Where did paper money come from? That’s the question behind this article from The New Yorker: The Invention of Money. It’s a review of recent biographies of John Law and Walter Bagehot. The author concludes:
The present moment in financial invention therefore has some similarities with the period when money in the form we currently understand it—a paper currency backed by state guarantees—was first created. The hero of that origin story is the nation-state. In all good stories, the hero wants something but faces an obstacle. In the case of the nation-state, what it wants to do is wage war, and the obstacle it faces is how to pay for it.
At the same time, I’ve been reading a few popular books on monetary history. One is Jack Weatherford’s The History of Money. Weatherford, best known for his books about Genghis Khan, is eminently readable, and hits most of the major developments. However, he is clearly in the Ron Paul school of economics: gold alone is money, governments are profligate and can’t be trusted, free banking is good, central banks are bad, etc. There are also a number of basic factual errors in the book, which leads me to recommend it only if you take it as a brief survey that gets many things wrong and is a bit outdated.
Weatherford’s major reference for his chapter on paper money is John Kenneth Galbraith’s: Money, Whence It Came and Where It Went. So I decided to go directly to the source. Galbraith, a lauded economist, has a view that is much more authoritative and nuanced than Weatherford’s. Galbraith’s book concentrates mainly on the origins of banking and the modern money system, and not so much on the deep history of money in the ancient world or the Medieval period.
I’d like to take these (and others) and give an account of how the money system works today. While Modern Monetary theory is a good descriptor of how money works in nation states in the present, it often doesn’t describe how that system initially came about, and what makes it so radically different from how the money system functioned in ancient economies.
But first, I’d like to say a few brief words on why any of this matters.
Like it or not, money runs the world. If you want to understand how the world works—and how to change it—it’s important to know how the systems comprising it work. Money may seem like a boring topic (sorry!), but I would argue that no knowledge is more fundamental and useful for trying to make things marginally better. I can’t tell you how many people I’ve met who call themselves “Socially liberal but fiscally conservative.” And what do they mean by “fiscally conservative?” Nine times out of ten, it’s this: money is inherently scarce; debt is evil; and government budgets should be balanced down to the penny. You also have libertarian Bitcoin cranks, who are convinced that algorithms will save mankind once the state somehow withers away. These views are extraordinarily resistant to any kind of challenge, almost as if they were a de facto religion (in fact, they are probably even more resistant to rational analysis that most people’s religious faith!) Such people would be amenable to a more progessive message if not for the universal brainwashing about what money is, and what it does. History can provide a useful guide.
China’s False Start
All paper money all rests on the same fundamental basis: they are circulating IOU’s. The name of the creditor backing them and what’s used to securitize them changes over time, however. Sometimes it’s a particularly reputable member of the community. Sometimes it’s a king or other ruler. Sometimes it’s a democratically-elected government–or more precisely, the future anticipated revenues of that government. Sometimes it’s backed by something tangible, like silver, gold, or real estate (the most common options). Sometimes it’s not. Nowadays, sovereign money is usually backed by the government’s ability to redistribute and to impose binding liabilities on its citizens (and, by extension, it’s monopoly on the use of legitimate force).
Paper money began where papermaking began: in China. The usual sources were hemp and mulberry bark, and printing blocks were made of wood or metal. Because of China’s strong imperial state structure, centrality, and geographic reach, it could command officially stamped pieces of paper to be accepted by its citizens as currency in lieu of precious metals. The story is told in this excellent podcast by Tim Harford on the origins of paper money: Paper Money (50 Things that Made the Modern Economy)
In Harford’s telling, paper money begins in Sichuan province, where iron coins were used rather than gold and silver in order to keep specie from leaking out of China to the hostile territories surrounding China, such as those of the Jurchen. Iron coins had holes in the middle and were carried around on cords, called cash.
The problem, as you might expect, was that these strings of heavy iron coins were extremely cumbersome. You would be turning over larger weights of coins that the weight of the things you were trying to buy: 10 pounds of coins for a five pound chicken, or something like that.
Sichuan’s iron currency suffered from serious deficiencies. The low intrinsic value of iron coins, worth no more than a tenth of the equivalent amount of bronze coin, imposed a great burden on merchants who needed to convey their purchasing capital from one place to another, and on ordinary consumers as well. A housewife would have to bring a pound and a half of iron coin to the marketplace to buy a pound of salt, and a merchant from the capital would receive ninety-one and a quarter pounds of iron coin in exchange for an ounce of silver.
Of course, the inconvenience of transporting low-value coin affected bronze currency as well. In the early ninth century, the Tang government created depositories at its capital of Chang’an where merchants could deposit bronze coin in return for promissory notes (known as feiqian, or “flying cash”) that could be redeemed in provincial capitals. “Flying cash” was especially popular among tea merchants who wished to return their profits from the sale of tea in the capital to the distant tea-growing areas of southeastern China. The Song dynasty continued this practice under the rubric of “convenient cash” (bianqian), accepting payments of gold, silver, coin, or sil in return for notes denominated in bronze coin. (The Origins of Value, pp. 67-68)
In the mid-990s, Sichuan was captured by rebels (partly angered by depreciating currency), who shut down the mint. It remained shut even after the government regained control of the province. This prompted some private merchants to issue their own paper bills to compensate for the acute shortage of coins. Such bills represented debt—the debt of the private merchant, of course. These bills soon began to circulate, and people began using them in place of iron coins, as Harford describes:
Instead of carrying around a wagonload of iron coins, a well-known and trusted merchant would write an IOU, and promise to pay his bill later when it was more convenient for everyone.
That was a simple enough idea. But then there was a twist, a kind of economic magic. These “jiaozi”, or IOUs, started to trade freely. Suppose I supply some goods to the eminently reputable Mr Zhang, and he gives me an IOU. When I go to your shop later, rather than paying you with iron coins – who does that? – I could write you an IOU.
But it might be simpler – and indeed you might prefer it – if instead I give you Mr Zhang’s IOU. After all, we both know he’s good for the money. Now you, and I, and Mr Zhang, have together created a kind of primitive paper money – it’s a promise to repay that has a marketable value of its own – and can be passed around from person to person without being redeemed.
This is very good news for Mr Zhang, because as long as people keep finding it convenient simply to pass on his IOU as a way of paying for things, Mr Zhang never actually has to stump up the iron coins. Effectively, he enjoys an interest-free loan for as long as his IOU continues to circulate. Better still, it’s a loan that he may never be asked to repay.
No wonder the Chinese authorities started to think these benefits ought to accrue to them, rather than to the likes of Mr Zhang. At first they regulated the issuance of jiaozi, but then outlawed private jiaozi and took over the whole business themselves. The official jiaozi currency was a huge hit, circulating across regions and even internationally. In fact, the jiaozi even traded at a premium, because they were so much easier to carry around than metal coins.
Over the next ten years, these “exchange bills” became important in China’s intraregional trade, but the problem of bogus private bills issued by unscrupulous traders remained an ongoing problem for government officials. There were growing calls for government to get more involved in the circulation of bills. Enter the new prefect of Chengdu, one Zhang Yong. He issued a series of government reforms to address this problem in 1005. He:
1.) reopened Sichuan’s mints and introduced a new large iron coin that was equivalent to ten small iron coins, or two bronze coins;
2.) restricted the right to issue exchange bills to a consortium of sixteen merchant houses in Chengdu that were known to have sufficient financial resources to back the bills up, and;
3.) standardized the bills by mandating that they be issued in a specified size, color and format, using government-supplied labor and materials (although merchants could add their own watermark).
There were no standard denominations; rather, the merchants ascribed the value of the note in ink as needed. A three percent fee was charged for cashing in the notes. There was no limit on the number of bills issued. The amount of bills in circulation tended to vary with the seasons: more bills were issued in the early summer when new silk reached the market and in the fall during the rice harvest.
There were still problems with the paper currency, however, such as counterfeiting and overissuance of bills without sufficient backing. In 1024 under a new governor, Xue Tian, the government took over the issuance of jiaozi. A state-run Jiaozi Currency Bureau was established in Chengdu and given exclusive rights to issue jiaozi. The bills had the same format, but were issued in fixed denominations: one and ten guan. Most significantly, the bills had an expiration date of two years, exchangeable for fresh ones, giving the government a modicum of control over the amount issued and preventing the counterfeiting of worn or outdated bills. Also, quotas were established for the issue of the currency. Tea merchants engaged in intraregional and international trade were the most enthusiastic users of the currency, as it eliminated the need to transport heavy coins and prevented robbery by bandits (note that the needs of traveling merchants were also instrumental in the creation of Bills of Exchange issued by banks in medieval Europe centuries later).
Yet there were still problems. The government issued notes to procure military supplies from the merchants; and the ongoing costs of wars on the frontier led to their overissue. Plus, a new emperor nationalized the tea industry, meaning that the major consumers of jiaozi—the tea merchants—no longer had as much use for them. This loss of demand alongside oversupply caused a sharp depreciation in the value of the currency in the market. Instead of trading at a ten percent premium, the bills were now accepted at a ten percent discount. In 1107 the government issued a new paper currency—the qianyin—at a rate of 1:4 to the old, depreciating the earlier jiaozi bills in effort to reduce the supply.
The rest of the history of China’s bills is basically a cycle of the same thing: issuing new bills, overspending due to military needs on the frontier, rampant counterfeiting, bills depreciating, demonetizing old notes, new dynasties issuing new bills, etc. Bills were still in use in trade when Marco Polo vistied China. This is the description from the fourteenth century by the Arab Traveller ibn Battuta:
The Chinese use neither [gold] dinars nor [silver] dirhams in their commerce. All the gold and silver that comes into their country is cast by them into ingots, as we have described. Their buying and selling is carried on exclusively by means of pieces of paper, each of the size of the palm of the hand, and stamped with the sultan’s seal. Twenty-five of these pieces of paper are called a balisht, which takes the place of the dinar with us [as the unit of currency]
This demonstrates some of the essential dictums of Modern Monetary Theory.
The first is Hyman Minsky’s dictum: Anyone can create money, the secret is in getting it accepted.
The second is Felix Martin’s definition of money: Money is tradeable debt.
The other is the observation that that: The credit that is bears highest reputation is typically that of the sovereign. Gresham’s Law being what it is, this usually means that sovereign’s money will drive out all competitors, as we’ll see much later in the United States during the Civil War.
As a reminder, Gresham’s Law is this: Bad money drives out good, or perhaps, more accurately, people spend “lesser” money if they can, and hoard “greater” money for themselves.
Gresham’s Law…is perhaps the only economic law that has never been challenged, and for the reason that there has never been a serious exception. Human nature may be an infinitely variant thing. But it has it’s constants. One is that, given a choice, people keep what is best for themselves, i.e. for those whom they love the most. (Galbraith, p. 8)
A similar rationale led to the establishment of banks and banking in Northern Europe during the Age of Sail. You deposited coins and got a receipt for the amount of coins stashed in the vault. These receipts could be used to pay for things, with the value equivalent to the coins traded (in fact, the notes were more valuable, since they couldn’t be melted down or devalued).
A final interesting note: overissuance of paper currencies and lavish spending by the Yongle emperor Zhu Di (on wars, but also notably on the Chinese treasure ship voyages) led to China going back onto a silver standard just in time for the European discovery and conquest of the New World. The Chinese demand for silver is what fueled the European trade with the Far East, since the Europeans had nothing else that the Chinese wanted to exchange for goods like silks and porcelain. Without that silver standard, who knows what would have happened?
The sizable deficits incurred by Yongle’s costly foreign expeditions, including the famous maritime explorations of Admiral Zheng He and his fleet, and the emperor’s decision to relocate the Ming capital from Nanjing to Beijing were abated, albeit temporarily, by printing more money. Finally, in the 1430s, the Ming yielded to economic realities, abandoning its paper currency and capitulating to the dominance of silver in the private economy. The Ming state gradually converted its most import and sources of revenue payments in silver, while suspending emission of paper money and minting in bronze coin.
Though still uncoined, silver prevailed as the monetary standard of the Ming and subsequent Qing dynasty (1644-1911), fueled from the sixteenth century onward by the import of vast quantities of foreign silver from Japan and the Spanish colonies in the Americas. In times of fiscal crisis, such as on the eve of the fall of the Ming dynasty in 1644 and during the worldwide depression of the 1830s to 1840s, appeals to restore paper currency were renewed, but ignored. In the nineteenth century private banks, both Chinese and foreign, began to issue negotiable bills, but the weakness of the central government after its defeat in the Opium War precluded the emergence of a unified currency…Not until 1935, under the Republic of China, did China once again have a unified system of paper currency. (The Origins of Value, p. 87-89)
Although paper money first originated in China, the paper money we use today has no direct lineage with these systems. Government-issued paper money was invented independently in Western Europe, and under very different circumstances. We’ll take a look at that next time.
Despite the importance of paper money in Chinese history, the modern world system of paper money did not develop in China, or even in the Mediterranean homeland of Marco Polo or ibn-Batuta. It evolved in the trading nations around the North Atlantic. (Weatherford, p. 129)