Understanding money: Banknotes and fiat

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Mar 5 · 4 min read

Quickly, what came first, the gold standard or fiat money?

Did you say the gold standard?

Really?

AHAH, WRONG

Well, now that we’ve put you in your place, welcome to the third chapter of Utrust’s history of money. We expect you’ll have read the last couple of chapters, which you can find here and here. If you haven’t checked them out, they’re about the first forms of money in history and the appearance of metal coins, respectively.

We’ll give you a few minutes to read them.

Ok, done? Good.

Now, we are going to take a big leap in time.

The first paper money appears in China, in the 7th Century

First thing’s first, though: what is fiat money?

is actually a latin word. It’s a verb, and it indicates a command, or an order. It means “make it so”, or “let it be done”. This should be our first clue about what fiat money means. It’s money that functions as money because someone decided that it would.

Who’s that someone? The government.

The government’s authority is what ensures that fiat money must be accepted for all trade within the area it governs.

Because the principal characteristic of fiat money is that it has no intrinsic or use value.

We have talked about three kinds of money before, if you’ll remember. Representative money, commodity money, and standardised coinage. We’ve explained what they are in the first chapter.

Fiat is different from all of them because it is not pegged to anything of value, and it is not an object that is valuable in and of itself.

So how about those banknotes in China?

The Chinese government monopolised their issuance in the 11th Century

Before this happened, you could speak of paper money, or banknote-like money (quite the invention, by the way, coins had been the rule for centuries), but you couldn’t speak of fiat. Since the government didn’t vouch for their value, banknotes before the 11th Century were more likely than not representative money, pegged to copper coins. Metal coins are heavy, evidently. This meant that some people, those wealthy enough to own a large amount of them, didn’t want to carry them around on commercial trips. They would deposit them with a trusted party, and get a voucher in return. This voucher could then be exchanged back.

And so it was for around 400 years. Banknote-type vouchers circulated alongside copper coins in China. You could speak of paper money, but not of a fiat.

Then the government realised this was an excellent way of replenishing its coffers.

The government started issuing their own paper vouchers in exchange for people’s coins, ensuring anyone using them that they could exchange the vouchers for specie whenever they liked.

But wait.

Doesn’t this make these notes representative money, not fiat?

It’s debatable.

Theoretically, the vouchers were exchangeable for coinage (or even other materials, like silk), but in practice this was never allowed. By the time the Yuan dynasty came along (1271–1368), these exchanges were banned entirely, and paper money became the rule. The banknotes’ value was ensured by the authority of the government, not by any reserves of actual valuable materials.

To be fair, the notes in circulation had surpassed the coin reserves almost immediately.

Europe would take a looooooooong time to catch up

Were there promissory notes being used during medieval times and afterwards? Sure.

But these were more akin to what we think of as bank cheques nowadays than actual banknotes. The Chinese were using banknotes of varying values, printed by the millions, by the middle of the 13th Century. Europe wouldn’t see anything similar until the British started doing it in the late 17th Century, about 400 years later.

Why did they do it?

The Spanish were flooding Europe with gold and silver

Ah, colonialism.

Between the 15th and 16th Centuries, the Spanish (and the Portuguese, we might as well say it), were really taking mining for precious metals into overdrive. It is estimated that silver influx doubled between 1470 and 1520, and increased even more in the 1520s. This increased supply of money made prices skyrocket. There simply were too many people with too much money and not enough stuff to buy.

This made people and governments reevaluate the value of money. People were starting to understand that if the value of gold and silver could fluctuate this much, then perhaps it wasn’t so essential after all.

The modern banknote admits that the value of money is defined by its usage, meaning some form of social and legal consensus.

The British were very wary of completely untethering paper money from gold, however, since that was still seen at the time as some form of guarantor of value. This means we can’t really speak of fiat money yet.

What the Western world was preparing for is something very different: the gold standard.

Were there any forms of true fiat money popping up around this time? .

We will tell all about it in the next chapter: The rise and fall of the gold standard!

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Building the world’s first cryptocurrency payment solution…

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Building the world’s first cryptocurrency payment solution to offer instant transactions, buyer protection & crypto-to-cash settlements. utrust.com

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The easiest way to pay with & accept digital currencies. The money of tomorrow is here. Experience digital payments with Utrust: utrust.com

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Building the world’s first cryptocurrency payment solution to offer instant transactions, buyer protection & crypto-to-cash settlements. utrust.com

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