word “talent” to qualify a person that has worth. In 400 BC or BCE, the Romans began circulating a bronze coin called the As, which originally weighed one Libra, that is, one Roman pound. Eventually, this coin was referred to simply as a Libra because of its weight. We get our abbreviation for pound, as “lb.” from this word Libra. The As was divided into twelve parts. Each of these parts was called Uncia, from which we get our English unit ounce. The Libra had a lasting influence in Britannia after the Romans were expelled. The British currency unit is denoted by the capital letter “L” crossed by a hyphen, but pronounced “pound” from the Latin word, pondus. The British Pound Sterling simply had its origin as the weight of one pound of silver. So, since the beginning of coinage we can see that value and weight of coins were intimately related.
The quality or fineness of metal coinage was also of utmost importance. People wanted to know that the coin not only had the proper weight, but also contained a known and reliable content of precious metal within the alloy. Sterling silver’s fineness, for example, is 92.5% pure silver alloyed with copper. In early coins, fineness could vary, so verification was commonly done by merchants by means of an assay. Coins from recognized minters that had a reputation for uniform weight and consistent fineness became the most desirable coins in the marketplace. One such coin known for its superb quality was a one-ounce silver weight minted by a Bohemian Count named Schlick beginning in 1519. The Count lived in region called Joachimsthal, or we would say Joachim’s Valley or Dale. These large, hefty coins were widely called Joachim’s thalers and finally, “thaler.” In 1528, the Hapsburg Emperor revoked the count’s charter and made thalers the coin of the realm. Thalers were adopted for the coinage of many other areas in Europe and eventually our name “dollar” emerged from “thaler.”
Probably the most widely circulated and once-famous-but now-forgotten coin in history was the silver Ocho Reales or “pieces of eight” – a reale meaning “royal money.” These large coins were minted in Mexico and Peru by Spain from the fabulously rich silver deposits of the New-World mines. They become the first truly global money, for they were used everywhere from the Americas, east to Europe, and west to China via the Spanish colony of the Philippines. The coins were known for uniform quality and were made more secure from the common tampering practice of coin clipping by having a milled or ridged edge. The obverse depicts a crown over two globes representing the old and new worlds. Flanking the globes are two pillars or columns representing the opposite promontories of the Straits of Gibraltar which signify the gates to the New World and symbol of Spanish power. Each column is draped with a S-shaped swag of ribbon which taken together read “Plus Ultra” – more beyond. The official name of this coin was the “Columnario,” but the Spanish-speaking regions just called them “peso” – the Spanish word for “weight.” In English speaking regions, these coins were called “Pillar dollars” or Spanish milled dollars. The symbol for dollar that we still use today is believed to be taken from the “S”-shaped swag superimposed on a pillar, it’s the vertical line we draw through a capital letter “S”.
In colonial America and the fledgling new nation just after the Revolution, Spanish coins were used as the principle metallic money, making it the currency used by our Founding Fathers. If George Washington did actually toss a coin across the Rappahannock River, it would have been a Spanish Pillar Dollar. So influential was the Spanish Dollar that when it came time for the United States to establish its own mint in 1792 and coin its own currency, it was modeled on the features of the Spanish coin. The U.S. silver dollar, first minted in 1794, was designed to match the value, dimensions, weight, fineness and features of the Spanish peso right down to the milled, ridged edges. This resemblance was a factor in making the new U.S. coins acceptable.
The Coinage Act of 1792 specified that the dollar would be the nation’s monetary unit, defined in terms of both gold and silver, with gold valued at exactly fifteen times higher than silver. The U.S. dollar was officially defined as the value of 371 ¼ grains of pure silver (that’s about 4/5ths of an ounce) and proportional fractions for the smaller silver pieces: half dollar, quarter dollar, dime and half-dime. The dollar was also defined as exactly 24 ¾ grains of gold (about 1/20th of an ounce). Defining the dollar in terms of both gold and silver without favoring the use of either metal came to be known as the “double standard” or bimetallism. Our good friend, Alexander Hamilton, as first Secretary of the Treasury, was a firm believer in coins of high intrinsic value. He deplored any form of debasement that would reduce the pure metal content of a coin to less than its money value. But the bimetal standard proved to cause severe difficulties as supply and prices of silver and gold metals fluctuated affecting their circulation. A large number of coins during the first thirty years of the mint’s operation never got into circulation. Hamilton’s 15 to 1 gold to silver valuation ratio differed from European ratios creating circumstances that at times overvalued or undervalued one metal in relation to the other. U.S. coins often fell into the hands of metal speculators, who would melt them down or ship them out of the country at a profit. There was little choice but to continue using Spanish dollars and other foreign coins.
Unlike the Spanish system of subdivision into 8 pieces, the United States chose to use a decimal system for its money. Because both U.S. and Spanish dollars co-circulated for the first few decades of this country, it’s interesting to see prices for items at 12 ½ cents or 37 ½ cents for merchandise at the time reflecting the use of Spanish dollars divisible into 8 reales or bits as American’s called them. Two bits lived on as an expression for a quarter – shave and a haircut – two bits! Another holdover of the piece-of-eight Spanish dollar into our time, was stock values on the New York Stock Exchange, which started in 1792. Stock prices were valued to the nearest eighth of a dollar as recently as 2001, when the system was finally converted over to decimals.
In the 1850s, the United States finally created and maintained, for the first time, an adequate supply of its own coins in circulation. First, the gold-silver ratio was changed to 16:1 in 1834, overvaluing it in the world market, allowing the gold coins finally to stay in circulation. Second, the pure silver content of the proportional coins, half dollar, quarter and dime, was reduced 7% to end speculation and melting of some silver coinage. When coins no longer have a pure-metal commodity value that matches their money value, they are called “subsidiary” coins. But, third, as most importantly, the discovery of gold in California in 1848 and the gold rush following the next year was a momentous event for U.S. coinage. Gold coins were brought into use on an unprecedented scale. So finally in 1857, the U.S. was in a position to outlaw the use of the Spanish dollar and all other foreign coins as legal tender.
It wasn’t long thereafter that the Civil War erupted and brought a new form of money into use on a national scale - paper currency. (Okay, now we’re talkin’). Of course it’s true that paper money wasn’t really new. It had been tried during the Revolutionary War to finance that war. The Continental Congress tried to make the paper currency representational currency, meaning that it was fully backed by metallic money and redeemable in gold or silver coin, specifically mentioning the Spanish milled Dollar. But Congress didn’t have the power to enforce obtaining specie metal from the states; the populace saw through this and the value of Continentals became worthless. Paper money, in the form of bank notes representing silver and gold coin in vaults, were also issued from many banks in early America, but they were only good within a limited area and often were redeemed below par value depending on the bank’s reputation.
So it was a bold step for the United States government, which had previously shied away from issuing paper money, given the miserable experience of the paper Continentals, to try it again. But something had to be done. Hoarding at the start of the war took much of the gold and silver money out of circulation. Congress passed the Legal Tender Act in 1862 which made paper notes, called greenbacks - so-named for their all-over, backside green ink color - the principle lawful money in the North. These greenbacks were not representational money, they weren’t redeemable in coin or any other security, but had legal tender status solely on the ability of the United States to make them good. We call this “fiat” money. Fiat money allows a government to expand the money supply beyond the restriction of a finite commodity money supply. It only has value in an exchange of buyer and seller if both have full faith in the credit of the issuing authority. But, America still wasn’t ready for fiat money. The greenbacks began to depreciate as soon as they were issued and attendant price inflation caused their value to sink to about 75 cents on the dollar by the end of 1862, eventually reaching the lowest point of 35 cents on the dollar by 1864. They bounced up in value at the end of the war, and surprisingly, years later did eventually reach their full face value again in 1879. The United States had been on a de facto gold standard since the 1850’s with overvalued gold, and finally made it official in 1873 in concert with other European nations. Silver continued to circulate as subsidiary coinage. The gold standard brought price stability, even deflation, to the economic system. Bitter debates raged between those who wanted to return silver to full-metal status with gold as a way to inflate the money supply, and those who wanted to maintain the rigid discipline of the gold standard based on a pretty-much fixed metal monetary base.
In the end, the United States emerged in the last decades of the 19th century as a rising world economic power after developing powerful industries in railroads, oil, manufacturing and banking. Paper money held the confidence of the American populace, mostly because it was backed by gold or silver, but even those fiat greenbacks held their par value. In response to this success, the United States government embarked on a program to expand the quantity of representative money in the form of paper currency in 1879 and was looking for a paper manufacturer to offer a better, more cost-competitive product. A young man from Dalton, Massachusetts, Winthrop Murray Crane, representing a family papermaking concern traveled to Washington and placed a bid for the contract at 39 ¼ cents per pound against tough competition and won. Upon returning to Dalton, his first task was to find a mill in which to make all this paper and hire a work force. He bought the idle textile mill of Thomas Colt’s in Pittsfield and got the operation underway. Paper money continued to find acceptance with the American public and the world, and that contract has been renewed continuously now for over 128 years and represents the oldest contract in continuous existence with the United States government.
But, I digress…
The concept of money changed in other ways as a result of changes made during the Civil War. In 1863, Congress authorized the National Bank Act; this law created a system of national banks and regulated those functions involved with banking and currency issuing. The national banks had the power to issue bank notes backed up with government bonds. With the principle of fractional reserve banking – meaning that banks only had to hold a fraction, usually 15 – 25% of their total deposits in hard-money gold or silver instead of all of it to meet depositor’s potential demands for it – banks could loan out money they could create from thin air. This is called bank money. Making loans based on only partial reserves is a risk banks assume to make good returns, but it also works powerfully to expand the money supply to meet a growing and prosperous economy if controlled well. Bank money is inherently inflationary and if there is ever a loss of confidence by the public leading to a run on reserves that just aren’t there, the system breaks down. Even increasing government control of national banks had not been enough to prevent the panics of 1873, 1893 and 1907, for example.
The political response to these panics was the creation of a central bank for the United States, The Federal Reserve System, in 1913. The Federal Reserve was given controlling power over the nation’s economy with the ability to create the country’s paper money, to put money into circulation or take it out, to create credit and to raise and lower interest rates. The Federal Reserve also acted as the clearing house for bank checks, an increasingly preferred form of money for Americans to pay their bills a hundred years ago that has continued to this day.
War has a monumental effect on money and World War One proves the statement. That Great War resulted in upsetting the available resources and money supply of the major European powers. Early in the conflict, gold flowed into the United States from the European Allies on an unprecedented scale in payment for supplies and materials. By war’s end, the U.S. had 40% of all the world’s gold reserves. The war also contributed to an extremely heavy demand for paper money caused by the expansion of business and employment for the war effort. The Federal Reserve issued fiat “Federal Reserve Notes” in response, the initial issue of the only bank-note type still in existence today. As a result of the war, the American dollar became that world’s leading monetary unit, backed by increasingly large reserves and strong credit position.
England, France and other European nations had to abandon the gold standard as the war left them with depleted treasuries. The United States, however, maintained the gold standard and enjoyed fabulous gains in prosperity and leisure during the 1920’s. Then came the greatest economic calamity in the nation’s history, the Great Depression, precipitated by the Stock Market Crash of 1929 that not even the Federal Reserve at the time could really solve. The money supply contracted by one third; stocks fell by five-sixths of their pre-crash levels. Upon taking office in March 1933, President Roosevelt took quick action to stem the disappearance of gold by hoarders by prohibiting private ownership of gold, which culminated in taking the United States off the gold standard a month later. Gold was devalued to define the dollar as only 13.71 grains instead of 23.22 grains making its price $35 an ounce instead of $20.66. The nation no longer had a gold standard for its own citizens, but gold still backed the dollar for the purposes of valuing it for international trade. This “Gold Management Standard” as it was called, was codified in 1946 with the Bretton Woods agreement following World War Two. The Bretton Woods System created a system of fixed exchange rates that allowed governments to sell their gold to the United States treasury at the price of $35/ounce. The Bretton Woods system ended in 1971, when President Richard Nixon stopped the trading of gold at the fixed price of $35/ounce and let the price float. That point marks the first time in history that the formal connection between major world currencies and real commodities was severed.
Now for my final remarks…When the 20th century began, money was largely based on gold and consisted principally of gold certificates, gold coin, greenbacks and bond-secured notes. Subsidiary silver coins of 90% fineness for small change and silver paper certificates, backed by silver dollars that few people wanted to carry, also circulated until the price of silver on the open market reached $1.38/ounce in 1964, exceeding the face value of silver coinage. Nickel-copper clad coinage began in 1965 as a result, except for the newly issued Kennedy half-dollar which contained 40% silver until reverting itself to copper-nickel clad in 1971. Once a prevalent coin in daily transactions, half dollars stopped circulating as a result of people keeping the more valuable silver coin over silverless ones. In the 1970s, the only currency left was clad coins and fiat paper Federal Reserve Notes.
In the past 40 years, we have gone from money being or having some link to precious-metal commodities to money that is really just another form of credit. No longer are we wealthy because of claims to hordes of silver and gold treasure, our wealth is measured by the number of digits found on checking-account bank statements, mutual fund accounts, stock portfolios, social security and pension statements, and real estate valuations. If not satisfied with the magnitude of those digits from our income, we can readily add more on with easy credit to support a lifestyle we choose, but hope that we can keep the debits from overwhelming the credits while we enjoy the good life. The $700 billion of U.S. currency in circulation has become a tiny 1 ½ % of the over $47 trillion dollars of financial assets in the United States, a nation which itself owns 34% of all the world’s wealth. All the gold ever mined in human history, some 152,000 metric tons, and worth $3.2 trillion at current prices, wouldn’t begin to back the phenomenal wealth that exists in this country or the world for that matter. Our wealth may not be real in the time-honored sense of a basis in hard money, but our system seems to be working. But something the influential economist John Maynard Keynes said still gnaws at me. To quote: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” I count myself among those unseeing millions, but I surely would like to find that one knowing man to ask him if this is all going to last.
Photo by Booleansplit, under Creative Commons License.