History of Money and its significance to the rise of Bitcoin — Part II
This is Part 2 of the blog post. Please first read Part 1. We will continue our discussion on the problems encountered with financial systems historically.
“I can make more generals, but horses cost money.” - Abraham Lincoln
Examples from history of inflation and recession
- Financial crisis leading to collapse of Roman empire: The first historic account of Govt. bailout is recorded in 33 ACE. Tiebrius was a very frugal emperor and levied fewer taxes. But in a very short span rebellions broke out, the land was hit by drought, some provinces came under attack, ships with treasures sunk and banks asked debtors to return the money and debtors were already bankrupt so their assets were seized. This lead to a big financial crisis and the Emperor had to bail out banks from his own treasure. It his beautifully explained in this article.
- Paper currency in China: The first known paper notes were used in China. The concept was simple. Coins were already being used but its value was very less and to buy items on a big scale a huge amount of coins were needed. Hence traders used to deposit coins at Govt. kiosks in exchange of currency notes. With these currency notes, the traders could then buy goods from all over the kingdom. Even the sailors from South Asia and Europe had to deposit all goods first with the Emperor’s trusted ministers and they would be given notes of value as deemed appropriate by them. The sailors could then buy items from local traders. If anyone in the kingdom did not accept the notes then they were punished by death sentence (‘Commies’, I tell you :) :) ). But then existing paper notes in circulation were not reused and were made from a non-durable material (tree bark) which was affected by weather. Hence constant printing of money led to severe inflation
- Bank of Amsterdam: All territories under King of Amsterdam had a different coinage system. Amsterdam was one of the most prosperous Port in Europe. The Bank accepted all types of coinage, gold, silver and even debased coins. The bank acted purely as a depository initially. It used to issue a ‘Bank money’ as credit in an account. This incorporated many modern banking concepts like trustworthy state guarantor, legal regulation and fractional reserve banking (which we will discuss later in this blog post). This fractional reserve banking led to the collapse of the bank and financial crisis in the country.
Gold Standard in USA
Since American independence till early 1900, its constitution gave Congress exclusive rights to print money which was backed by Gold reserves however central Federal reserve system was not in place. From there till Great Depression (1929) value of the dollar was fixed by Govt. in terms of gold. US Govt. passed controversial laws like forcing citizens to sell gold to Govt for fixed price but better cash benefits to foreign Govt for their gold. After World War 2, Europe had a financial crisis but it did not affect the USA and its dollar soon became the most important reserve currency in the world. Govt started printing currency notes which were not backed by any metal reserve and countries globally were debasing their coins (reducing the amount of gold and silver in coins). So now total currency notes with foreign Govt was more than currency notes in USA Govt reserve. Foreign Govt. started demanding gold back from US Govt. in return of US Dollars at the same rate which was offered to them. This system was abolished in 1971 and since that time the global market forces decide the value of gold and each currency.
“History reminds us that dictators and despots arise during times of severe economic crisis” -Robert Kiyosaki
Hyperinflation in 20th century
- Germany, 1923: German had to meet huge obligations because of loss after World War 1. The solution of the Govt was to print a tremendous amount of currency notes which devalued it and hence more needed to be printed. This lead to a vicious spiral and to buy weekly grocery one needed horse cart full of money.
- Hungary, 1945: This is the worst case of inflation and similar circumstance like Germany, albeit it was after World War 2. The prices doubled every 15 hours and its peak inflation was 1.3 X 10 ^16 per month.
Recently Zimbabwe also faced similar hyperinflation.
Few Evils of current financial System and a desperate need for an alternative
- Fractional Reserve Banking: We mentioned this term in above section. Banks keep a fraction of what we have deposited and lends out the remaining amount. Eg: When a customer deposits 100 ₹ in the bank then the obligation to the bank is just to keep a fraction of it (say 10% which is decided by central / federal bank) and lend out remaining. Smaller the value then more liquid cash in market which leads to more lending and can lead to financial crisis. Hence heavy regulation is in place for this
- 100% Fiat money in circulation: Till World War II the currency notes in circulation of a Govt. were backed either fully or partially by precious metal reserves like Gold. Hence if there is shortage then it can be compensated by selling the gold in its reserves. But today USD is a 100% fiat currency ( money which is irredeemable for commodity and only redeemable for fiat money)
- Government controlled (Centralized): All it takes a crazy democratically elected (or even otherwise) person to be in charge of the Govt. Zimbabwe is facing currently a situation of hyperinflation. For multiple reasons about 2 decades back, Ecuador adopted USD as its currency and initial years were very tough for poor and lower middle class. Decision on currency is taken by a few individuals and our entire life depends on them.
- Tracking of money: USA owes trillions of dollars to other nations and other nations owe similar amounts to USA. Almost each western country is facing financial challenges and even each major city is in debt. There is absolutely no track of the entire global debt economy. Moreover every individual 1 $ currency note that is printed exchanges thousands of hands in its life time and there is no tracking of each individually minted currency.
- Counterfeit able: Have you seen Hollywood movie ‘Catch me if you can’?. Con artist have existed since the birth of civilizations. Fake currency in circulation is one the biggest challenges of every Govt. With all security practices in places still people manage to duplicate it.
I hope by now you are completely convinced that the modern financial system is based on 2000 years of history and is far from perfect.
Each financial system has failed for various reasons
In my next article I will try to deconstruct the enigma behind Bitcoin but first it is imperative to understand a brief history of Bitcoin
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