“A nickel ain't worth a dime anymore.” - Yogi Berra
This week continues our series inspired by our recent talk entitled Decrypting Cryptocurrencies. Last week we started off the series by defining What Is Money and this week we will take a closer look at the history of money to learn more about its origins as well as the different forms it has taken throughout time.
Nobody really knows the true origin or history of money, but it’s is commonly believed to have been introduced for convenience purposes out of an economic system based on unspoken promises (e.g. “I owe you one”) or bartering (e.g. trading 6 chickens for a cow). The first known form of money was the cowrie shell, which comes from a type of mollusk primarily found in the Indian Ocean. Cowrie shells were first introduced as money in China and eventually adopted throughout Eurasia and Africa. The cowrie shell is actually the longest tenured currency in existence. In central Africa it was still possible to pay ones taxes in cowries all the way up to the early 1900s and to purchase small items at market well into the 1950s. So as a side note, the next time you meet a doomsday prepping gold bug, you might want to suggest that they turn their attention to cowrie shells instead!
Then around 1,000 BC China started using coins and small tools which were made of a variety of base metals such as copper, tin, or iron as currency. In last week’s post on the definition of money we talked about how money itself has very little to no intrinsic value, but it is used to acquire things with true intrinsic value (e.g. food, shelter, health, happiness, etc.). In this instance, the base metal coins and tools are one of the only examples of money carrying both intrinsic and implied value since both were extremely useful and could serve a variety of different purposes at that time.
Around 500 BC, coins using precious metals were first introduced in western Asia or modern day Turkey. Unlike base metals, precious metals don’t have much intrinsic value because their softness. But what they lack in industrial value, they make up for in scarcity. One aspect of good money, which we will talk about more next week, is that it needs to be scarce and difficult to counterfeit. In this regard, precious metals definitely have a leg up on base metals.
Then around the turn of the century, China introduced what many consider to be the first banknotes which were made of deerskin leather but eventually gave way to parchment or paper. The banknotes were first introduced due to metal shortages with the initial intention of being fully backed by coins. But over time this changed as the government took the liberty to increase the supply of paper money in order to finance their expenditures without an offsetting increase in metal coins. In other words, they “printed money.” The increase in the supply of banknotes without a corresponding increase in coins eroded the confidence in the paper currency which eventually became worthless. This cycle repeated itself for over 600 years and led to the collapse of five different Chinese dynasties until paper, or what the Chinese ended up calling “empty money”, was finally outlawed in the middle of the 1600’s.
Not coincidentally, this was right around the time when the first banknotes were being issued in Europe. Unlike the Chinese, most early banknotes in Europe were being issued by private banks, businesses, and even individuals rather than just the government. Quoting from an article entitled A History of Printed Money:
Soon states, principalities, cities, banks, guilds, institutions, and even private individuals - just about anyone with access to a printing press – started churning out banknotes.
As a side note, this practice sounds oddly familiar to the current state of the cryptocurrency market, but we’ll dive into that in more detail in upcoming posts. As you might imagine, these banknotes ended in much the same way as the Chinese ones did and in many cases they became completely worthless.
Eventually, governments centralized their currencies by making it illegal for other institutions to issue legal tender. They also almost universally embraced the idea of a currency backed by some sort of precious metal like gold or silver in order to re-build the public’s confidence in money. The US government took both of these steps right around the time of the Civil War in order to centralize their currency.
A commodity backed, centralized currency worked fairly well more or less until the Great World Wars and the corresponding economic depressions of the early 1900’s. During this time John Maynard Keynes introduced his economic theories which advocated for the government to take counter-cyclical measures by increasing spending during recessions to smooth out the economic cycle. In order to do so and as a response to the worldwide depression, major economic world powers including England and France, and eventually the US, abandoned the gold standard and adopted a pure fiat currency backed only by the full faith and credit of the issuer. Unlike a commodity backed currency where the supply of the paper money is dictated by the availability of the commodity backing that money (in most cases gold and silver), fiat money can be increased or decreased as needed. This flexibility has proven useful in times of economic depression, but it also has given a tremendous amount of power to the entity which controls the money supply (e.g. the Federal Reserve here in the USA).
Fast forward to the Global Financial Crisis where central banks around the world took extraordinary measures with their monetary policies in order to try to restore faith in the global financial system. Now almost a decade removed from the depths of the Crisis, many experts believe that the actions of the US Federal Reserve and other central banks around the world saved the financial system from a complete collapse…but at what cost? What many people learned from the Crisis was that the modern day financial system is a complex, fragile, interdependent web with a tremendous amount of power lying in the hands of a select few. And this set the stage for the now infamous white paper published under the pen name Satoshi Nakamoto, which gave rise to Bitcoin, the first widely accepted cryptocurrency, in 2008.
There are two key takeaways from the history of money. First, pretty much anything can act as a form of money as long as everyone agrees that it is so and secondly, no form of money is immune to failure. As such, an argument could be made for a new form of currency eventually replacing our current, established forms of money. In next week’s post we’ll look at some aspects of money that differentiate good versus bad forms of currency and eventually apply cryptocurrencies to this test to see where they fall on the spectrum.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
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