A Brief History of Money, Central Banks, and Currencies
In a world where there are many things for sale, we persist in selling dreams to each other. You wonât find any of that here. Thereâs some messing, to liven things up in an otherwise drab subject. Nonetheless, the discussion will be a brief history of money, central banks, and currencies. Particular attention will be paid to inflationary and deflationary monetary policies.
The History of Money
Contrary to popular belief, it began with the barter system in 6000 BC. Bartering is the swap of one resource for another like a farmer trading milk for new clothes. Bartering requires finding someone with the things you want and them wanting what you have to offer. It would often take several attempts to complete a trade. Some think money was initiated from a currency like beads, shells, coins, etc. Currency actually manifested to solve the flaws within the barter system by establishing a standard unit of exchange. Henceforth, currency, cash, and money will be used interchangeably for meaning the same thing.
Sound Money has 5 attributes:
- Divisible
- Durable
- Verifiable
- Portable
- Scarce
It wonât take long to realise that milk doesnât have any of those properties. Sound money is a phrase coined from the sound that gold makes when it is dropped to verify its authenticity. Itâs suddenly becoming clear why Irish people use âsoundâ as slang to describe a genuine person. A currency can only be considered sound money when all 5 traits are consistently upheld. Can todayâs money be considered sound? Money has changed several times throughout human history so it is likely to change again. Although, itâs shocking to see new money invented during a lifetime. You can probably tell where Iâm going with this but hold that thought.
Paper bill usage has been traced back to China from 618â907 during the Tang dynasty. Merchants could redeem paper money for gold coins and vice versa. However, that canât be done today. Present-day fiat banknotes are different because they canât be redeemed for nada. Fiat money basically means âvalue by decreeâ. Therefore, fiat money only has value because governments say that it does.
Remember what I said about selling dreams? The biggest lie isnât the devil convincing the world he doesnât exist, its governments convincing the public their paper money has value.
Central Banks
Letâs be clear, Iâm not an anarchist but Iâm skilled at calling a spade a spade. Long after the spell in China, paper bills were adopted by Europeans in the 17th century. The first batch of paper money doing rounds in Europe was made by the Bank of Stockholm in 1661. These banknotes were also redeemable for gold coins. This iteration of paper money was an IOU (I Owe You) â an acknowledgement of debt. Thus, exchanges between people and businesses were categorised as debtors, the amount owed, and creditors. The debtor would give an IOU banknote with the amount owed. The creditor would go to the local bank to redeem it in gold.
Eventually, banks realised that the people they gave printed IOUs didnât return for gold at the same time. This was the inception of Fractional Reserve Banking.
This method of Banking is a policy whereby banks only hold a fraction of their allocation of money and loan out the rest to generate interest. This wasnât sustainable because occasionally people would do bank runs at the same time. Local banks wouldnât be able to honour the redemption of IOU banknotes because they didnât have the gold anymore. They inflated the money supply and made it less scarce. Central Banks were developed as a result to prevent bank runs from happening. Itâs beginning to make sense why your parents and grandparents donât trust banks, right?
The first Central Bank was the Bank of England founded in 1694. Central Banks regulated local banks. Only Central Banks could print notes and old banks needed to remove their notes from circulation once they went bust. Soon just Central Bank notes remained. Now each country has a Central Bank run by the government that is responsible for the countryâs currency.
Although Ireland is in the European Union (EU), Ireland still has its own Central Bank. Fun fact, itâs not Bank of Ireland. Hereâs a bit of nostalgia â before the gentrification of Dame Street, there was a big grey building with a giant golden ball on a stick in the cultural hub of Temple Bar. Emos and Spicers alike used to meet up at âThe Bankâ. In all honesty, everyone met up there as it was a notable landmark. That Bank was our Central Bank until it was knocked down to put Central Plaza in its place. Irelandâs Central Bank moved to the Docklands. The Irish euro coins arenât minted (made) there either. The Irish Mint is at Sandyford in Dublin.
The Gold Standard
The Central Bank IOUs became problematic when countries printed too much of them (surprise, surprise). Once again, they broke the cardinal rule of scarcity required for sound money. A classic example of the nursery rhyme involving the old lady who ate the fly, then a spider to catch the fly, followed by a bird to catch the spider, and so on. The initial problem wasnât solved and reactionary solutions made things worse. In the same fashion, local banks inflating IOUs wasnât solved by Central Banks, yet here comes the gold standard. Countries needed to back up their currency. Consequently, the United States of America (USA) established a gold standard in 1879.
In those days, you could exchange an ounce of gold for $20.67. The gold standard deflated the use of banknotes. Drastic inflation was averted but not for long. There was a change in the gold standard after World War 1 in 1914 which subsequently led to the Great Depression in 1929. This was due to the US government printing more money than it had. In 1930, the United Kingdom (UK) and the USA stopped redeeming notes for gold coins. There wasnât enough gold to back up the extra money they printed. They needed to print more money (to inflate the economy).
Governments figured out that, the more money people had, the more people would spend. This is still true today e.g., the 2008 recession and recent covid pandemic payments. Citizens in the 1930s wanted to get their moneyâs worth instead of saving it because later on, that money wonât have the same value. The difference can be observed in the modern version of the US dollar bill which no longer references gold.
The Bretton Woods Agreement
Countries printing money as much as they wanted induced issues as some nations purposely devalued their currency to increase the value of their exports. In 1944, US President Roosevelt enabled the Bretton Woods Agreement to come to fruition. 44 countries met in New Hampshire and agreed that all currencies were backed up by the US dollar (USD) and the USD was backed by gold. The International Monetary Fund (IMF) was simultaneously created. The role of the IMF was to lend to countries in need. The World Bank was also created during that time to aid developing countries specifically. Partially due to the effects of World War 2 which was still taking place and didnât end until 1945.
The Bretton Woods Agreement ensured exchange rates were fixed across global currencies. It was a means to deflate the use of banknotes as well. Nevertheless, the policy was short-lived and was ended in 1971 by US President Nixon. The USD and effectively all the global currencies it backed became floats, i.e., backed by nothing. It also explains why exchange rates fluctuate nowadays.
Inflation vs. Deflation â Conclusion
In the 51 years since the Bretton Woods Agreement, the USD has lost 85% of its value due to inflation. That is to say, $1 saved in 1971 is now 0.15c in 2022. Itâs stark when you increase the capital saved. $100 back then is now worth $15. $1,000 back then is now worth $150. The loss of buying power is frightening especially if you wish to leave an inheritance for your kids.
Inflation is like a thief going into your house taking 1 thing every day. By the time you notice youâre like 𤏠This is what happens when there is a centralised monopoly on money.
Itâs no wonder why Ray Dalio, owner of the worldâs largest hedge fund, popularised the saying âCash is Trashâ. Fiat money is inflationary and centralised (controlled by a single authority). Itâs not worth holding for extended periods. This is prevalent in how all Irish banks provide crap saving interest rates. A measly 25 basis points (0.25%) interest on savings. If you add into the context that the Consumer Price Index (CPI) showed Irelandâs economy inflated by 2.4% in 2021 â savings didnât reduce the blow. The Central Statistics Office (CSO) of Irelandâs blanket CPI average isnât a good enough metric for inflation in my opinion, as it differs from individual to individual and sector to sector. For instance, drivers will notice the recent rise in the cost of petrol faster than those that donât drive. Evidence of this can be seen in the graph below.
Saving enough for emergencies is where I draw the line before looking for greener pastures. Wealthy people know this. Thereâs a metaphor that states âThe poor spend. The middle class save. The rich investâ. Youâll find that in my articles, problems are not just identified â they are met with solutions. Inflation is an enemy when the only asset you have is money. If you have a house or stocks, the economy inflating is a good thing because it increases the value of those scarce assets. Itâs basic supply and demand economics. For example, if there are only 1000 houses by the beach and everyone in that area gets a salary raise, beach houses will also rise in price. Thatâs due to a higher amount of money (or demand) chasing the same supply of goods.
An asset is something of value that appreciates over time. Weâve confirmed that money loses value over time. How is money an asset? There are different asset classes e.g., stocks, bonds, commodities, real estate, collectibles, etc. They are deflationary (scarce). Money isnât scarce because governments excessively print it. Cash is a liquid asset that is easily converted to something else (fungible). When financially literate people say they are âliquidâ, they mean that they have the cash to use while their other assets are tied up. When you google a celebrityâs net worth, youâre seeing an estimate of what their assets are worth if they were liquidated (sold) for money.
Cryptocurrencies are deflationary assets that are decentralised (controlled by the public). Iâll focus on Bitcoin (BTC) for the remnant of this article as I plan to delve deeper into crypto in next weekâs release. Bitcoin was created by the pseudonymous Satoshi Nakamoto in 2009 after the 2008 financial crisis. BTC is the epitome of sound money based on the qualities depicted at the start of this article. It's divisible into 100 million units. Bitcoin is durable as it runs on the worldâs most secure database â the bitcoin network. BTC is verifiable because of its cryptographic nature, it cannot be forged or counterfeited. It is also portable, irrespective of banks or borders you can send Bitcoin globally 24/7 in minutes to hours. Most importantly, Bitcoin is scarce because there will only ever be 21 million BTC.
The number of millionaires in the world is 56 million at the moment, if BTC was to be evenly divided they all couldnât own a whole bitcoin. Furthermore, the worldâs total 8 billion people wouldnât own a whole bitcoin if it was evenly split. You donât need to own a whole bitcoin but, you do need to get it while you can.
*** If you made it this far itâs been a pleasure writing for you. I hope you enjoyed it and picked up something along the way. I want to simplify complex things including the environment, economics, and crypto. Please follow, like, and share as it helps me a lot. Subscribe to get exclusive access to the audio version of this article. Tune in weekly for more insights.
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