Editor’s Note: This is the next in a Continuing Series of Articles by Joe, as excerpted from his Book;“Banking on Failure” co-authored by Laurel McDevitt.
[su_dropcap style=”flat”]B[/su_dropcap]ANKING IS A large collection of financial (i.e., “money”) services and transactions. As we learned in the story of “Those Dishonest Goldsmiths” and in the discussion of currency exchange in chapter 6, gold also plays a prominent role in the history of banking. This chapter further recounts stories of money, gold, other metals, and their evolving and intertwining relationships.
The principal points are that money is necessary but that there is no clear best choice of what money should be. What a predicament! Like Thomas Edison’s apocryphal statement “I have not failed – I’ve just found 10,000 ways that won’t work,” it may be that civilization has not yet found
the optimal money. Or it may be that no single “right answer” exists. We will find in later chapters that one mission of modern central banks is to control money through “monetary policy.” Our discussion here sets the stage for the evaluation of such monetary control and other topics.
Resource material for this chapter includes (i) P. L. Bernstein, The Power of Gold: The History of an Obsession, Wiley, 2004, (ii) P. L. Bernstein, A Primer on Money, Banking, and Gold, Random House, 1968, (iii) A. Fergusson, When Money Dies: The Nightmare of the Weimar Collapse, Kimber, 1975, (iv) L. E. Lehrman, The True Gold Standard – A Monetary Reform Plan without Official Reserve Currencies, The Lehrman Institute, 2012, (v) M. N. Rothbard, The Case for a 100 Percent Gold Dollar, Ludwig von Mises Institute, 2001, (vi) N. Ferguson, The Ascent of Money: A Financial History of the World, Penguin Press, 2008, (vii) L. E. Lehrman, Money, Gold, and History, The Lehrman Institute, 2013, and (viii) J. M. Pimbley and L. McDevitt, Simple Money, 2nd Edition, Maxwell Consulting, LLC, 2013.
Role of Money
Let’s start at the beginning. Every adult must acquire the survival necessities of food, shelter, and clothing. The most direct means of acquisition is to grow one’s own food, build one’s own shelter, and make one’s own clothing. Free people, however, choose otherwise. Just as baking two pies is little more effort than baking one, production of food, shelter, and clothing admits vast economies of scale. A farmer can double the size of her “garden” to feed two families rather than one without doubling her labor or investment in tools. By doubling her production, the farmer will exchange the excess crops, perhaps, for the clothing and firewood that her neighbor provides.
The superior efficiency of this exchange, or “barter,” system is indisputable. All participants in this barter system earn their necessities with less time and effort. The heightened efficiency increases survival probability in “lean years” and, in good times, enables pursuit of happiness in the form of, for example, recreation and entertainment. Voluntary participation is the ingenious element that powers gains in productivity through barter.
Direct barter is potentially manageable in small communities but suffers from the complexity of innumerable “exchange rates” among the barter items (e.g., vegetables, meat, clothing, livestock, lumber, barn construction, medical services, et cetera). The establishment of money simplifies the barter system tremendously. People exchange their goods and services for money that they use, in turn, to exchange for items they need from others. Money becomes the preeminent barter item but has value only in its ability to facilitate free market exchange of goods and services.
Money is an extraordinarily simple and elegant solution to the barter exchange rate problem. Further, the size and scope of the barter market increases tremendously due to our ability to save money for future years, borrow money for future repayment, and transmit money easily over long distances. Essentially all human societies invent money, just as they discover fire, in their pursuit of survival and advancement.
Yet what particular barter item could serve as money? The requirements “to save money for future years” and “transmit money easily over long distances” eliminate most candidates. Crops and cattle, for instance, are of great value and some historical accounts consider them as early forms of money.[1] But they are not well suited as money. The dominant money of the thousands of years of recorded history has consisted of coins of metals and alloys such as copper, bronze, silver, and gold.[2]
The requirement that trumps all others is the certainty people have that whatever serves as money has enduring value. A man will agree to accept copper coins for his bushels of wheat only if he is confident in the value of other goods he can purchase with the same coins – whether now or next year or within the same village or many days’ travel away.
Gold and Silver through the Millennia
What substance or physical item could possibly inspire such confidence simultaneously in almost all people? What would all people agree has value “now” and will have significant value at all future times? There is nothing tangible on Earth that can provide this certainty of value. Surprisingly and with no strong explanation, however, the metals gold and silver are history’s best attempts to answer these questions.
Gold, and to a lesser extent silver, has smitten human beings through all of recorded history and across a wide range of cultures. No society rejects gold. (Lenin may have said “we will make public toilets out of gold,” but neither he nor his successors in the Soviet Union followed through on this promise.[3]) While gold does have practical industrial uses as an excellent conductor of both electricity and heat,[4] jewelry serves as the primary non-monetary “utility” for gold. The application as jewelry, of course, makes the point that gold captivates people. Whether in the palaces and tombs of Egyptian pharaohs or the emperors of China, the rulers of India, the czars of Russia, or the royalty of Old Europe, the evidence shows not merely “demand” for gold but downright emotional zeal!
The history is clear. Human beings have always regarded gold and silver as “valuable.” This persistence and confidence are precisely what one needs for viable money. But there’s a counter-argument: why should this work? If a society bases its money on gold or silver and then, suddenly, a large fraction of the society realizes one “cannot eat” gold or silver and that there is no evident value other than “shiny and pretty,” what happens then? The monetary system would fail. But it has never happened. There is no certainty gold or silver will always work as money, but the world has thousands of years of good experience.
Gold and silver also have convenient chemical and physical properties for use as money. They are generally stable and un-reactive (especially gold) so that, for example, gold does not rust (form an oxide layer) as does iron. The melting temperatures of gold and silver are low so that it’s straightforward to melt these metals and recast them as other coins or objects when desired. Consistent with the similarity of these properties and the allure to human beings, gold and silver occupy the same column of the Periodic Table of the Elements.[5]
Figure 7‑1 Silver (Ag) and gold (Au) in the same column
Successful monetary systems of many societies have consisted of various denominations of gold coins, silver coins, and coins of copper, bronze, and other metals. When a society attempts to define its currency with more than one metal simultaneously (e.g., “bi-metallism” with two metals), difficulty ensues since the relative value of any two metals evolve over time due to supply and demand. As one example, the Coinage Act of 1792 in the U.S. dictated that one ounce of gold would equal fifteen ounces of silver of defined purity levels.[6] Legislative acts of this sort ultimately fail when one metal loses value relative to the stipulated ratio. Citizens prefer to spend the coins of the cheapened metal and thereby drive coins of the more expensive metal out of circulation.[7]
Precious metal coins have also fallen prey to “clipping” in which owners surreptitiously shave or cut small pieces of metal off the coin circumference.[8] After accumulating significant quantity, these clippers would melt the residue to form larger pieces to sell. Not only was the practice illegal, this currency debasement was often punishable by death in societies such as seventeenth century Great Britain.[9]
The next excerpt for Chapter 7 will discuss “Fiat Money”
[1] See, for example, chapter 1 of N. Ferguson, The Ascent of Money: A Financial History of the World, Penguin Press, 2008.
[2] See, for example, Money and coinage through History.
[3] See, for example, “World Business: That Russian [USSR] Gold,” Time, May 15, 1964.
[4] See, for example, http://periodic.lanl.gov/79.shtml .
[5] A convenient Periodic Table is available at http://periodic.lanl.gov/index.shtml. Note that copper (“Cu”), silver (“Ag”), and gold (“Au”) are lightest-to-heaviest in the same column of the Periodic Table. We don’t believe this observation has any financial meaning, but let’s diffuse scientific knowledge wherever possible!
[6] See http://www.constitution.org/uslaw/coinage1792.txt .
[7] See, for example, this discussion of Gresham’s Law: “Bad money drives out good if their exchange rate is set by law.”
[8] See chapter 12 of P. L. Bernstein, The Power of Gold: The History of an Obsession, Wiley, 2004.
[9] Id.
