Driving the evolution of money, from the earliest
emergence of commodity money, has been the desire to increase the efficiency of
carrying out exchanges. In the absence of money, trade is accomplished by
barter, the direct exchange of commodities or services to the mutual advantage
of both parties. Such exchanges require a double coincidence of wants or
multiple trades. If I have apples and want grain, I have to find someone who
has grain and wants apples. Alternatively, I can engage in a series of
intermediate trades that ultimately result in the exchange of apples for grain.
In primitive societies with a small range of goods, barter can work well
enough, but as the range of goods expands, barter becomes increasingly
inconvenient and costly.
Several considerations have affected the evolution of
commodity money itself--from cattle and grain toward shells and then bronze and
ultimately to silver and gold. Commodities are useful as a means of payment and
store of value if they were are less bulky in relation to their value, more
durable, more homogeneous, and more easily verified as to their worth than
other commodities. These considerations favored the use of the precious metals,
for example, over cattle and grain, encouraged the use of gold and silver
rather than bronze and copper, and further affected the way that silver and
gold were used as money over time. Early commodity money, for example, was
weighed, not counted, including the early uses of silver and gold. The
introduction of coins that were stamped with their weight and purity allowed
money to be counted and again reduced the costs associated with making
transactions. Silver became the dominant money throughout medieval times into
the modern era. Relative to silver, copper was too heavy and gold was too light
when cast into coins of a size and weight convenient for transactions.
The next important evolution was the introduction of
"representative" paper money. Warehouses accepted deposits of silver
and gold and issued paper receipts. These paper receipts in turn began to
circulate as money, used as a means of payment and held as a store of value.
The paper was fully backed by the precious metals in the warehouse. Once again,
efficiency was enhanced by the convenience of carrying paper money as opposed
to the bulkier silver or gold coins.
Owners of the warehouses soon learned that the holders
of the paper receipts would not simultaneously redeem the gold deposited with
them. The warehouses could therefore lend the gold--in turn, often converted
into paper notes--holding a reserve of gold that allowed them to meet the
normal demands for redemption. This is the beginning of fractional reserve
banking.
Seventeenth-century English goldsmiths are usually
credited with this transition to modern banking, though the first paper money
was introduced in China in the seventh century, a thousand years before the
practice became widespread in Europe. Paper notes and early banking were
introduced in Europe in medieval times and further advanced by the great
banking families of the Renaissance. The spread of paper notes and fractional
reserve banking opened up the potential for credit expansion to support
economic development but also introduced the possibility of runs and liquidity
crises as well as the risk of insolvency through the credit risk associated
with the lending.
In the nineteenth century, many countries were on a
bimetallic standard, allowing the minting of both gold and silver coins. But by
late in that century, many countries had moved to the gold standard, and
currency and bank reserves were backed exclusively by gold. Barry Eichengreen
(1996) describes the gold standard as "one of the great monetary accidents
of modern times," owing to England's "accidental adoption" of a
de facto gold standard in 1717. Sir Isaac Newton was master of the mint at the
time and, according to Eichengreen, set too low a price for silver in terms of
gold, inadvertently causing silver coins to mostly disappear from circulation.
As Britain emerged as the world's leading financial and commercial power, the
gold standard became the logical choice for many other countries that sought to
trade with and borrow from, or emulate, England, replacing silver or bimetallic
standards.
England officially adopted the gold standard in 1816.
The United States moved to a de facto gold standard in 1873 and officially
adopted the gold standard in 1900. The international gold standard refers to
the period from the 1870s to World War I, during which time the major trading
countries were simultaneously on the gold standard. Though many countries went
off the gold standard during World War I, some returned to a form of gold
standard in the 1920s. The final blow to the gold standard was the Great
Depression, by the end of which the gold standard was history.
Eichengreen argues that the emergence of the gold
standard reflected the specific historical conditions of the time. First,
governments attached a high priority to currency and exchange rate stability.
Second, they sought a monetary regime that limited the ability of government to
manipulate the money supply or otherwise make policy on the basis of other
considerations. But by World War I, economic and political modernization was
undermining the support for the gold standard. Fractional reserve banking,
according to Eichengreen, "exposed the gold standard's Achilles'
heel." The threat and, indeed, reality of bank runs created a
vulnerability for the financial system and encouraged governments to seek a
lender of last resort to provide liquidity at times of distress. Such
intervention was, however, inconsistent with the gold standard.
The international gold standard involved adherence to
certain "rules of the game." First, the national unit of currency had
to be defined in terms of a certain quantity of gold. Second, central banks had
to commit to buy and sell gold at that price. Third, gold could be freely
coined, such coins represented a significant part of the money in circulation,
and other forms of money were convertible into gold at a fixed price on demand.
Fourth, gold could be freely imported and exported.
With the collapse of the gold standard, countries
moved to fiat money systems. Fiat money is inconvertible, meaning that it is
not convertible into nor backed by any commodity. It serves as legal tender by
decree, or fiat, of the government. Its value is based on trust--specifically
that others will accept it in payment for goods and services and that its value
will remain relatively stable. This trust is based, in part, on laws that make
the fiat money "legal tender" in the payment of taxes and, in the
United States, also in the payment of private debts.
Fiat money consists of both paper currency and metal
coins the face value of which exceeds the value of the metal content of the
coins. The need to finance wars encouraged early efforts by governments to
issue fiat money. Early examples include the continentals issued by the
American government during the Revolutionary War, assignats issued during the
French Revolution, and the greenbacks issued during the Civil War. Most such
issues of fiat money were followed by severe increases in prices, as
governments tapped to an ever greater degree the easiest--in some cases perhaps
the only--source of revenue. These experiences highlight the importance of
control of the money supply for achieving price stability.
Today, money consists of currency, coin, and
transactions deposits (that is, checking accounts) at depository institutions,
including, in the United States, commercial banks, thrift institutions, and
credit unions.It is not clear when the first check was written.
The earliest evidence of deposits that might be subject to checks is from
medieval Italy and Catalonia. But at that time, the depositor had to appear in
person to withdraw funds or to transfer them to the account of another
customer. Checks did not come into widespread use until the early sixteenth
century in Holland and until the late eighteenth century in England.
The payment system has evolved further in recent
decades with the spread of credit cards and then debit cards. Credit cards
allow consumers to purchase all kinds of goods "on credit," making
payment to the credit-card company for a collection of purchases later by
check. In effect, the use of credit cards separates the purchase of goods from
the ultimate settlement but increases the efficiency of exchange. Debit cards
allow the consumer to make a purchase from a checking account through an
electronic instruction to debit the account instead of by writing a check,
another advance in efficiency.
Even more recently, electronic money has been
introduced, still perhaps more in concept than in practice, at least in the
United States. I will return to the role of electronic money today and the
potential for the spread of electronic money in the future.
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