The Origin of Guilds

In my previous post, I wanted to “set the stage” as to why it was Northwestern Europe, and not the many other locations around the world where complex civilizations developed, that formed the basis of the modern world. From this corner of the world sprang the impersonal markets and financial institutions that became the cornerstones of the modern world—institutions expressly designed for the plundering of resources from Africa, Asia, and the Americas by Western Europeans–the “Mongols of the Sea.”

But first we’re going take a short detour into the history of guilds.

Most people are aware of the basics of the guild system: practitioners of skilled trades in the Middle Ages were members of a guild which trained the members of said profession, regulated the working hours and conditions, and determined quality standards for production. In addition, members pooled their resources and took care of members who were unable to work, or the widows and orphans of members who had died. These were the Craft Guilds. Wikipedia describes them as, “…organized in a manner something between a professional association, a trade union, a cartel, and a secret society.”

However, guilds were not just craftsmen, but also merchants. Merchant guilds policed themselves and highly regulated business and trade in the Middle Ages. Buying and selling was tightly regulated by the merchant guilds, in accord with the charters granted to them by city officials, throughout the Middle Ages. Thus we see that unregulated commercial activity and “free trade” was not the historical norm by any means, but, rather, is a relatively recent development in human society.

Two other lesser known types of guilds were religious guilds, or confraternities; and frith (defensive) guilds, or mutual protection associations–perhaps something on the order of what we might call a “militia” today.

In tracing [the] history [of the guilds] we find the merchant guilds, the prototypes of the modern corporations; the religious guilds, the prototypes of modern church societies; the social guilds, the prototypes of Masonic, Odd Fellow and kindred organizations; the craft guild, the predecessor of the modern trades-unions; and finally, guilds of lawyers, and guilds of litterateurs and artists. [1]

We can consider guilds, then, as a form of risk-pooling, a uniquely human endeavor which has been going on probably since at least the Ice Age, and certainly as far as 12,000 years ago as evidenced by religious/feasting events at Göbekli Tepe, and later, at Stonehenge. As we learned in our study of the feasting theory, feasting and food-sharing appears to be inherent in the human species, and it likely enhanced cooperation among social groups allowing the formation of complex societies. Feasting events may have contributed to the formation of classes and inequality out of smaller, egalitarian band-level societies.

…Yet it is…evident that the sentiment of the Guild–that is, the desire to establish fraternal relations for mutual aid and protection…may rather be contemplated as a human sentiment, arising from the innate knowledge of his own condition, which makes man aware of his infirmity and weakness in isolation, and causes him to seek for strength in association with his fellow man.

The similitude, therefore, if not the exact form of the Guild, has appeared in almost all civilized nations, even at the remotest periods of their own history. Wherever men accustom themselves to meet on stated occasions, to celebrate some appointed anniversary or festival and to partake of a common meal, that by this regular communion a spirit of fraternity may be established, and every member may feel that upon the association with which he is thus united he may depend for relief of his necessities of protection of his interests, such an association, sodality, or confraternity, call it by whatever name you may, will be in substantial nature a guild. [2]

Let’s take a look at the history and anthropology behind such cooperative groups.

The first thing to understand about the ancient world, broadly speaking, is that there was no such thing as “the lone individual” or “individualism.” Everyone was defined by membership in a corporate group of some sort; the consanguineous family or tribe if nothing else. To not be a member of some sort of larger social group—i.e. an outcast—was a virtual death sentence. For most of human history, the lone individual was a dead individual. No doubt some people managed an existence on the margins of  society, but these were the exceptions. No example of a society of “lone individuals” has ever been found by anthropologists. Rather, pre-state societies were held together by their reckoned descent from a common ancestor, and often times the veneration of those ancestors. This has been a universal phenomenon known to anthropologists since the late Nineteenth century.

It was the interaction of these various social groups that formed the basis of society. Ancient laws were designed to facilitate interactions and mediate disputes between various groups, NOT to enforce contracts between individuals. Formal contracts between individuals did not exist (nor were they needed); rather your social behavior towards others was dictated primarily by kinship (actual or fictive)—father to son, wife to husband, uncle to nephew; cousin to cousin; slave to master; patron to client, and so on. Private and public interactions were mediated by social status—people knew what to expect of one another based on their relative social position. As people agglomerated in ever-larger groups due to population growth, eventually laws and behaviors needed to become more formalized by the rulers.

Originally, ancient laws were oral codes, but over time they increasingly came to be written down. They weren’t designed to facilitate dealings between solitary individuals , because, as we said, there was no such thing as “the lone individual”—everyone was associated with their social group and was seen by society as a representative of said group. Besides, there was no way to enforce the word of a truly solitary individual—he or she (usually he) would be regarded with suspicion, and, besides, no one would be able to “vouch” for them or make amends should they welsh on a deal. I plan to take this up in much more depth in future posts, but for now, this quotation should give us a good illustration of the concept:

In his [book] Early Institutions [Henry S. Maine] subjects the Brehon Laws of early Ireland to a suggestive examination as presenting an example of Celtic law largely unaffected by Roman influences. He there shows, as he has shown in Ancient Law, that in early times the only social brotherhood recognised was that of kinship, and that almost every form of social organisation, tribe, guild, and religious fraternity, was conceived of under a similitude of it. Feudalism converted the village community, based on a real or assumed consanguinity of its members, into the fief in which the relations of tenant and lord were those of contract, while those of the unfree tenant rested on status. [3]

Tribe, guild and religious fraternity were conceived in a similitude of the family. This is an essential point, and crucial to our understanding ancient society. It also feels odd to our modern Western sensibilities where each of us by default has no relationship whatsoever to absolutely anyone else outside of our immediate family—our biological parents and siblings—and sometimes not even with them! That is, we are all “lone individuals.” Most of our relationships are  all voluntary contracts, with terms explicitly spelled out in writing, and can be terminated by either party at any time. The ancient world was not like this.

Put succinctly, the “natural” basic unit of human society is not the lone individual, but the descent group—people who trace their descent to a distant common ancestor, even if such descent is largely fictitious. Thus, all early institutions were, more or less, a simulacrum of the family unit. The interaction of these various groups formed the basis of all political and social life. Food sharing and ritual behaviors tap into kin psychology to create larger groups than the consanguineous extended family.

So it follows that the earliest guilds were based on the family structure as the German historian Lujo Brenanto—one of the first to study the history of guilds—wrote (he uses the more accurate word Gild):

The family appears as the first Gild, or at least of the archetype of the gilds. Originally, its providing care satisfies all existing wants; and for other societies there is therefore no room. As soon however as wants arise which the family can no longer satisfy—whether on account of their peculiar nature or in consequence of their increase, or because its own activity grows feeble—closer artificial alliances immediately spring forth to provide of them, in so far as the State does not do it.

Infinitely varied as are the wants which call them forth, so are naturally the objects of these alliances. Yet the basis on which they all rest is the same: all are unions between man and man, not mere association of capital like our modern societies and companies. The cement which holds their members together is the feeling of solidarity, the esteem for each other was men, the honour and virtue of the associates and the faith in them–not an arithmetical rule of probabilities, indifferent to all good and bad personal qualities.

The support which the community affords a member is adjusted according to his wants–not according to his money stake, or to a jealous debtor and creditor account; and in like manner the contributions of the members vary according to the wants of the society, and it therefore never incurs the danger of bankruptcy, for it possesses an inexhaustible reserve fund in the infinitely elastic productive power of its members.

In short, whatever and however diverse may be their aims, the Gilds take over from the family the spirit which held it together and guided it: they are its faithful image, though only for special and definite objects.

The first societies formed on these principle were the sacrificial unions, from which, later on, the Religious Gilds were developed for association in prayer and good works. Then as soon as the family could no longer satisfy the need for legal protection, unions of artificial-family members {sic} were formed for this purpose, as the State was not able to afford the needful help in this respect. These Gilds had their origin in direct imitation of the family. Most certainly, none were developed from an earlier religious union: as little as were the Roman collegia opificum from the Roman sacrificial societies, or the Craft-Gilds from the Gild-Merchants, or any Trade-Unions from a Craft-Guild. [4]

Ancient institutions, including the extended family itself, were held together by common worship, typically involving some sort of ritual. The French historian Fustel de Coulanges argued that the primary Roman descent group–the gens–was held together by ancestral worship. It controlled its own ancestral lands, it had its own burial grounds, had its own deities and rituals (Sacra), and all property of a deceased person was partitioned out among all surviving members of the gens (rather than inherited by the eldest male offspring). Gentes were sort of a society in miniature, composed of related individuals, and their interactions were the basis of the wider society. Coulanges then went on to make the case that the entire Ancient City was sort of a superfamily based around similar communal rituals and worship, in this case the worship of a municipal deity (such as Pallas Athena at Athens, or Jupiter at Rome).

One thing appears to be universal among all of these early corporate groups (gens, sodalites, collegium, eranoi, etc.): the sharing together of a common meal. We see this has a very old pedigree indeed—it probably developed out of feasting rituals that hearken back to the very origins of civilization. The custom of assembling together at a common ceremonial banquet on various solemn occasions appears to be universal, and anthropologists have found much evidence of it at all stages of social development. Chimpanzees share meat from the hunt. The secretion of cholecystokinin (CCK) from a fat and protein-heavy rich meal induces feelings of satiety and allows for social bonding, as does alcohol consumption.

Undoutedly the collegia and sodales [sic]–Roman or Romanized institutions–founded themselves on the common meal, which was so sacred and significant a symbol in all the relations of the Aryan household. The functions of worship which the house-father (the Roman gentile head) could alone administer, the sacra, had passed into keeping of priest and church. When the sodalitates were instituted, they took to themselves the social power, perhaps we should say the socio-religious sympathy of the common meal. [6]

The second universal feature is the payment of some sort of communal dues. The world Guild itself comes from the Anglo-Saxon word gildan, meaning to pay, from which derives the word gegilda, meaning the subscribing member of a guild. [7] This allows risk pooling while minimizing the risks of free-riding, which is always a concern for collective action. Thus, guilds would have tapped into kin psychology by using their own communal banquets, rituals, and status relationships.

As labor became more specialized, especially in cities, one of the earliest class-based associations to form were occupational. In fact, groups of specialists, often associated with some sort of religious institution, look to be the core basis underlying the formation of early proto-cities. We know that specialized occupations, including merchants, had their own unique quarters in these ancient proto-cities. Thus, it makes sense that the complex and highly specialized world of ancient Mesopotamia, with its weavers, bakers, goldsmiths, builders—and, of course, merchants—was the first place on earth for large urban agglomerations to form.

Ancient Guilds

Did guilds exist in ancient Mesopotamia? Opinions differ, but it appears certain that practitioners of various specialized occupations did indeed associate together in some sort of formal—perhaps religious—structure. They may have shared meals and had their own rituals. But these differed greatly from later guilds in several regards.

First, there was no attempt to prevent people outside the guild from participating in various occupations. Second, there appears to have been no formal attempt to regulate workmanship or working conditions. In other words, the cartel-like activities of later guild systems were not present. There may have been some sort of insurance or risk-pooling; it’s hard to tell. One thing is certain, however,—guilds originated in the cities where specialized labor, long-distance trade, and raw materials were present:

Throughout the history of Mesopotamia, the skilled craftsmen had a distinct and prominent position in society…Their distinct status is especially clear in the first millennium, when we find clear evidence for craftsmen’s quarters in various cities (183)… It is thus logical that they would feel an affinity for their colleagues, and that they would form professional associations. From the early second millennium onward such organizations are attested to in the texts. It has been stated that these groups depended on the palace or the temples because they were headed by an overseer, but this common and broad title can also indicate that one of the members was selected to represent the group in its interactions with the government authorities…

The strength and cohesion of these associations is hard to define. They have been called ‘guilds’ by a minority of scholars, usually under severe criticism. In a sense, the issue whether or not it is appropriate to use that designation boils down to one of terminology, and to what one has in mind when talking about guilds. Many of the characteristics of a medieval European guild cannot be documented in Mesopotamia, including the crucial element that only guild members could perform a particular craft. But their absence also cannot be proved, and I think we should not underestimate the power of these professional associations. [8]

As mentioned above, most social organizations were based within the family: thus ancient private businesses were wholly synonymous with various Houses—that is—kin groups. Two of the most famous were the House of Egibi and the House of Murashu, whose archives have been found and studied by archaeologists. These entrepreneurial families would send relatives throughout the civilized world to run various outposts of the family business, since one can theoretically trust one’s own family members (and not outsiders). The wealth of the House was collectively owned, and collectively passed down inside the family.

Thus, we see that ancient business dealings were conducted mainly by “reputation mechanisms” and furthermore, the reputation in question was typically never that of a lone individual, but of a corporate group; a corporate group in which all the members agreed to take collective responsibility for the actions and obligations of any one of its members. Thus, entrance into any such group was heavily policed by reputation, and disreputable members could be ejected by the will of the majority (since everyone was liable for that person’s actions). This allowed transactions based on trust to take place before the advent of formal corporations, written contracts, business law, or governmental institutions.

Ancient Greece

Ancient Greece appears to have been driven by bonded/unfree labor in the from of slaves and immigrant labor (metics). Guilds were less important. However, even here we do see mutual aid societies centered around communal dues, food sharing, and common rituals, even without an explicit focus on occupation:

The Eranos among the Greeks was in every minute respect the analogue of the Guild…Clubs or societies of this kind established for charitable or convivial purposes, and sometimes for both, were very common at Athens, and were also found in other cities of Greece. These Grecian Guilds were founded on the principle of mutual relief. If a member was reduced to poverty, or was in temporary distress for money, he applied to the Eranos, or Guild. and the relief required was contributed by the members. Sometimes it was considered as a loan, to be repaid when the borrower was in better circumstances.

The Eranos met at stated periods, generally once a month, had its peculiar regulations, was presided over by an officer styled the Eramarches, and the Eranistoi, or members, paid each each a monthly contribution. There does not really appear to have been any material difference between the organization of these sodalities and the Saxon and mediaeval social Guilds. [9]

Ancient Rome

We are on somewhat firmer ground when it comes to the ancient Roman world. There were several major social groups in ancient Roman society that we know of. One early form of group was the solidates, and these appear to have began as ritual cults, often of priests (Flamen), or as common burial societies.  Another type of organization was the collegia, which was any association of individuals, not necessarily for religious or cult purposes. A third category was socialies, which were basically business partnerships for some definite purpose designed to be temporary in nature.

In ancient Rome, the principle of private association was recognized very early by the state…It can be difficult to distinguish between the two words collegium and sodalitas. Collegium is the wider of the two in meaning, and may be used for associations of all kinds, public and private, while sodalitas is more especially a union for the purpose of maintaining a cult. Both words indicate the permanence of the object undertaken by the association, while a societas is a temporary combination without strictly permanent duties.

The Collegia was the basis of the collegia opificum, or trade associations, during the Roman Empire. There were nine major categories of trade association that were sanctioned by the Roman government. This is the origin of our modern word college, which was originally a guild of students in the High Middle Ages: “An important result of the guild framework was the emergence of universities at Bologna (established in 1088), Oxford (at least since 1096) and Paris (c. 1150); they originated as guilds of students (as at Bologna) or of masters (as at Paris).”

List of Ancient Roman Collegia (Wikipedia)

Of course the societas developed into the business partnership known as the societas publicanorum—publican societies—which were the private organizations that administered the expanding Roman Empire. These organizations were pools of money, where one’s membership was anonymous and one’s stake could be transferred to other people if desired, which is why the publican societies are considered to be the forerunners of today’s corporations.

Economist Peter Temin describes Roman guilds in his extensive study of the ancient Roman market system:

…While guilds were formal organizations of men tied together by a common occupation, they differed from the European craft guilds of the Middle Ages and early modern period. Many Roman guilds, such as the sack-carriers, or longshoremen, did not require mastery of a specific artisanal skill; their work was unskilled. The guilds of skilled workers focused more on cerebral tasks like piloting ships. All guilds allowed their members to compete freely with each other, and nonguild workers could also find employment in tasks normally performed by guild members. There were significant benefits to membership…although there is no evidence that guilds acted as unions to control wages.

Guilds could prevent crime because they functioned as self-enforcing cartels; a guild could easily refuse membership and its benefits to an outsider or punish active members who stole or behaved corruptly. Elections ultimately determined guild membership, although some guilds required an entry fee in addition. Some guilds, such as the public grain-measurers, forced new members to “take a valid oath to do honest work”.

The guild members collectively elected officers and managed business operations. Those officers held terms of between two and five years, depending on the guild. While membership was not a hereditary right, sons often followed fathers into the same guilds, and freedmen similarly followed the families from which they had won their freedom and now considered their patrons. It is unclear how many members each guild had…

The strong organization of the guild and its ability to exert collective action made guild membership desirable. Guilds often pooled resources, and most guilds had guild houses stocked with gifts and decorations given by members. Many also had their own temples, while others used their resources to engage in civic life. The measurers, for instance, were one of the guilds who erected statues to the Prefects of the annona. Guilds also elected “patrons,” men of varying influence and wealth, giving members access to those men. Less powerful guilds invited reputable local men to be their patrons; more significant guilds, like the shippers, included a handful of senators on their list of patrons. A guild member would not lightly throw away such positive social benefits.

Guilds must have monitored their members’ behavior closely. The common treasury would have produced a strong interest in members to monitor one another. More important, the reputation of the entire guild could have suffered from the bad acts of one of its members. Even if corrupt members were not expelled, it is unlikely that they would ever have been voted into officer status or given special honors by their peers.

Legal systems, and other formal organizations do not exist in a vacuum; it is often informal social custom that proves even more effective than official sanctions. Merchants relied on informal institutions to promote honesty and trustworthiness. The guarantee of reputation is the most likely candidate for the unofficial enforcement mechanism in Rome. This ex-ante solution would have prescreened the agents available to the merchants.

If the Romans used a reputation mechanism, what was the signal that established trustworthiness? Roman religion did not involve an ethical code, as is present in Judaism, Christianity, and Islam, so an appeal to religious values could not ensure trustworthiness. Instead, it seems plausible that the criterion for establishing trustworthiness was the recommendation of another merchant knight or senator, especially given the homogeneity of the two primary classes of senators and knights and the close proximity in which merchants worked in Ostia, as we shall see later.

In addition, honor and probity were important secular values among the Roman aristocracy; men of these higher ranks were considered to be de facto trustworthy and could explicitly lend that trustworthiness to others. Naturally, not all members of these classes were trustworthy, but the small, close-knit community ensured that a deviant individual couldnot hide behind his rank indefinitely. [12]

We might compare the ancient Roman Collegia to something like the Screen Actor’s Guild, or Equity today. These organizations do not have an absolute monopoly over “acting” per se, nor do they enforce quality standards (as community theater can attest). Nevertheless, the precarious nature of acting and theater work has caused these organizations to form, allowing professional actors to pool their resources to ensure their members have a decent quality of life (insurance, retirement, health care, etc.). You do not have to be a member, but the benefits are too great not to be, as long as you qualify–Earning a SAG card is a rite of passage in Hollywood. Many ancient professions were of a similar nature (as opposed to permanent contract employment today).Guilds were self-regulating and self-policing without state involvement, although the state would no doubt take an interest in certain critical occupations, later even forbidding the departure from those occupations.

It’s likely that Christianity itself began as a combination of a common meal-sharing group and religious cult. This probably developed out of the communal meals the early Christians hosted in their homes during in the Roman empire. Christians were also obliged to take care of one another and help each another out—something that would have been invaluable in a rapidly decaying Empire where entire families had been decimated and civil order was rapidly declining due to civil ward, endemic corruption, and plagues.

The Agapa or Love Feats of the early Christians, though at first established for the commemoration of a religious rite, subsequently became guild-like in their character, as they were sustained by the contributions of its members, and funds were distributed for the relief of widows, orphans, and the poorer brethren. Indeed, they are supposed by ecclesiastical writers to have imitated the Grecian Eranos. The Government looked upon them as secret societies, and they were consequently denounced by imperial edicts. [13]

Medieval Guilds

There are four major theories of how medieval guilds formed, each championed by various scholars. They are:

1.) They are continuation of the ancient Roman collegia.

2.) They were formed out of the Christian monastic orders, which were organized on the basis of collective solidarity and brotherhood among their members.

3.) They were the continuation of pagan banquets held on special occasions. At these events, warriors undertook pledges of collective solidarity for war and raiding–often under the watchful eye of the gods. “The Germanic term Gild appears in connection with these banquets. “In its origin the word guild is found in the sense of “idol” and also of “sacrifice”, which has led some writers to connect the origin of the guilds with the sacrificial assemblies and banquets of the heathen Germanic tribes.” [14]. The connection with “payment” occurs in the potluck nature of these banquets.

4.) They originated as co-grazing partnerships in pagan herding societies. In these societies one’s social standing was based on control over land and wealth, primarily livestock. Subsequently, one’s rights and freedoms were based on one’s social status. Co-grazing partnerships allowed members of the lower (free or unfree) orders to pool their resources and increase their social standing. Each member of the partnership assumed responsibility for all the others. Each member paid in to the partnership, hence the use of the term gild or gildan–meaning “to pay.”

Let’s take a closer look at each one of these:

1.) For a long time scholars thought that medieval guilds were just a continuation of the ancient Roman collegia, but it’s now clear that in most locations the collegia did not survive the fall of the Roman Empire (leading to the subsequent loss of know-how). However, some scholars still argue that the old Imperial craft traditions managed to persevere, especially in Northern Italy and Southern France. From there they spread throughout Northern Europe as the Dark Ages waned and Christianity spread.

I am inclined…to attribute them to that spirit of associated labor and union of refreshment which had existed in the Roman Colleges of Artificers, where…there existed that organized union of interests which continued to be displayed in the Guilds. I will not aver that Guilds were the legitimate and uninterrupted successors of the Roman Colleges, but I will say that the suggestion of the advantages to be derived from an association in work, regulated by the ordinances that has been agreed on, governed by officers who might judiciously direct the exercise of skill and the employment of labor, the result of all of which was a combination of interests and the growth of a fraternal feeling, was suggested by these Roman institutions, and more especially adopted by the Craft Guilds, which, at a later period in the Middle Ages, directed all the architectural labors in every country of Europe. [16]

It’s possible that in at least some locations in southern Europe, this may, in fact, have been the case. But guilds as we know them first spring up in places like Dark Ages England under the Anglo-Saxon invaders where a Roman origin is extremely unlikely. Also, guild-like associations appear to have predated Roman influence.

2.) Another concept was they developed out of religious or monastic brotherhoods. However, this idea has also fallen out of favor. It appears to be the other way around—medieval brotherhoods were derived from the kinds of mutual aid associations commonly found among pagan tribal communities.

Wilda thinks that the peculiar character of the Guilds was derived from the Christian principle of love, and that they actually originated in the monastic unions, where every member shared the benefits of the whole community in good works and prayers, into the advantages of which union laymen were afterward admitted.

But the untenableness of this theory is evident from the fact that the same characteristic of mutual aid existed in the pagan nations long before the advent of Christianity, and was presented in those sodalities which represent the form of the modern Guild.

Besides the admission…that the early Saxon Guilds were so tinctured with the superstitious customs of the pagan sacrificial feasts, and that the Church had to labor strenuously and for a long time for their suppression, would prove that we must look beyond the monasteries of the true origin of the Guild. [17]

3.) The first historian of guilds, the aforementioned Brentano, argued that guilds arose out of the sacrificial feasts of the Old Germanic peoples. Only later where they “Christianized” to include things like mutual aid and support in times of distress:

The Northern historians, in answer to the question, whence the Gilds sprang, refer above all to the feasts of the German Tribes from Scandinavia, which were first called Gilds. Among the German tribes, every occurrence among the more nearly related members of the family required the active participation in it of them all. At births, marriages, and deaths, all members of the family assembled. Banquets were prepared in celebration of the event, and these had sometimes even a legal signification, as in the case of funeral banquets, namely that of entering an inheritance; and, when they concerned kings, that of a coronation.

Further, great social banquets took place on occasion of the sacrificial assemblies at the great anniversary festivals, which coincided with the national assemblies and legal assizes, and on occasion of important political events; and at the same time the common concerns of the community were deliberated on at these banquests. Moreover, they also furnished an opportunity for the conclusion of those alliances for the purpose of plunder or war, of which we have accounts, espcially in the case of Sweden and Norway, as well as of those close unions of friends, in which, according to the Scandinavian Sagas, two warriors of antiquity were wont to confederate for life or death, for common enterprises and dangers, and for indescriminate revenge when one of them should perish by violent death.

Every freeman was obliged to attend these feasts, and bring with him whatever food and drink he might require. Hence these feasts were also called Gilds; for “Gild” meant originally the sacrificial meal made up of the common contributions; then a sacrificial banquet in general; and lastly, a society. When in later times Christianity spread itself in the North, the sacrificial banquets, with all their customs and ceremonies, remained in existence, and Christ, the Virgin Mary, and other saints, stept [sic] into the place of Odin and the rest of the gods.[18]

4.) An alternate explanation was provided by historians of the Celtic peoples of ancient Ireland. Ireland was never conquered by the Romans, and thus retained many of the pagan traditions of the North. Many of these were preserved in a series of laws that were later written down and came to be known as the Brehon Laws. These laws give a rich insight into the social structure of pagan European tribal communities before the Roman conquest. “Irish law represents possibly the oldest surviving codified legal system in Europe, and is believed to have Proto-Indo-European origins in common with the Hindu Laws of Manu.” [19]

Class differentiation, as with much of the Indo-European peoples, was based around ownership of cattle and control over common grazing lands. There were two major categories of citizens: bonded and free. At the top of the social heap were the hereditary landowners, or Flaths [flah] (Noble, chieftain, prince). Below them were the lesser classes of freeholders called Aires [arra] (or Bóaires; i.e. lords). “Any free man might become first a ‘Bo-Aire,’ or cow-lord; then after possessing land for three generations his descendants might aspire to become Flaths, or hereditary lords.” [19].

Below these classes were free tenants with little or no property who paid rent dues and placed themselves under the protection of an overlord—Ceiles, [kailas] who were the equivalent to the old English ceorls, or churls. They formed the base-class of society They were further classified into “free” (saer) and “base” (daer) tenants. Ceiles rented either a portion of the common tribal lands or private lands from a noble (Flath). All freeholders had a right to access a portion of the commons owned by the fine, or clan.

Below these were the lower tier of the social order, the great mass of indentured, or “unfree” laborers, who correspond roughly to medieval serfs.  They had no claim to the tribal lands, although they were permitted to till plots for subsistence under strict conditions. The non-free classes were the Bothachs (cottars), the Sen-Cleithes (usually servants of the nobles), and the Fuidhirs (those without a clan; refugees). Saint Patrick was originally brought to Ireland as a daer fuidhir (a semi-slave). Classes were not absolute, as in a caste system; upward mobility was possible.

According to the laws, only those who held a specified share of landed property, as determined by the laws, were entitled to the full rights of citizenship: “Only a property holder could be a compurgator, a surety, a witness (the equivalent of a modern juryman), or exercise any of the functions of a freeman. The complete person as I have described him, emerging from the Roman law, was not yet born into society. A personage must have property. The next equivalent to the protection of a lord was the support of a mutual partnership or guild.” [20]

So an option for a free person, rather than pledging oneself to an overlord, was pooling resources with other clan members in order to gain control control of enough pastureland to enjoy the same rights and privileges as a noble (Aire). Each subscriber would pledge a portion of their land and livestock to the pact, which was secured by a solemn oath between the members:

…In this view of the origin of this sort of association, the meaning of the word itself becomes important. It was a payment which was symbolized in “guild.”…the link of etymology…are the Irish words gial (” a pledge or security”), gialda (“to be a pledge or security”), which bring over the earlier customs that prevailed prior to the Guild as we know it: I mean the passage of the early Aire partnership, by which the freemen first raised themselves into a position where they could get some of the advantages of chiefs or lords, into the later association of the Guild.

Four freemen, some of whom might be free “foreigners” with no tribal home, united closely for mutual support, and became each responsible for the dues of the other to society and the tribal State. Through this union one becomes an Aire, or had the privileges of a lord. They assumed these responsibilities solemnly in the presence of an Aire, and sometimes it is supposed with religious ceremonies…

These rights of co-grazing, and their corresponding duties, must have been a very early form of social development. For, as previously shown, cattle, next to human chattels (which I throw out of the discussion) was the early form of desirable property…It is significant that the bond of this association was symbolized in a payment, a contribution free in essence yet enforcing a strong obligation…There is no doubt that the feast began in common contributions, which were in one sense payments. The common meal underlay the guild, and a common obligation underlay the meal.

These rural origins of the guilds were forgotten in the course of time, as the medieval guild as we know it formed when people fled their clans and moved into towns forming similar associations there. Preserved in these guilds was the idea of paying one’s dues to the larger association, the taking of responsibility for one’s brethren, coming to their aid, pooling resources for the common good, and the communal banquet. [21]

Guilds coalesced in towns and cities where workmen were free of feudal duties. These “ports of trade” at rivers and seaports were where long-distance trading took place. Guilds played a crucial role in these activities. The city dwellers were often “refugees” from the countryside who no longer wished to live under feudal obligations (or could not—many were probably expelled from their kinship groups for some reason). We can expect the unrelated citizens of such ports of trade to have been much more “individualistic” in their outlook than their brethren left behind in the countryside due to personality self-sorting. Eventually, these free cities would become the nucleus of a new kind of economy centered around trade, money, and contracts rather than reciprocity, kinship and social status. By contrast, the household model continued to predominate in the remote areas of Europe, organized according to what Thompson called the “moral economy.”

In the eleventh century the process…had assumed definite form, both in England and on the Continent. The barons had laid firm hold of the dwellers in the fields. The peasants, who had proved too stubborn for enfiefment, had either been subjected, as in the Jaquerie of Normandy and other revolts too insignificant for historical record, or they had escaped into the growing towns, and there maintained the personal rights which their forefathers imbibed from the old Aire partnership. In this period, the earliest charters of the religious or social guilds appear in England…[22]

The ultimate origins of the medieval guild system, however, will probably never be known:

The early guilds had no connection with trade or industry, but were voluntary associations formed for a variety of purposes-political, social and religious.

Endeavors have been made to trace their origin to the pagan customs of the primitive Teutons at the sacrificial banquets and funeral festivities…But this is clearly inadequate. The common banquets were not peculiar to the Scandinavians, but on the contrary were an institution of the most wide-spread character. They occur in the early history of every nation from the Asiatic joint families to the Roman collegia, Russian villages and Irish septs.

Still more unsatisfactory is the statement…that these drinking bouts contained in germ the essence of all guilds. Occasional survivals of the practice are still found to-day on the islands of the Baltic, and it would require a peculiarly lively imagination to connect these casual festivals with the medieval unions. There is absolutely no evidence that any of the Anglo-Saxon guilds ‘were founded on such a basis, nor is there any more reason to assert a similar origin for those of the continent.

In fact, the attempt to discover any one particular source is idle. Combined efforts of individuals have always existed to supplement the defects of government and to afford mutual protection in case of need. Indeed the social instinct of man, the impulse to work or worship in common, has shown itself in all nations and at all times. The names of these associations naturally varied with the different countries, and the ends they sought to attain bore a fixed relation to the changing needs of the society in which they existed. But the idea that all guilds are derived from one fountain head is plainly erroneous, and this vain attempt to discover the impossible explains the one-sided, divergent views of so many historians.’ [23]

It was the gradual decline and sunset of this formerly effective system for both merchants and craftsmen that led to the formulation of the modern globalized market economy. Institutions such as law courts, commercial banks, and joint-stock corporations took the place of these institutions for conducting large-scale international business and trade, and thus laid the foundation for the modern world and the rise of the Liberal ethos of “hyperindividualism”—something we’ll take a look at next time.

Markets don’t function well if they are ridden with frictions like lack of information, lack of trust, or high transaction costs. In the presence of frictions, business is often conducted via relationships.

Until the end of the fifteenth century, impartial institutions like courts and police that serve all parties generally—so ubiquitous today in the developed world—weren’t well developed in Europe. In such a world without impartial institutions, trade often was (is) heavily dependent on relationships and conducted through networks like merchant guilds. Such relationship-based trade through dense networks of merchant guilds reduced concerns of information access and reliability. Not surprisingly, because the merchant guild system was an effective system in the absence of strong formal institutions, it sustained in Europe for several centuries. In developing countries like India, lacking in developed formal institutions, networked institutions like castes still play an important role in business.

Before the fourteenth century, merchant guild networks were probably less hierarchical, more voluntary, and more inclusive. But, with time, merchant guilds started to become exclusive monopolies, placing high barriers to entry for outsiders, and they began to resemble cartels with close involvement in local politics. There were two reasons why these guilds erected such tough barriers to entry:

Repeated committed interaction was the key to effectiveness of merchant guilds. Uncommitted outsiders could behave opportunistically and undermine the reliability of the system. Therefore, outsiders faced restrictions.
Outsiders threatened the position of existing businessmen by increasing competition. So, even genuinely committed outsiders could be restricted to enter as they threatened the domination of existing members.

But, in the sixteenth century, the merchant guild system began to lose its significance as more impersonal markets, where traders could directly trade without the need of an affiliation, began to emerge and rulers stopped granting privileges to merchant guilds. The traders began to rely less on networked and collective institutions like merchant guilds, and directly initiated partnerships with traders who they may not have known well. For example, in Antwerp the domination of intermediaries (called hostellers) who would connect foreign traders declined. Instead, the foreign traders began to conduct such trades directly with each other in facilities like bourses. [24]

[1] The Story of Manual Labor in All Lands and Ages: Its Past Condition, Present…By John Cameron Simonds, John T. McEnnis pp. 569-570

[2] The History of Freemasonry: Its Legends and Traditions…, Volume 2 By Albert Gallatin Mackey, William Reynolds Singleton, William James Hughan p. 56

[3] Ancient Law: Its Connection to the History of Early Society by Maine. Introduction, p. xii

[4] On the history and development of gilds, and the origin of trade-unions p. 16

[5] Not used

[6] The Social Law of Labor by William B. Weeden, p.145

[7] http://www.newadvent.org/cathen/07066c.htm

[8] The Ancient Mesopotamian City by Marc Van De Mieroop p. 190

[9] The History of Freemasonry: Its Legends and Traditions…, Volume 2 By Albert Gallatin Mackey, William Reynolds Singleton, William James Hughan p. 560

[10] https://en.wikipedia.org/wiki/Associations_in_Ancient_Rome

[11] Not used

[12] The Roman Market Economy by Peter Temin, pp. 109-110

[13] The History of Freemasonry: Its Legends and Traditions…, Volume 2
By Albert Gallatin Mackey, William Reynolds Singleton, William James Hughan pp. 560-561

[14] http://www.newadvent.org/cathen/07066c.htm

[15] Two Chapters on the Mediaeval Guilds of England by Edwin R. A. Seligman p. 10 footnote 1

[16] The History of Freemasonry: Its Legends and Traditions, Its …, Volume 2 By Albert Gallatin Mackey, William Reynolds Singleton, William James Hughan p. 562

[17] The History of Freemasonry: Its Legends and Traditions…, Volume 2 By Albert Gallatin Mackey, William Reynolds Singleton, William James Hughan pp. 561-562

[18] On the History and Development of Gilds, and the Origin of Trade-unions by Lujo Brentano, pp. 3-4

[19]https://en.wikipedia.org/wiki/Early_Irish_law

[20] The Social Law of Labor by William B. Weeden, p. 68

[21] The Social Law of Labor by William B. Weeden, p. 146-147-148

[22] ?

[23]?

[24] Two Chapters on the Mediaeval Guilds of England by Edwin R. A. Seligman pp. 1-2

[25] https://promarket.org/markets-europe-opened-guild-monopolies-declined-sixteenth-century/

Latitudes not Attitudes or ‘Maps not Chaps’

Geography is … only a branch of statistics, a knowledge of which is necessary to the well-understanding of the history of nations, as well as their situations relative to each other.
–WILLIAM PLAYFAIR

I’ve been think a lot about the way geography shapes history. A lot of the big questions of history can be boiled down to simple geography.

What brought this to mind was this interview with Ian Morris:

Philip Dodd: “The three paradigms in which you want to work are biolgical, sociologicial…[and geographical]. Tell us why geography is so important to you…”

Ian Morris: “It follows on fairly directly from the ways I was thinking about biology and sociology. It seems to me the major implication of recent work in evolutionary biology is that human beings are all more or less the same things all over the world, which is—clever chimpanzees. That’s what we are. And we do the same things as most other kinds of animals, we’re just better at it…”

“It seemed to me, as I was looking for patterns across the last 15,000 years, was that the real motor for why some societies have developed at different paces than others was simply geography. That’s just what it came down to.”

PD: Give us briefly an example of how geography is determining.

IM: “The most glaring case of geographical determinism is the beginnings of agriculture the end of the Ice Age. There were only a few places in the world while wild species of plants and animals had developed that were potentially domesticable. If you were a hunter-gatherer in central Siberia, it didn’t matter if you were Albert Einstein, you were never going to domesticate plants and animals because it could not be done. If you lived in southwest Asia, it was massively more likely that domestication would happen there than anywhere else because these plants and animals are so densely concentrated there…”

“…Much of what humanists like to dwell on as agency I think is an obsession with the noise generated by human beings. We’re very good at thinking up grand theories about the afterlife for example—about things that very likely don’t exist at all. That is just a distinctively human version of the agency that generally applies to living things.”

“Plants have agency of a kind, bunny rabbits have a lot more, chimpanzees have a lot more still. We have most of all. And we have so much of it, that we clearly have in some ways moved wildly away from what we share with animals. But in other ways we continue to share a great deal of what we do with animals.”

“I like to say when I’m teaching that history is a subfield of biology. It’s the record of what one particular species does. And when you put it like that it’s hard to argue with [that]…”

Richard Cohen and The Ancient Egyptian Book of the Dead (BBC Arts & Ideas)

The interview is from a few years back in reference is Morris’ book Why the Rest Rules–for Now. In that book, he traces history back 15,000 years in order to find the reason why the societies of the North Atlantic ended up dominating and ruling much of the planet today rather than, say, the Middle East or Africa China or South America. The geography factor came up fairly late in his inquiry, and caused him to rethink his assumptions. As he says:

“This is something that actually didn’t fully dawn on me until I was quite some way into writing the book, and I had to go back to the beginning and start doing it all over again…The reason why the book ends up being rather a long one rather than a one-page thing saying ‘it’s geography’ [is because] geography is a somewhat complicated thing. On the one hand, physical geography determines how societies develop. But the way societies develop determines what physical geography means.”

In a column for the Daily Beast he summarizes some of his major conclusions:

When the world warmed up 15,000 years ago, geography dictated that there were only a few regions on the planet where complex societies could develop. This was because only a few regions had the kinds of climate and landscape that allowed for the evolution of wild plants and animals that could be domesticated; and farming could only arise in these places.

The densest concentrations of these plants and animals lay toward the Western end of Eurasia, around the headwaters of the Euphrates, Tigris, and Jordan Rivers in what we now call southwest Asia. It was therefore here, around 9000 BC, that farming began, spreading outward across Europe. Western Eurasia became the richest part of the world.

Farming also started up independently in other areas, from China to Mexico; but because plants and animals that could be domesticated were somewhat less common in these zones than in the West, the process took thousands of years longer to get going.

Ian Morris on Why the West Rules but China Is Next (Daily Beast)

On a similar theme is a book I read recently called Prisoners of Geography by Tim Marshall. It’s mostly about current geopolitical tensions than it is about geography, but it does cover some useful facts about why certain parts of the world developed in the way they did.

It’s a good illustration of how countries came to be, and why they are the way they are. Political scientists like to talk about “Path Dependence”—the fact that understanding why societies are the way they are now has a lot do with historical circumstances, sometimes stemming from a very long time ago. To cite just one example, when you look at current voting patterns in the U.S., counties which had the best conditions for growing cotton in Dixie are the most likely to vote for Democrats today, because they have a larger concentration of African-Americans to this day. And, of course, the conditions for growing cotton growing had to do with climate and geological processes that took place even before modern humans had emerged.

1. WESTERN EUROPE

But what really got me thinking about this was looking back at the history of financial innovations. It makes sense that these all began in places which had to have expansive trade by necessity. These were places that were rich in some resources, but poor in other critical ones, and so trading became a necessity. That’s why it is in such places that we must look to find their origins. You’ll find that in history, things are invented out of necessity when and where they need to be. Ian Morris articulates this as his ‘Morris Theorem’: “Change is caused by lazy, greedy, frightened people looking for easier, more profitable and safer ways to do things. And they rarely know what they’re doing.”

The Tigris-Euphrates valley is the major case in point. The well-watered flat river valleys produced lots of raw materials, but not much in the way of stone, gems, or precious metals. So it was here that the first trading “innovations” began such as writing, double-entry bookkeeping, bonds, insurance, tradeable debt, and the like. By contrast, the Nile region was much more self-sufficient. It’s trading was command-and-control, organized through the Pharaoh’s household which owned the major national resources, such as mines and the shipping fleet.

A Four Thousand Year Old Bond (Marginal Revolution)

Looking at Europe a different situation emerges. Why didn’t Europe, with all its geographical advantages, take the lead rather than the Middle East? Marshall notes some of the advantages:

The climate, fed by the Gulf Stream, blessed the region with the right amount of rainfall to cultivate crops on a large scale, and the right type of soil for them to flourish in. This allowed for population growth in an area which, for most, work was possible year-round, even in the height of summer. Winter actually adds a bonus, with temperatures warm enough to work in but cold enough to kill off many of the germs which to this day plague huge part of the rest of the world.

Good harvests mean surplus food that can be traded; this in turn builds up trading centers that become towns. It also allows people to think of more than just growing food and to turn their attention to ideas and technology.

Western Europe has no real deserts, the frozen wastes are confined to a few areas in the far north, and earthquakes, volcanoes, and massive flooding are rare. The rivers are long, flat, navigable, and made for trade. As they empty into a variety of seas and oceans, they flow into coastlines that are—west, north and south—abundant in natural harbors…These are the factors that led to the Europeans creating the first industrialized nation states, which in turn led them to be the first to conduct industrial-scale war. pp. 88-89

Well, we know that people tend to remain foragers rather than forming more complex societies if they can avoid it, because foraging offers a much better quality of life with a lot more freedom. Complex societies that produce surpluses end up allocating those surpluses to an elite managerial class that can then use its control over the surplus to dominate and control the majority. As Johnson and Earl put it, “…the benefits of a larger community must outweigh the costs before people will form one, or join an existing one…the intensification of the subsistence economy, itself an outcome of rising population and technological innovation, creates a problem that can best be solved by working in larger groups.” (The Evolution of Human Societies, p. 141) Populations in Northern Europe did not need to rely upon intensification as did those in the Tigris/Euphrates (or Yellow River) valley.

When you look at the Near East, their dependence upon massive, labor-intensive irrigation works which can only be produced and maintained communally, as well as their dependence upon annual cereal crops for sustenance, means that it was here that complex proto-states would likely form before anywhere else. The land in the great river valleys was far more fertile than the surrounding countryside, which was dominated by nomadic pastoralists living at lower densities.

Although hydraulic theories of state formation have fallen out of favor, it does seem as though more complex civilizations tend to form first in regions where large-scale irrigation is required for crops. The labor needed to maintain a large infrastructure requires more coordination between disparate villages, which in turn causes supra-regional associations to form which elites can control. This also spurs trade between villages.

In Europe, by contrast, crops were rain-fed. The fact that the continent was originally heavily forested also meant there were lots of places to hide from despotic elites. It was only when the larger, more complex Roman Empire conquered the numerous chiefdoms of Northwestern Europe and introduced things like writing, bureaucracy and money that these lands became organized into more complex, hierarchical civilizations than chiefdoms.

So the direction of cultural transmission was destined to be from East to West rather than West to East, expanding from eastern Eurasia and the Levant across the Mediterranean Sea to Greece, and later to the Italian peninsula. The trade around the Mediterranean became so intense during the Bronze Age that some consider it to be the first global economy.

The year 1177 BCE roughly demarks the disintegration of humanity’s first global civilization: the Late Bronze Age. At its peak, a booming trade in raw materials, agricultural goods, and finished products—from jewelry to pottery, spices and wine—encircled the Mediterranean and stretched north, perhaps as far as present-day Scandinavia, and east to Afghanistan and India. Then, after centuries of brilliance, the civilized world of the Bronze Age came to an abrupt and cataclysmic end.

Drought and unrest sparked global societal collapse in the Bronze Age. Is it happening again? (Quartz)

Where else on Earth do you get something like the Mediterranean Sea, a huge inland sea surrounded by diverse ecosystems separating continents, occupied by diverse cultures, and yet small enough to traverse fairly easily? Nowhere else that I know of. In fact, Neanderthals might have even sailed around the Mediterranean before humans showed up.

Evidence suggests Neanderthals took to boats before modern humans (Phys.org)

Fast forward to the Roman Empire. Why did the Western Empire fall, while the Eastern Empire continue to function for centuries more?

The reasons are complex, but it boils down to this: The Eastern Roman empire had older, more complex settled urban civilizations than the Celtic/Germanic barbarian West did. So it had a longer tradition of civilization, a higher tax base, a longer institutional history, older cities, and more trading links to more “developed” civilizations, most notably China and India.

Western contact with China began long before Marco Polo, experts say (BBC)

Rome itself was something of an “accidental capital”—never strategically well-placed and vulnerable to invasions (as indeed the Celts had done prior to the Empire). This forced the Latins to develop formidable armies, but their geographical location still made them vulnerable.

Byzantium, however, was ideally placed, and it is this reason why Emperor Constantine established his capital here and named it after himself. Constantinople is the ideal strategic location—the gateway between Europe and Asia, as Istanbul still is today. Thus, the Roman East was shielded from armies storming out of the North European plain by the Bosporus, the Mediterranean Sea, and the mountains. The only way to get to North Africa, the breadbasket of the Roman Empire, was through two “pinch points”—Gibraltar and the Bosporus. Coming from nomadic stock, the tribes had little maritime experience—the experienced Roman navy would have made quick work of any attempts by them to attack North Africa or the Levant by sea.

So the Romans managed to confine the barbarian wanderers to Europe, fighting skirmishes but never letting them cross over into Asia or North Africa. An attempt to reunify the empire under Justinian was brought down by plague. Eventually the Vandals managed to cross into North Africa. Once the barbarians did manage to sweep across North Africa, the Eastern Empire started to decline. It remained for the Muslims storming out of the desert in the seventh century, and later the Turks from central Asia, to deal the final blow.

With the gradual dissolution of the Western Roman Empire, it was destined that Europe would end up divided into multiple, competing nations, rather than coalescing back into a single unified state as China managed to do several times throughout its history. Once again, this is due mainly to geography:

If we take Europe as a whole, we see the mountains, rivers, and valleys that explain why there are so many nation states. Unlike the United States, in which one dominant language and culture pressed rapidly and violently ever westward, creating a giant country, Europe grew organically over millennia and remains divided between its geographical and linguistic regions. p. 89

Europe’s major rivers do not meet (unless you count the Sava which drains into the Danube in Belgrade). This partly explains why there are so many countries in what is a relatively small space. Because they do not connect, most of the rivers act, at some point, as boundaries, and each is a sphere of economic influence in its own right; this gave rise to at least one major urban development on the banks of each river, some of which in turn became capital cities. pp. 89-90

Europe’s second longest river, the Danube (1,771 miles), is a case in point. It rises in Germany’s Black Forest and flows south on its way to the Black Sea. In all, the Danube basin affects eighteen countries and forms natural borders along the way, including those of Slovakia and Hungary, Croatia and Serbia, Serbia and Romania, and Romania and Bulgaria. More than two thousand years ago it was one of the borders of the Roman Empire, which in tum helped it to become one of the great trading routes of medieval times and gave rise to the present capital cities of Vienna, Bratislava, Budapest, and Belgrade. It also formed the natural border of two subsequent empires, the Austro-Hungarian and the Ottoman. As each shrank, the nations emerged again, eventually becoming nation states. However, the geography of the Danube region, especially at its southern end, helps explain why there are so many small nations there in comparison to the bigger countries in and around the North European Plain. p. 90

When you look at a map of Europe, you can’t help but be struck by just how much coastline there is! Really, almost everywhere is not that far from a sea, river or ocean. Compare that to the massive continental bulk of Asia or Africa, for example. Plus, its rivers are long, flat and navigable. This practically guaranteed that Northern Europe would became a major trading center, and that’s exactly what happened. And that’s why so many trade innovations originated there, including capitalist markets.

When “civilization” finally took root in northern Europe thanks to Roman military pacification, ports of trade developed all along Europe’s coasts and rivers (London was an early one of these). Eastern Europe, distant from the Roman heartland and shielded by mountains, remained behind their western neighbors. Not to mention they had to fight off Mongols and Turks.

One thing I always found unique about Europe is that it was “separate yet unified.” That is, even though it was divided into separate nation states, it had a common religious bureaucracy maintained by the Catholic Church in Rome (arguably the first international corporation), and it had a common language in the form of Latin thanks to the legacy of ancient Rome, meaning that scholars from different cultures could communicate in a shared language and tradition, while still maintaining cultural diffeences.

Remember how we said the Eastern Mediterranean was where the older, urban civilizations and all the riches were? And how they had trading connections with the rest of Asia? Well, it’s here that the big lake called the Mediterranean came into play once again. Islamic empires formed throughout the Middle East which linked India and Southeast Asia to the Mediterranean economy. The Pax Mongolica connected East and West along the Silk Road. The entrance of luxury goods from the Abbassid Exchange like spices, cotton and tea created a space for merchants that had not been there before. While Northern Europe concentrated on exporting raw materials, the Northern Italians formed trading empires from their urban centers. They became the conduit between the kingdoms of Northwest Europe and the riches of the East.So it was that Venice, founded by refugees from the dying Roman Empire, became the merchant center of Europe. They were quickly soon joined by other Medieval communes throughout Northern Italy whose wealth would derive from trade instead of farming or raw materials.

Through a series of fortunate events in the ninth century, Venice became politically independent. This, together with Venice’s fortunate geography, uniquely positioned it to benefit from rising trade between Western Europe and the Levant. These two factors combined to enrich Venetian merchants, who used their newfound economic muscle to push for institutional change.

So it was that Northern Italy became the center of banking and trade. Their proximity and dealings with Islamic merchants led to the adoption of Arabic innovations such as Arabic numerals and checks. Here are just a few of the financial innovations that trace their history back to Northern Italy:

By the early fourteenth century, financial innovations included: the appearance of limited liability joint stock companies; thick markets for debt (especially bills of exchange); secondary markets for a wide variety of debt, equity and mortgage instruments; bankruptcy laws that distinguished illiquidity from insolvency; double-entry accounting methods; business education (including the use of algebra for currency conversions); deposit banking; and a reliable medium of exchange (the Venetian ducat). All these innovations can be related directly back to the demands of long-distance trade.

And nearby Genoa created the first quasi-state bank:

The Casa di San Giorgio came a long way and boasted a long history of banking operations. Some scholars even called the first modern bank, predating the Bank of England established on 1695. It also preceded the British East India Company as a private enterprise that administered territory, collected taxes, and raised armies. Indeed, so much the Casa had garnered power, influence, and wealth that Machiavelli praised its administration.

Casa Di San Giorgio: Genoa’s Premier Financial Institution (Exploring History)

By contrast, southern Italy, though not culturally behind in the days Roman Empire (Pompeii is near Naples), fell behind the north in innovation thanks to constant invasions by people like the Normans and Arabs. They would end up being ruled mostly by a succession of foreigners, hence developing a distrust of government institutions and history of corruption that persists to this day.

The countries of northern Europe have been richer than those of the south for several centuries. The north industrialized earlier than the south and so has been more economically successful. As many of the northern countries comprise the heartland of Western Europe, their trade links were easier to maintain, and one wealthy neighbor could trade with another-whereas the Spanish, for example, either had to cross the Pyrenees to trade, or look to the limited markets of Portugal and North Africa.p. 90

The contrast between northern and southern Europe is also at least partly attributable to the fact that the south has fewer coastal plains suitable for agriculture, and has suffered more from drought and natural disasters than the north, albeit on a lesser scale than in other parts of the world. As we saw in chapter one, the North European Plain is a corridor that stretches from France to the Ural Mountains in Russia, bordered to the north by the North and Baltic Seas. The land allows for successful farming on a massive scale, and the waterways enable the crops and other goods to be moved easily. pp.91-92

Of all the countries in the plain, France was best situated to take advantage of it. France is the only European country to be both a northern and southern power. It contains the largest expanse of fertile land in Western Europe, and many of its rivers connect with one another; one flows west all the way to the Atlantic (the Seine), another south to the Mediterranean (the Rhone). These factors, together with France’s relative flatness, were suitable for the unification of regions, and-especially from the time of Napoleon-centralization of power.

And, sure enough, France became the location of the earliest complex states to form in Northern Europe under Charlemagne (the Holy Roman Empire, the Carolingian Renaissance). it was in France where the great Champagne fairs of Europe took place. Eastern Europe, as we saw above, tended to miss out on the party; the Adriatic Coast is a partial exception, falling under the sway of the Venetians.

So it was that we can use the fairs of Europe as a starting point of Western capitalism. But, ultimately, it’s all due to geography.

WHY EUROPE DOMINATES THE WORLD

With the closing of eastern trade routes after the dissolution of the Mongol Empire and the fall of Byzantium 1453, the race was on for the maritime countries of Europe to find an alternate route to the Indies without dealing with Italian or Arab/Turkish middlemen. Portugal was uniquely placed to send its pelagic vessels south down the coast of Africa to find alternate trade routes. Eventually, they did so, circumnavigating Africa and crossing the Indian Ocean.

But it was an Italian sailing for Spain who would really change things. Ian Morris explains what happened next:

Western Europe—sticking out into the cold North Atlantic, far from the centers of action—had always been a backwater. But when Europeans learned of the East’s oceangoing ships and guns, their location on the Atlantic abruptly became a huge geographical plus.

The Atlantic, 3,000 miles across, became a kind of Goldilocks Ocean, not too big and not too small. It was big enough that very different kinds of goods were produced around its shores in Europe, Africa, and America; but it was small enough that the ships of Shakespeare’s age could cross it quite easily.

Ian Morris on Why the West Rules but China Is Next (Daily Beast)

So of course trade moved north, to the Atlantic Coast—Portugal, Spain, France and England. But it was the small Dutch Republic that ultimately took the lead thanks to a series of commercial innovations. Again, a glance at the maps tells us why the Dutch were so focused on maritime trade. The Low Countries are all below sea level, and their land has been painstakingly reclaimed from the sea by a series of dikes and walls built over centuries. On this reclaimed land sits a very dense population, surrounded by culturally different neighbors and connected by canals. The amount of fertile land was limited, and so the Dutch compensated with entrepreneurial skills. While Dutch farmers made the most of their limited land area, it was inevitable that the economy would come to center around commerce rather than agriculture or natural resources as in France and England. Merchants earned pride-of-pace here, unlike other cultures, and they became politically dominant. It was the early modern precursor to modern-day entrepôts like Hong Kong or Singapore. The wide, flat landscape also made Holland ideal for the innovative use of wind power, increasing their energy consumption. The Dutch were also early pioneers in the use of burning fossil fuel in the form of peat.

The amazing prosperity of the small ‘Republiek der Zeven Provinciën’ and its exceptional position among the European powers during most of the seventeenth century has fascinated generations of historians…The more comes in the open about the thriving Dutch Golden Age society, the more intriguing the question becomes, how so small a population (a million and a half at the vertex of its power) could manage to play leading parts on almost every scene of human activities…This study was motivated by the historical problem of why around 1600 the Republic assumed the mantle of leadership on the path of mankind’s economic and social development. The answer is: because it was able to extensively apply inland navigation and, by that, to fall back on its peat deposits when everywhere (also in the Netherlands itself) deforestation had progressed to such an extent, that wood had become an expensive fuel. Its exceptional position becomes even more evident, when it is considered that at the beginning of the Dutch explosion of prosperity each one of the cities in the ring Amsterdam, Utrecht, Gouda, Rotterdam, Delft, Leiden, Haarlem had an abundance of easily transportable (low peat) turf of excellent quality within a few kilometers of its gates. No wonder, that the centre of gravity of economic development became located in this part of the country.

Peat and the Dutch Golden Age (PDF)

Like Venice centuries earlier, the Dutch were a republic run by bourgeois merchant princes. By this time Protestantism, with its concept of an individual relationship to God supplanting older ideas of communal solidarity and mutual aid, had taken hold in Europe.

The Bank of Amsterdam (Amsterdamsche Wisselbank) was founded in 1609.The original conception of the bank was as a conservatively designed “exchange bank” –a ledger-money bank backed principally by coin–following the example of Venice’s Banco di Rialto. Through a series of innovations, however, the Bank of Amsterdam was ultimately able to achieve a greater degree of success than its Venetian predecessor. Almost until its demise in 1795, the bank was widely admired and served as an inspiration for public banks in other cities. The Bank of Amsterdam never issued notes, but by limiting its depositors’ withdrawal rights, was able to create a highly liquid, quasi-fiat asset in the form of its ledger money.

With the Protestant merchant coup d’etat in Britain known as the Glorious Revolution, the new Dutch king became subordinate to an English parliament increasingly aligned with mercantile, rather than traditional agrarian, interests (as demonstrated by the Corn Laws). The powerful English constitutional monarchy would reshape English society in the eighteenth and nineteenth centuries according the will of commercial interests, establishing the factory system, and consequently turning land and labor into commodities for sale to a greater extent than anywhere else. The rest, as they say, is history.

INDIA

The triangular Indian subcontinent, battered by monsoons and separated from East Asia by the Himalayas, and by deserts and mountains to the west, never had much of chance at conquering the world, despite its huge population. It’s contributions rest more in being the source of exotic products traded with both the Abbassid and European cultures.

One surprisingly important philosophical contribution, however, was India’s numerical system. The alphabet had first been developed in the Near East. But Indian mathematicians and philosophers came up with the idea of zero as a number. It is thought that the Hindu religious concept of “nothinginess” (shunyata) may have played a role in this. It’s hard to imagine the modern world without numbers, science and accounting.

“[T]he creation of zero as a number in its own right, which evolved from the placeholder dot symbol found in the Bakhshali manuscript, was one of the greatest breakthroughs in the history of mathematics. We now know that it was as early as the 3rd Century that mathematicians in India planted the seed of the idea that would later become so fundamental to the modern world. The findings show how vibrant mathematics have been in the Indian sub-continent for centuries.”

How India gave us the zero (BBC)

THE AMERICAS

North America had become populated at the end of the Ice Age when a corridor opened in the Canadian Ice Sheet, allowing migrants to march south into the North American continent from Beringia, an isolated Siberian region full of wild game (indeed, the last woolly mammoths would perish on Wrangel Island just as the first pyramids were under construction). Rising sea levels due to melting ice would submerge this region, permanently cutting off the the American population from Asia.

However, recent research has cast some doubt on the above theory. It now seems more likely that humans colonized the Americas by taking watercraft south along the western coast of North America, only later moving inland as the glaciers melted.

This research suggests there could have been two separate migration thrusts into North America, the first along the Pacific coastline around 15,000 years ago, and the second one when the ice-free corridor became habitable and human-friendly, around 12,600 years ago. But this new data presents another intriguing possibility. Perhaps there was only one single migration wave along the West coast, but once the ice-free corridor became habitable, these early settlers started to make their way northwards through the corridor all the way back into Alaska.

We Were Wrong About How Ancient Humans Colonized North America (io9)

Another controversial theory is that the Americas were at least partly colonized from Europe during the Ice Age:

The major evidence driving [the Soultrean] hypothesis is the presence of artifacts found in six sites in the eastern United States dating to somewhere between 18,000 and 26,000 years ago. These tools more closely resemble that of the Solutrean culture that endured in Europe between about 21,000 and 17,000 years ago than the Clovis culture that first appeared in North America about 13,000 years ago.

Could the first humans to reach the Americas have come from Europe? (io9)

The fact that North America was populated late in the game, due to its distance from the African homeland, along with its lack of domesticable herbivores (only llamas and alpacas), meant that civilization would inevitably be slower to take off here than in Eurasia; the thesis of Jared Diamond’s famous “Guns, Germs and Steel”.

The relative genetic isolation of the Beringian population would prove to be especially fatal, as this exacerbated their vulnerability to the relatively novel zoonotic diseases brought over by Old World colonists. North America became settled primarily by English, French and Dutch, while Central and South America became Spanish and Portuguese colonies. The two cultures took very different trajectories.

South America, despite its large land mass, has been relatively backward economically because of a combination of history and geography.
The limitations of Latin America’s geography were compounded right from the beginning in the formation of its nation states. In the United States, once the land had been taken from its original inhabitants, much of it was sold or given away to small landholders; by contrast, in Latin America the Old World culture of powerful landowners and serfs was imposed, which led to inequality.

On top of this, the European settlers introduced another geographical problem that to this day holds many countries back from developing their full potential: they stayed near the coasts, especially (as we saw in Africa) in regions where the interior was infested by mosquitoes and disease. Most if the countries’ biggest cities, often the capitals, were therefore near the coasts, and all roads from the interior were developed to connect to the capitals but not to one another.

Now Europeans themselves could grow the exotic items they so desired like sugar, coffee and cotton (along with new ones like cocoa). This would, in turn, spur the development of the factory system in Northern Europe. The potato would cause a population explosion, ensuring plenty of desperate factory workers. To replace the native workforce for their export plantations in the New World, the Europeans would resort to buying an enslaved workforce from the southern African continent.

AFRICA

So why did Africa, the birthplace of Homo sapiens, not became the center of world culture and trade, rather than the Near East, China or Europe? After all, it had the biggest head start of all! Plus, it has the greatest human genetic diversity, since everyone outside of the continent is descended from what is thought to be a relatively small population of migrants.

Given that Africa is where humans originated, we are all African. However, the rules of the race changed circa 8000 BCE when some of us, who’d wandered off to places such as the Middle East and around the Mediterranean region, lost the wanderlust, settled down, began farming, and eventually congregated in villages and towns.

But back south there were few plants willing to be domesticated, and even fewer animals. Much of the land consists of jungle, swamp, desert, or steep-sided plateau, none of which lend themselves to the growing of wheat or rice, or sustaining herds of sheep. Africa’s rhinos, gazelles, and giraffes stubbornly refuses to be beasts of burden–or as Jared Diamond puts it in a memorable passage, “History might have turned out differently if African armies, fed by barnyard-giraffe meat and backed by waves of cavalry mounted on huge rhinos, had swept into Europe to overrun its mutton-fed soldiers mounted on puny horses.”

But Africa’s head start in our mutual story did allow it more time to develop something else that to this day holds it back: a virulent set of diseases, such as malaria and yellow fever, brought on by the heat and now complicated by crowded living conditions and poor health care infrastructure. This is true of other regions—the subcontinent and South America, for example—but sub-Saharan Africa has been especially hard-hit, for example by HIV, and has a particular problem because of the prevalence of the mosquito and the tsetse fly. pp. 112-113

Most of the continent’s rivers also pose a problem, as they begin in highland and descend in abrupt drops that thwart navigation. For example, the mighty Zambezi might be Africa’s fourth-longest river, running for 1,700 miles, and may be a stunning tourist attraction with its white-water rapids and the Victoria Falls, but as a trade route it is of little use. It flows through six countries, dropping from 4,900 feet to sea level when it reaches the Indian Ocean at Mozambique. Parts of it are navigable by shallow boats, but these parts do not interconnect, thus limiting the transportation of cargo. p. 113

Another contributing factor, Marshall informs us, is simply the massive size of the African continent. Because maps are flat representations of a sphere, northern areas tend to be exaggerated in size, while those closer to the equator are depicted more realistically. While Prisoners of Geography has a good description of just how big Africa is, a picture is worth a thousand words, and this image went viral on the internet a while back:


The massive size of the continent, combined with variable microclimates and a complete lack of navigable rivers meant that civilizational development was held back.

Unlike in Europe, which has the Danube and the Rhine, this drawback has hindered contact and trade between regions-which in tum affects economic development and hinders the formation of large trading regions. The continent’s great rivers—the Niger, the Congo, the Zambezi, the Nile, and others—don’t connect, and this disconnection has a human factor. Whereas huge areas of Russia, China, and the United States speak a unifying language, which helps trade, in Africa thousands of languages exist and no one culture emerged to dominate areas of similar size. Europe, on the other hand, was small enough to have a lingua franca through which to communicate, and a landscape that encouraged interaction.p. 114

Even if technologically productive nation states had arisen, much of the continent would still have struggled to connect to the rest of the world because the bulk of the landmass is framed by the Indian and Atlantic Oceans and the Sahara Desert, The exchange of ideas and technology barely touched sub-Saharan Africa for thousands of years. Despite this, several African empires and city states did arise after about the sixth century CE: for example the Mali Empire (thirteenth to sixteenth century), and the city state of Great Zimbabwe (eleventh to fifteenth century), the latter in land around the Zambezi and Limpopo Rivers. However, these and others were isolated to relatively small regional blocs, and although the myriad cultures that did emerge across the continent may have been politically sophisticated, the physical landscape remained a barrier to technological development by the time the outside world arrived in force, most had yet to develop writing, paper, gunpowder, or the wheel p.114

When the Europeans finally made it down the west coast in the fifteenth century they found few natural harbors for their ships. unlike Europe or North America, where the jagged coastlines give rise to deep natural harbors, much of the African coastline is smooth. And once they did make land they struggled to penetrate any farther inland than roughly one hundred miles, due to the difficulty of navigating the rivers as well as the challenges of the climate and disease.p. 115

Southern Africa with its tropical diseases, lack of ports, and lack of navigable rivers, and cut off from the west of the world by the vast Sahara desert, remained divided and tribal, which it remains to this day. Even today its infrastructure remains underdeveloped.

But the most tragic part of Africa’s colonization by Europe (apart from the slave trade) was that countries were established solely on the basis of ensuring the political control of the colonizers.

In 1884 at the request of Portugal, German Chancellor Otto von Bismark called together the major western powers of the world to negotiate questions and end confusion over the control of Africa. Bismark appreciated the opportunity to expand Germany’s sphere of influence over Africa and desired to force Germany’s rivals to struggle with one another for territory.

The Berlin Conference was Africa’s undoing in more ways than one. The colonial powers superimposed their domains on the African Continent. By the time Africa regained its independence after the late 1950s, the realm had acquired a legacy of political fragmentation that could neither be eliminated nor made to operate satisfactorily. The African politico-geographical map is thus a permanent liability that resulted from the three months of ignorant, greedy acquisitiveness during a period when Europe’s search for minerals and markets had become insatiable.

At the time of the conference, 80% of Africa remained under Native Traditional and local control…Following the conference, the give and take continued. By 1914, the conference participants had fully divided Africa among themselves into fifty unnatural and artificial States.

How African countries got their borders (TYWKIWDBI)

CHINA:

At the other end of the Eurasian continent lay China, and complex civilizations formed very early here was well. Once again, the nucleus was the great river valleys where millet, and later rice, were grown:

The concept of China as an inhabited entity began almost four thousand years ago. The birthplace of Chinese civilization is the region known as the North China Plain, which the Chinese refer to as the Central Plan. A large, low-lying tract of nearly 160,000 square miles, it is situated below Inner Mongolia, south of Manchuria, in and around the Yellow River and down past the Yangtze River, which both run east to west. It is now one of the most densely populated areas in the world. p. 39

The heartland, as the North China Plain is known, was and is a large, fertile plain with two main rivers and a climate that allows rice and soybeans to be harvested twice a season (double cropping), which encouraged rapid population growth. By 1500 BCE in this heartland, out of hundreds of mini city-states, many warring with each other, emerged the earliest version of a Chinese state–the Shang Dynasty. This is where what became known as the Han people emerged, protecting the heartland and creating a buffer zone around them. The Han now make up more than 90 percent of China’s population and they dominate Chinese politics and business. p. 40

The Yellow River basin is subject to frequent and devastating floods, earning the river the unenviable sobriquet “scourge of the sons of Han.” Nevertheless, the Yellow River is to China what the Nile is to Egypt—the cradle of its civilization, where its people learned to farm, and to make paper and gunpowder. pp. 39-40

To the north of this proto-China were the harsh lands of the Gobi Desert in what is now Mongolia. To the west the land gradually rises until it becomes the Tibetan Plateau, reaching to the Himalayas. To the southeast and the south lies the sea.

The heartland is the political, cultural, demographic, and crucially—the agricultural center of gravity. About a billion people live in this part of China, despite it being just half the size of the United States, which as a population of 322 million. Because the terrain of the heartland lent itself to settlement and an agrarian lifestyle, the early dynasties felt threatened by the non-Han regions that surrounded them, especially Mongolia, with its nomadic bands of violent warriors…By the time if the famous Chinese philosopher Confucius there was a strong feeling of Chinese identity and of a divide between civilized China and the “barbarous” regions that surrounded it. There was a sense of identity shared by 60 million or so people. p. 41

China’s geography and history caused it to turn inward, instead of outward, and this has made all the difference.

By 200 BCE. China had expanded toward, but not reached, Tibet in the southwest, north to the grasslands of central Asia, and south all the way down to the South China Sea. The Great Wall (known as the Long Wall in China) had been first built by the Qin dynasty (221-207 BCE), and on the map China was beginning to take on what we now recognize as its modem form. It would be more than two thousand years before todav’s borders were fixed, however.

Between 605 and 609 CE the Grand Canal, centuries in the making and today the world’s longest man-made waterway, was extended and finally linked the Yellow River to the Yangtze. The Sui dynasty (581-618 CE) had harnessed the vast numbers of workers under its control and used them to connect existing natural tributaries into a navigable waterway between the two great rivers. This tied the northern and southern Han to each other more closely than ever before. It took several million slaves five years co do the work, but the ancient problem of how to move supplies south to north had been solved but not the problem that exists to this day, that of flooding.

The Han still warred with each other, but increasingly less so, and by the early eleventh century CE they were forced to concentrate their attention on the waves of Mongols pouring down from the north. The Mongols defeated whichever dynasty, north or south, they came up against, and by 1279 their leader, Kublai Khan, became the first foreigner to rule all of the country as emperor of the Mongol dynasty. It was almost ninety years before the Han would take charge of their own affairs with the establishment of the Ming dynasty.

By now there was increasing contact with traders and emissaries from the emerging nation states of Europe, such as Spain and Portogal. The Chinese leaders were against any sort of permanent European presence, but increasingly opened up the coastal regions to trade. It remains a feature of China to this day that when China opens up, the coastland regions prosper but the inland areas are neglected. The prosperity engendered by trade has made coastal cities such as Shanghai wealthy, but that wealth has not been reaching the countryside. has added to the massive influx of people into urban areas and accentuated regional differences. p.41-42

China’s vast distance from the New World was to prove fatal, as Ian Morris explains:

Before people could cross the oceans, it had not mattered that Europe was twice as close as China to the vast, rich lands of the Americas. But now that people could cross the oceans, this became the most important geographical fact in the world.

The Atlantic, 3,000 miles across, became a kind of Goldilocks Ocean, not too big and not too small…The Pacific, by contrast, was far too big. Following the prevailing tides and winds, it was an 8,000-mile trip from China to California—just about possible 500 years ago, but too far to make trade profitable.

Geography determined that it was Western Europeans, rather than the 15th century’s finest sailors—the Chinese—who discovered, plundered, and colonized the Americas. Chinese sailors were just as daring as Spaniards; Chinese settlers just as intrepid as Britons; but Europeans, not Chinese, seized the Americas because Europeans only had to go half as far.

Europeans went on in the 17th century to create a new market economy around the shores of the Atlantic, exploiting comparative advantages between continents. This forced European thinkers to confront new questions about how the winds and tides worked. They learned to measure and count in better ways, and cracked the codes of physics, chemistry, and biology.

As a result, Europe, not China, had a Scientific Revolution. Europeans, not Chinese, turned science’s insights onto society itself in the 18th century in what we now call the Enlightenment.

By 1800, science and the Atlantic market economy pushed Western Europeans into mechanizing production and tapping the power of fossil fuels. Britain had the world’s first Industrial Revolution, and by 1850 bestrode the world like a colossus.

One popular theory is that Grand Canal provided a substitute for outward exploration:

Was the Grand Canal a substitute for Chinese ocean exploration? (Marginal Revolution)

This comment to the above article does a good job of explaining why Portugal’s explorations were profitable enough to be self-sustaining, while Chinese “treasure ship” fleets were more about projecting power, and were not economically viable in the long term (even if Gavin Menzies claims are correct):

The way European and Chinese explorations were initiated was a bit similar, a state funded project to achieve non-economic goals. But China gave huge resources to the project, while Portugal had strictly limited resources, the land income of military monastic orders (Order of Aviz, Order of Christ) that became under-employed after Portugal ended reconquista. Crusades in Morocco were tedious and rather fruitless. Henry the Navigator, younger brother of the king got the history changing idea of sending ships further south than Morocco even though nobody knew what they will encounter. But risking few lives was exactly what military orders were doing: taking care of the younger sons of nobility so they would not become highway robbers, rebels etc. However, even “rich” orders had scant resources in a kingdom with one million inhabitants so as soon as possible explorations were aimed to give some profit and sustain themselves. One should also note that ships that were seaworthy in the stormy seas of western Atlantic were seaworthy pretty much everywhere. After some 30 years, explorations that had budget fitting the dedicated budget of the orders started to yield increasing profits, and after 70 years Africa was circumnavigated and reaching Asian trade routes and lucrative markets became imminent. Then the neighboring Spanish hopped onto the bandwagon etc. Later European monarchs from countries closer to the mercantile center of Europe actively supported piracy and other “omnivorous” sources of profit. In other words, the continuation of expeditions beyond the lifetime of Henry the Navigator had good economic case.

Zheng Ho was a friend of the Chinese emperor and he got approval and budget to build Treasure Fleet that informed barbarians about the glory of the Empire of the Center. The ships were huge and magnificent, but following the traditional Chinese shipbuilding that allowed to navigate without difficulty in the zone of Trade Winds, but probably not so much beyond that. Circumnavigation of Africa would require sustained effort and decades of initially fruitless technological progress. Ships were loaded with beautiful products from state supervised manufactories, e.g. porcelain, and were bringing back “gifts from barbarians”, that could delight the emperor but were not justifying the huge expense. Having a giraffe in the imperial menagerie was a success that Confucian scholars in the administration of the empire did not appreciate, they would rather trim the budget and decrease taxes. And once the patron and friend of Zheng Ho was replaced with his successor the program was abolished.

It is easy to see that China could not achieve through “explorations” what they were getting anyway by foreign traders visiting their ports. More irrational was the lack of military navy that would defend the coast against Japanese pirates. In the same time, that was actually related to the renovation of the Grand Canal. That renovation was related to the change of capital from Nanjing or Beijing, and the change of focus in the foreign affairs from the south-central sea cost to the steppe of Manchuria and Mongolia, and internally, the calamities faced by the coastal Chinese were neglected to focus on the danger from the nomads. Basically, for a huge empire internal politics are much more important that whatever happens beyond the borders, and the directions of foreign policy are mostly dictated by the internal circumstances of the ruling elite. Some contemporary states come to mind…

The most popular explanation for why it was foggy England rather than China (which had plenty of coal) that started the Industrial Revolution was articulated by the economic historian Kenneth Pomeranz, and also has to do with geography, specifically where those coal deposits were located:

What, then, does account for the “great divergence” of the book’s title? Pomeranz argues for the importance of two factors, essentially exogenous “shocks” outside the price system that had important effects on the economy: the distribution of energy-generating resources and the accident that Europe discovered the New World, whereas China did not.

The first argument might be termed “geology is destiny.” Coal was the chief energy-generating resource significant for the Industrial Revolution. The location of major coal deposits was a critical factor in determining the viability of industrialization. England’s coal deposits were located almost exactly where manufacturers would have placed them if they had had a say in the matter; transportation costs therefore were low and were made still lower by the ready availability of efficient water transport. Compare this development-friendly geographic distribution in Europe with the geographic distribution in China. Although China was blessed with large coal reserves, they were located for the most part in the thinly populated northwest, hundreds of miles from the potential manufacturing centers in the south and east. Thus, China was at a relative disadvantage compared to Europe in terms of the luck of the geological draw. At the same time that coal in eighteenth-century Europe was cheap and readily available to fuel industry, in China that resource remained relatively expensive and in large part a curiosity relegated to the collections of rock hounds.

The second argument is another variation on the “good luck versus bad luck” theme. The fortuitous (for Europe) circumstance of the discovery of the Americas and the subsequent availability of resources for the Industrial Revolution that this discovery entailed were the exogenous factors. The flow of cotton, sugar, timber, and tobacco to Europe from the New World gave economic development there a significant boost at a critical time; China enjoyed no advantage even remotely comparable.

The Great Divergence (The Independent Review)

THE MIDDLE EAST

Although the Near East was where complex civilization first emerged in Eurasia, it fell behind China and Europe in the Early Modern period for reasons which are still debated. The sack of Baghdad by the Mongols appears to have been a critical blow for Islamic civilization.

The most salient geographical fact about it in my mind has to be—that’s where the oil is! This factor was unimportant until liquid hydrocarbon fuels became essential to the Industrial Revolution, particularly for transport. Now it’s arguable the most important geopolitical factor in the world.

The Greater Middle East extends across one thousand miles, west to east, from the Mediterranean Sea to the mountains of Iran. From north to south, if we start at the Black Sea and on the shores of the Arabian Sea off Oman, it is two thousand miles long. The region includes vast deserts, oases, snow-covered mountains, long rivers, great cities, and coastal plains. And it has a great deal of natural wealth in the form that every industrialized and industrializing country around the world needs–oil and gas.

It also contains the fertile region known as Mesopotamia, the “land between the rivers” (Euphrates and Tigris). However, the most dominant feature is the vast Arabian Desert and scrubland in its center, which touches parts of Israel, Jordan, Syria, Iraq, Kuwait, Oman, Yemen, and most of Saudi Arabia, including the Rub al Khali or “Empty Quarter.” This is the largest continuous sand desert in the world, incorporating an area the size of France. It is due to this feature that not only the majority of inhabitants of the region live on its periphery, but also that, until European colonization, most of the people within it did not think in terms of nation states and legally fixed borders.

The notion that a man from a certain area could not travel across a region to see a relative from the same tribe unless he had a document, granted to him by a third man he didn’t know in a faraway town, made little sense. The idea that the document was issued because a foreigner had said the area was now two regions and had made up names for them made no sense at all and was contrary to the way in which life had been lived for centuries. pp. 135-136

As with Africa, it was the partitioning of antagonistic tribal cultures into modern nation states by European powers which set the stage for much of the chaos taking place in that region today. Climate change is certain to make this even worse in the future.

In 1916, the British diplomat Colonel Sir Mark Sykes took a grease pencil and drew a crude line across a map of the Middle East. Ie ran from Haifa on the Mediterranean in what is now Israel to Kirkuk (now in Iraq) in the northeast. It became the basis of his secret agreement with his French counterpart Francois Georges-Picot to divide the region into two spheres of influence should the Triple Entente defeat the Ottoman Empire in the First World War. North of the line was to be under French control, south of it under Brit:ish hegemony. p.136

…there was violence and extremism before the Europeans arrived. Nevertheless, as we saw in Africa, arbitrarily creating “nation states” out of people unused to living together in one region is not a recipe for justice, equality, and stability. Prior to Sykes-Picot (in its wider sense), there was no state of Syria, no Lebanon, nor were there Jordan, Iraq, Saudi Arabia, Kuwait, Israel, or Palestine. Modem maps show the borders and the names of nation states, but they are young and they are fragile.p. 137

RUSSIA

Finally, Russia, far to the north and east and mostly landlocked except for the ports on the Black and Baltic seas (until its later expansion across Siberia) was destined to be behind Western Europe. It formed a unique culture of its own, mixing East and West. Not until Peter the Great would it take its place among the great European powers.

But the biggest factor was it’s exposure to the nomadic pastoralist raiders of the vast Eurasian grasslands, most notably the Mongols. These steppe nomads would plague both Russia and China throughout their history. Not only would the wrenching changes of the North Atlantic pass by Russia by until much later in history (serfdom was abolished in 1861), but the leaders Russia to this day would obsess over establishing buffer zones to protect the Slavic heartland from invasion:

Russia as a concept dates back to the ninth century and a loose federation of East Slavic tribes known as Kievan Rus, which was based in Kiev and other towns along the Dnieper River, in what is now Ukraine. The Mongols, expanding their empire, continually attacked the region from the south and east, eventually overrunning it in the thirteenth century.

The fledgling Russia then relocated northeast in and around the city of Moscow. This early Russia, known as the Grand Principality of Muscovy, was indefensible. There were no mountains, no deserts, and few rivers. In all directions lay flatland, and across the steppe t the south and east were the Mongols. The invader could advance at a place of his choosing, and there were few natural defensive positions to occupy.

With no natural barriers, and surrounded by enemies, the Russians needed to develop a strong authoritarian state to survive at all.

Enter Ivan the Terrible, the first tsar. He put into practice the concept of attack as defense–i.e., beginning your expansion by consolidating at home and then moving outward. This led to greatness. Here was a man to give support to theory that individuals can change history. Without his character, or both utter ruthlessness and vision, Russian history would be different.

What they did was to spend several centuries developing a “buffer zone” around Moscow, at the same time establishing ports where this landlocked power could interact with the outside world via trade instead of just being invaded.

The fledgling Russia had begun a moderate expansion under Ivan’s grandfather, I van the Great, but that expansion accelerated after he carne to power in 1533. It encroached east on the Urals, south to the Caspian Sea, and north toward the Arctic Circle. I r gained access to the Caspian, and later the Black Sea, thus taking advantage of the Cau .. casus Mountains as a partial barrier between it and the Mongols. A military base, was built in Chechnya to deter any would … be attacker, be they the Mongol Golden Horde, the Ottoman Empire, or the Persians. There were setbacks. but over the next century Russia would push past the Urals and edge into Siberia, eventually incorporating all the land to the Pacific coast far to the east.
When they finally got to the Baltic Sea and established St. Petersburg, the rulers decided that it was time for Russia to become a great European power.

In the eighteenth century, Russia, under Peter the Great-who founded the Russian Empire in 1721-and then Empress Catherine the Great, looked westward, expanding the empire to become one of · the great powers of Europe, driven chiefly by trade and nationalism. A more secure and powerful Russia was now able to occupy Ukraine and reach. the Carpathian Mountains. It took over most of what we now know as the Baltic States-Lithuania. Latvia. and Estonia. Thus it was protected from any incursion via land that way, or from the Baltic Sea.

This chapter of the book was excerpted by The Atlantic, and be read here:

Russia and the Curse of Geography (The Atlantic)

Next time we’ll take a closer look about how a few accidents of geography led to the formation of capitalist markets in Western Europe based on a new theory.

The Origin of Money – Key Takeaways

“We begin with the story of the greatest conqueror in history, a conqueror possessed of extreme tolerance and adaptability, thereby turning people into ardent disciples. This conqueror is money. People who do not believe in the same god or obey the same king are more than willing to use the same money. Osama Bin Laden, for all his hatred of American culture, American religion and American politics, was very fond of American dollars. How did money succeed where gods and kings failed?”
~ Yuval Noah Harari, “Sapiens: A Brief History of Humankind,” (2015)

So I’m done for now writing about the history of money, which is doubtless good news to any readers I still have left (if there are any). I went way too far down the rabbit hole on this one 😊.

But the way it started was actually very simple. When I started, I had two major questions. One was, where did the notion of a “national debt” come from??? I mean, you never hear about the national debt of ancient Greece and Rome do you? In fact, it’s hard to imagine any ancient empire, from Persia to China voicing concerns about the national debt. Yet now it seems to drive just about every decision any government makes. We’re constantly told that “we can’t afford” this or that because it would increase the national debt. But how can a nation-state go into debt merely by issuing its own money? And how can every country in the world be simultaneously in debt? Since every nation-state is the ultimate source of its own currency, how can they be in debt? To whom?

The other major question I had was how did we get this weird hybrid system where we have government money, but private banks and financiers seem to control it? After all, money is a public good. We all need it. It should theoretically be under democratic control. But actual control over it is exercised by a secretive cabal of bankers and financiers who are not accountable to any democratic institutions. As Michael Hudson says, “every economy is planned, it’s only a matter of who does the planning.” He argues that in our society it is the private financial interests who do the planning rather than government bureaucrats, and they do so primarily to benefit themselves, even to the detriment of society. As Frederick Soddy said:

“… every monetary system must at long last conform, if it is to fulfil its proper role as the distributive mechanism of society. To allow it to become a source of revenue to private issuers is to create, first, a secret and illicit arm of the government and, last, a rival power strong enough ultimately to overthrow all other forms of government.”(The Role Of Money[1932]).

Hopefully we learned some answers to those two questions. A thoroughgoing history of money, rather than just being of historical interest, does give us some crucial insights into current dilemmas and what we need to do going forward.

So, by way of conclusion, here are some of the major takeaways I got while writing this series of posts. If your eyes glazed over during the series or you just quit reading over the summer (and I don’t really blame you), I encourage you to come back and at least read this instead:

What is money and finance at its heart? It’s a way to get large numbers of people to cooperate on the same goal. As Yuval Noah Harari writes in Sapiens, because our “natural” group size is fairly small (only about 150 or so), we need to invent shared fictions to get people in order to cooperate at larger and larger scales.

For a long time, religion was the major one. Then came the nation-state. Now finance seems to be the major way of controlling people and getting them to cooperate. With enough money you can get people to do just about anything, including have sex with you or kill one another. Money is permission. But usually it’s used for more benign purposes, such as getting thousands of people from all over the world to cooperate in a shared goal such as building electric cars or making and selling fizzy drinks.

Homo sapiens have no natural instincts for cooperating with large numbers of strangers. Humans evolved for millions of years living in small bands. Consequently, there are no instincts for mass social cooperation. To make up for that, humans have to rely on all kinds of imagined realities that regulate cooperation on such a huge scale. The human empires are based on shared common beliefs, social and legal norms that sustain them. The stability of the complex societies is not based on natural instinct or on personal acquaintance, but on shared imagined realities. Coursera: A Brief History of Humankind by Dr. Yuval Noah Harari

Both the corporation and the nation-state are shared legal fictions invented to bind large numbers of people together with imaginary ties to some sort of common purpose. Since its invention in the 1600’s, the corporate form has gained more and more power relative to the nation-state which created it.

Money is transferable debt (or credit). This is the “credit theory of money.” In “primitive” societies, many items are used to signify debts and obligations between various individuals, groups, and families. But once these obligations can be transferred among unrelated people, it becomes a type of money, even if the “exchange” is just by oral agreement (as on the island of Yap). “Money” may not even have corporeal form, but if it does, then it is usually standardized in some way (stone disks, shells, beads, coins, paper, etc.).

Money, then, is credit and nothing but credit. A’s money is B’s debt to him, and when B pays his debt, A’s money disappears. This is the whole theory of money (Innes 1913, p.16)

…money is anything that denotes and extinguishes one’s debt/liability to another; it was not a product of market exchanges but rather a byproduct of social relations based on debt…the nature of money is a credit-debt relationship that can only be understood in institutional and social contexts…Therefore, money originated as a byproduct of social relations based on debt and realized its standard form through the need of the central authority, as opposed to private individuals, to establish a standard unit of account to measure debt obligations or production surplus.
Vincent Huang, On the Nature of Money, p. 6

In fact, there are numerous examples from history where the state has stopped issuing money or the banks have closed (such as Ireland in the 1960’s), and private credit circulated as money in the form of checks. Rather than barter, the establishment of new credit-clearing systems is the common response when currency systems seize up and go under at levels greater than a local village. Also, we see that throughout history the shrinking of the state has led to a curtailment of trade, not an expansion, suggesting that the markets, money and governments are symbiotic and not in opposition as we are led to believe.

Money emerges when one class is able to impose obligations on the rest of society. This is the contention of John F. Henry. This could be a redistributor chief, a warlord, a royal household or a divine priesthood. Henry contends that hydraulic engineers were the first such class to emerge in ancient Egypt. Carroll Quigley argues that ancient priests used their knowledge of reading the movements of the heavens to predict floods, and this allowed them to set themselves up as a ruling class. Others posit that the need to wage warfare led to warlords setting themselves up a ruling class. Religion probably played a key role; the root of the word hierarchy is “hiero-“ meaning sacred.

In every case, this class probably engaged in astronomy; managed collective labor in some way, whether in military or engineering endeavors; and collected goods for redistribution among the populace.

Money has no value in and of itself. It is not the thing that matters, but the ability of one section of the population to impose its standard on the majority, and the institutions through which that majority accepts the will of the minority. Money, then as a unit of account, represents the class relations that developed in Egypt (and elsewhere), and class relations are social relations.

To service the activities of this class, resources needed to be deployed to fund their efforts. To keep track of these resources, a unit of account was established by these authorities (priests and scribes).

As James C. Scott points out, writing was originally invented as a tool for social control of the masses by the ruling class, not as a form of cultural expression (which was oral). Written records first emerge to manage inputs and outputs. There is a fascinating argument that clay bullae envelopes were a form of double entry bookkeeping, with debits represented by tokens placed inside and credits represented by the markings on the outside.

Apart from its role in the invention of writing, accounting is significant for human civilization because it affects the way we see the world and shapes our beliefs. To take this early example, the invention of token accounting in Mesopotamia was important not only because it facilitated economic exchanges and generated writing, but, according to Mattessich, “because it encouraged people to see the world around them in terms of quantifiable outcomes. …
Jane Gleeson-White, Accounting: Our First Communications Technology

Along with writing, establishing common standards of measurement appears to have been a chief function of the ruling classes since their emergence. Ancient priests tracked cyclical movements of celestial bodies and divided the year into discrete units to determine the precise timing of the planting and harvest, as well as ritual gatherings and feasts. They encoded these heavenly movements and measurements into their monuments in order to depict a kind of cosmic order on earth–“as above so below.” The built calendrical monuments such as Gobeckli Tepe, Stonehenge and Nabta Playa. They began to measure distance in addition to time (to mark off plots of land) and weights and quantities (to measure offerings to the gods). This process happened independently in both the Old World and the New. Thus, the creation of a unit of measurement to establish equivalencies between disparate goods produced by households was a logical extension of the duties of the ruling class once people began to occupationally specialize.

…the rise of class society and inequality took place alongside the emergence of money, whereby money played a key role in establishing, maintaining and exacerbating inequality and class division in societies. To put it simply, as soon as one witnesses the emergence of money, one observes the rise of class society and economic inequalities. Money, class society, and inequality came into being simultaneously, so it seems, mutually reinforcing the development of one another. Semenova and Wray, The Rise of Money and Class Society: The Contributions of John F. Henry (PDF) p.2

Which leads to the following conclusion:

The “unit of account” role appears to have been the first function of money to emerge (and not the “means of exchange” or “store of value” functions). Thousands of years before the first coins were minted, tributes and donations to temples were denominated in a standard unit of account, such as the shekel in Babylonia and the deben in Egypt. Babylonian scribes established money-prices for internal administrative purposes to track the crops, wool, barley, and other raw materials distributed to their dependent workforce, as well as to calculate the rents, debts and interest owed to the temples and palaces. These prices were then fixed to a certain weight of silver, allowing it to be used as a standard measure of value and means of payment. Initially, grain (the principal product of the Mesopotamian economy) was used, but its value fluctuates too widely from year-to-year, so silver replaced it.

Thus, the authorities can determine, for example, that 1 horse = 2 cows = 5 pigs = 10 bushels of grain = 1 ounce of silver. This was used to calculate inputs and outputs for the redistribution economies of the Bronze Age. It was also used in assessing fines and punishments by legal and religious authorities. Such compensation payments for transgressions kept societies stable in the face of increasing numbers of strangers living shoulder-to-shoulder. There are clues in our language: the word for “debt” also means “sin” or “transgression” in many languages, and the verb “to pay” also means “to appease” or “to pacify.”

…money as a unit of account precedes its roles as a medium of exchange and store of value… It thus follows that the physical manifestation of money (the “money things”) is not necessary since money as a debt relation needs not be physically tangible. This has been demonstrated as early as in Mesopotamia (3100BC) where crops and silver were used as standard units of account but not as a general medium of exchange. Exchanges simply took the form of credit and debit entries in clay tablets, similar to our electronic payment system today. Vincent Huang, On the Nature of Money p.6

Money (a standard unit of account, used to denote debts or assess value) predates coins by [millennia], and coins only ever comprised a small fraction of the money in daily use. Most ancient money was in the form of marks on clay tablets or notes on pieces of papyrus, just as it is today (computers replacing clay or papyrus)…Coins were for spot transactions, untrusted persons and ceremonial gifts (donatives). The real cost of making money was and is in establishing and maintaining the trust needed to support it. https://rwer.wordpress.com/2014/02/03/the-real-costs-of-making-money-2-where-did-the-silver-used-to-buy-josef-come-from/

The unit of account was typically based on what was most appropriate for giving to the gods. This is a point David Graeber makes. We are all “in debt” from the moment we are born–to the gods, to our ancestors, to our parents, and to our society. This “primordial debt” is discharged by sacrificing to the gods or gifts to temples (mediated by the religious authorities). Hence, that “universal debt” becomes the cornerstone of taxation, and hence the first monetary systems. For example, the Bible demands a ten-percent gift of one’s income to the temple (a tithe).

Every tithe of the land, whether of the seed of the land or of the fruit of the trees, is the Lord’s; it is holy to the Lord. If a man wishes to redeem some of his tithe, he shall add a fifth to it. And every tithe of herds and flocks, every tenth animal of all that pass under the herdsman’s staff, shall be holy to the Lord. One shall not differentiate between good or bad, neither shall he make a substitute for it; and if he does substitute for it, then both it and the substitute shall be holy; it shall not be redeemed.” (LEV. 27:30–34)

So, for example, in ancient Mesopotamia, the fact that silver is “captured sunlight,” gives it a divine quality which makes it highly desirable for gifts to the temple. Thus, the unit of account becomes equivalent to a certain weight of silver.

Silver was sort of a “goldilocks commodity” – there was enough of it for coinage, but no so much that it would be too easy for anyone to procure. It only comes from a single place–a mine down deep in the earth, most of which were owned by the authorizes. Things like apples and hides could not be useful, for example, because they were widely distributed. You had to use something whose issuance could be controlled by the state. By stamping the ruler’s mark on the coins, it gained value in exchange over and above its precious metal value. That is, they were tokens:

Coinage arose at approximately the end of the seventh century BCE in Lydia (in what is now western Turkey), where there was an abundant supply of electrum, a natural alloy of gold and silver. But coinage was first used in everyday life in the Greek city-states on the coast of Lydia. One plausible theory is that it arose out of the best possible way for the Lydian monarchy to use its abundant electrum to pay Greek mercenaries. Each piece of electrum had a different and undeterminable proportion of gold and silver (and so a different metallic value), but numerous pieces each with exactly the same value could be created by stamping them with a mark meaning ‘this is worth x’. And so from the very beginning of coinage its conventional value was different from (generally greater than) its metallic value. Radical Anthropology, Richard Seaford interview (PDF)

In ancient Greece, cattle were ranked and sacrificed to the gods. Thus, the value of things such as ships and armor were measured against cattle, even though no one ever used cattle to buy or sell anything. In ancient Ireland, slave girls (kumals) were the most valuable commodity, so items were evaluated against them. Eventually, the kumal became just an abstract unit of account for trading purposes, divorced from its original context.

Religiously significant metals became important as temple offerings and temples began accumulate large reserves. Followers of the religion would look to acquire the metal, to enable them to make an offering to the gods, and so the metal became the commodity in the most demand. The Ancient Egyptians, who had easy access to gold, used Cypriot copper for their religious offerings while the Cypriots used Egyptian gold. In Mesopotamia, the metal of choice was silver…Later, we read in Homer that the Greeks priced goods in terms of oxen, the animal that was reserved for sacrifices to the gods, ..When ‘Currency Cranks’ or ‘Bullionists’ argue that the economy would be improved by reverting to a Gold Standard because gold has an ‘inherent value’ they need to explain where is the value in gold, apart from its inherent symbolic, representative, value. Lady Credit (Magic, Maths and Money)

The Unit of Account and the Means of Exchange need not be the same. In fact, for most of history they weren’t! In the Middle Ages, prices were denominated and taxes assessed in a common unit of account (e.g. livres tournois), but hundreds of different coins churned out by dozens of mints were used to pay them (such as the Piece of Eight or Louis d’Or).

In many places, there was often no coin equivalent to the unit of account. Coins were exclusively minted by authorities. The coins didn’t have a fixed value, rather their exchange value fluctuated and was dictated by government fiat. However, their bullion value fluctuated according to supply and demand in the marketplace. Imbalances between bullion and exchange values led to surfeits and shortages of precious metals, with corresponding price swings (e.g. the “Price Revolution”). This led to efforts by authorities to restrict the movements of precious metals (bullionism).

Similarly, bills of exchange were denominated in an abstract unit of account (écu de marc), which did not correspond to any particular sovereign currency in circulation. The arbitrage between this abstract unit of account and the currencies of the time is how bankers made their money when usury was still illegal.

An interesting example of this was seen in Brazil in the 1990’s. The government created a totally new unit of account, the “Unit of Real Value” (URV) which would hold its value relative to the currency (the cruzeiro), which was subject to hyperinflation. Prices, taxes and wages would be denominated in the URV, which would remain constant, while the amount of cruzeiros needed to equal 1 URV would vary. Eventually, once prices stabilized, the country would introduce a totally new currency equivalent to the URV (the real).: How Fake Money Saved Brazil (NPR)

Items that can be accepted in payment as fines or taxes to authorities acquire value in private transactions. As MMT economists point out, the dollar is given value by the ability to pay ones taxes with it, that is, one is able to discharge one’s personal obligations to the state with dollars (and only dollars). Thus, prices are typically denominated in dollars as well, and producers accept dollars in exchange for goods and services.

While private money can be created and issued, the ability to pay one’s taxes with dollars means there is always a demand for them. Also, since money is transferable credit, the government’s credit is typically much more reliable than that of private individuals. This is often referred to as the “state theory of money,” of “chartalism”:

[While] private individuals may have different units of accounts (cattle, watermelon, etc.)…It is unlikely that any individual could have sufficient power to induce others to hold its liabilities as a standard unit of account…By choosing a unit of account as the only means for individuals to extinguish his/her liabilities to themselves, the central authorities “write the dictionary”. Hence, the power of the central authority (state, temple, tribe, etc.) to impose a debt liability (fines, fees, taxes, etc.) on its population gives the former the unique right to choose a particular unit of account as the only means of payment to the central authority.

Money’s value comes from faith in the issuing government’s credit. The loss of faith in the currency had much more to do with the stability of the issuing government rather than the amount of precious metal contained in the coin. Numismatists can find no solid correlation between prices and the precious metal content of coins over millennia. Nor can they find a consistent standard of how much specie a coin “should” have.

In the case of paper money, the paper itself is not valuable; it is the enforceable claim written on it that’s valuable. Originally this promised to pay the bearer in coin. Then it evolved into banknotes–sort of a “paper coin”–a signifier of government debt which did not pay interest.

The above leads to the following conclusion:

Money led to markets, not vice-versa. Once the concepts of money and prices are firmly established by central authorities, only then can decentralized exchanges can take place in markets. That these standards were initially set by authorities makes far more sense (and is historically better supported), than the idea that money emerged spontaneously by private individuals to reduce search costs without recourse to any centralized authority through innumerable acts of barter.

Once the state has created the unit of account and named what can be delivered to fulfill obligations to the state, it has generated the necessary pre-conditions for development of markets. The evidence suggests that early authorities set prices for each of the most important products and services. Once prices in money were established, it was a short technical leap to creation of markets. This stands orthodoxy on its head by reversing the order: first money and prices, then markets and money-things (rather than barter-based markets and relative prices, and then numeraire money and nominal prices). The Credit Money and State Money Approaches by L. Randall Wray, p.9

Religion played a key role in the establishment of money and markets from the very beginning. This makes sense, since religion was the primary unifying and coordinating “story” for ancient societies. The source of the word religion literally means “to bind together.” We saw above the Biblical instructions on tithing.

Temples appear to have been the first banks and the first treasuries. Sumerian temples stored precious metals, made loans, rented land, coordinated labor, established prices for key goods, and determined fees and fines. The obolos, the lowest denomination Greek coin, derived its name from the iron spits (obelos) through which sacrificial roast meat was evenly distributed to the members of the tribe. The drachma derives its name from obeliskon drachmai, a ‘handful’ of spits. This communal ritual is thought to have influenced Greek ideas of decentralized exchange and universal value, in contrast to the centrally-administered economies of the Near East. The iron spits acquired value in interpersonal exchange. Later, Greek temples distributed stndardized lumps of metal, stamped with the city’s emblem, to all adult male members of the polis which allowed for the unique social order to be maintained.

In contrast to most ancient near-eastern societies, the Greek polis had retained sacrificial ritual that embodied the principle of communal egalitarian distribution. The fact that the Greek word for this distribution (moira) came to mean ‘fate’ indicates the importance of the distributional imperative. Citizenship was marked by participation in communal sacrifice, which also provided a model for the egalitarian distribution of metallic wealth in standardised pieces.Some of the vocabulary of early coinage comes from animal sacrifice. For instance, the word ‘obol’, used of a coin, comes from the word for a spit. In the communal egalitarian distribution meat was distributed on iron spits, which were of standard size as well as being portable and durable, i.e. they could be used as money (in a limited way). With the use of more precious metal in exchange, ‘obol’ was transferred to a piece that was of roughly equal value and so of much smaller size (and so even more convenient). Radical Anthropology, Richard Seaford interview (PDF)

Markets also appear to have emerged around religious buildings. Many ancient exchanges were near temples. The great fairs of Europe in places like Champagne and Lyon took place near churches and cathedrals under the watchful eye of the all-seeing God. Since so much of trade relies on trust and belief (credit comes from credere = “to believe”), it is logical that religion would play a central role:

We tend nowadays to think of religion as the non-material activity of mankind. Did not Jesus expel the moneychangers from the Temple? Does not Islam forbid the charging of interest on loans? Did not a similar Christian prohibition of usury hold back mediaeval Europe’s economic development for centuries? Yet when Jesus took his action against the money-changers he must have been reversing the tradition of several millennia. The temples were the source of commercial law and practice. They had developed writing for the keeping of their accounts. They imposed the moral code which made promises inviolable. In Mesopotamia temples employed the poor, the widows and the orphans in factories which produced textiles to be traded abroad for the commodities the region lacked, including silver, copper, tin and lead. They were, it seems, the major business centres. (Innes p. 136)

Some theorists posit that as exchanges became more common and societies became more affluent, they invented “big gods” that could see everything and demanded that we behave a certain way (honest, truthful, etc.). These “Big gods” could transcend the limits of the old tribal gods that were based on shared ancestry and culture. All you had to do was profess belief! Wealth may have driven the rise of today’s religions (Science)

Trade Credit (not gold or silver) was the primordial form of commercial money. Rather than barter or coins, credit lines were probably what was used for exchanges in the days before currency became commonplace. In “primitive” cultures, reciprocity performs this role, where one’s gifts to others circulate back to the giver in time without a formal accounting of who owes what to whom. This helps maintain social relationships in small, close-knit societies.

As societies scale up, reciprocity is replaced with more formal agreements, often denominated in the standard unit of account. Even in modern times, credit is what is used to purchase inputs upfront, rather than just repeated spot transactions (as any businessperson or farmer can tell you).

The word credit is derived, very appropriately, from the Latin word for ‘to trust’. …the division of labour, from the very first moment it was applied, required the creation of a credit system of some kind. It was absolutely necessary to be able to trust one’s fellow workers’ promises to reward one appropriately at some future moment for one’s own products or services. It would have helped to have an enforcing authority, and that makes it all the more likely that trade was conducted in a regulated way, not by free individual option…it is obvious that a completely free market economy has rarely, if indeed ever, existed. We all rely on the existence of an enforcement system. We rely on the rule of law.

Trade credit (bills of exchange) formed much of the “money” of the Middle Ages and facilitated the commercial expansion in the absence of adequate gold and silver supplies. Huge amounts were transferred using double-entry bookkeeping (the “Venetian Method”) without any cash changing hands. Bankers would settle accounts at the conto which concluded the fairs. In fact, this may have been the original purpose of the fairs, with retail trade being subsidiary. Eventually, as commerce became more and more important after 1600, these economic activities were located in permanent banks and bourses established by the major port cities in order to facilitate the activities of merchants and the expansion of long-distance trade.

Trade credit is the essential foundation of the whole economic system, and the essential financial problem of economic development is to monetise trade credit, to turn it into an instrument for transferring value, for measuring value and for storing value. Wray. 121

Tally sticks, which keep track of debts and credits, may be the earliest form of money to emerge, even before coins or clay tablets. They were made of organic materials such as wood and bone. Because metal coins are what survive, tally sticks are sadly omitted in standard accounts of money: What tally sticks tell us about how money works (BBC)

Debt servitude appears to be the earliest form of mass slavery. While slaves were often captured prisoners of war in primitive cultures, their numbers were necessarily limited because having too many hostile foreigners living among your society and doing its essential chores would be dangerous (if not outright suicidal). That’s why in the ancient Near East, they were mainly women and children employed in domestic labor (cooking, cleaning, weaving, child care, etc.). Rather than slave labor, their massive walls and monuments were built by voluntary, mainly corvée labor, which served as a sort of social glue and proxy form of taxation in the absence of money.

But once debt becomes commonplace, large numbers of one’s own people could be compelled to labor for others in order to service their debts. This, as David Graeber points out, would be seen as just and fair, and thus the debtors would be less inclined to rebel. In fact, this may have been how the very first classes formed in ancient societies–debtors and creditors–rather than through military conquest or political decisions. Debt and chattel slavery existed side-by-side in most ancient societies. Even in colonial America, there were more indentured servants than African slaves.

Early rulers realized they needed to occasionally release the people from their debt obligations to public institutions (temples and palaces), otherwise they would lose the support of the people. They also needed enough free men to staff the armed forces, as debt-serfs could not afford to train or equip themselves. Debt serfs could also run away. Some argue that the debt serfs of ancient Mesopotamia, the Habiru, are the ancestors of the Jews (Hebrews).

And ye shall hallow the fiftieth year, and proclaim liberty throughout the land unto all the inhabitants thereof; it shall be a jubilee unto you; and ye shall return every man unto his possession, and ye shall return every man unto his family.
— Leviticus 25:10

Later, when professional soldiers replaced citizen armies, debt forgiveness was abolished and debts were held sacrosanct. This gave rise to a large class of hereditary debt serfs.

Only later on do prisoners of war become the major source of slaves in the Classical world. Some of the first markets to emerge were slave markets where prisoners of war were bought and sold. The Roman war machine brought in tens of thousands of slaves, diving their costs down and displacing free labor in agriculture. This allowed wealth to concentrate to a degree that undermined social cohesion. This may have been an underlying cause of Rome’s decline and fall.

All the major innovations in money and finance seem to have been created either to manage long-distance trade or to fund wars. The need to raise funds for war has seemingly driven all financial innovations since Medieval times. The “national debt” began when Venice needed to fund a war with Byzantium, and so they borrowed from their wealthy merchant classes. This borrowing eventually became done on a permanent basis. All the creditors’ obligations were eventually consolidated in one lump sum, revenue streams were dedicated to them, and payments were managed by a state-run bank. Thus the “national debt” was born. Borrowing was done by various municipalities in Northern Europe, but none of these were national debts. The Dutch seem to be the first country to leverage those techniques effectively on a national scale to fight for their independence from Spain.

Going even farther back, it appears that coinage was first invented to pay troops. Coins were distributed to soldiers as payment. Then a tax was then imposed on the conquered populations. The way to pay the tax was to acquire signifiers of the state’s debt in the form of coins by selling goods and services to the occupiers, thus redeeming signifiers of the state’s debt. There is another clue in the language here: the word soldier comes from the soldius, a gold coin used to pay troops in the late Roman Empire.

There is firm evidence to support money being a state creation. Money appears in Europe at the time the Greek city states became reliant on mercenary armies. Cities paid soldiers in gold to conquer some community, the soldiers then spent the gold in the colonised lands and the state recovered the gold by taxing the colonised merchants and innkeepers using the tokens that the soldiers had paid for food and lodgings. Greek and Roman citizens never paid tax, only the conquered paid for the privilege and were bound to the conqueror by having to exchange their resources for the Imperial currency. The model would survive and drive colonialism in the modern age, in the 1920s the British taxed Kenya at a rate of about 75% of wages, forcing the colonised to grow cash-crops to be consumed by the colonisers. Lady Credit (Magic, Maths and Money)

Financial innovations spread through the need to wage wars. If a system gave one nation a competitive advantage, it had to be adopted by other nations in order to compete. It was a sort of a Darwinian arms race: if a financial innovation allows a country to be more effective in trade or warfare, it will dominate countries that are unable to deploy their resources as effectively. The others will either adapt the innovation on their own or be subsumed into the empire (and thus gain the innovation that way).This is probably why financial techniques spread so rapidly in Western Europe as compared with China and the Middle East, who relied upon conscription and command-and-control systems rather than mercenaries & borrowing to fight wars.

In “patrimonial states”, where the state was an extension of the ruling family’s household, loans were essentially personal loans to the monarch that could be refuted at any time. Only when parliamentary systems come into play does state borrowing become a reliable means for governments to raise money. Thus merchant republics led the way, first in Italy, and then in Holland.

John Law’s financial innovations were an attempt to consolidate and manage the massive debts Louis 14th had run up with his wars and extravagances. Similarly, the debts generated by King William’s Glorious Revolution and subsequent wars led to the creation of the Bank of England, a joint-stock company designed to loan to the government and manage the state’s debt. This is the ancestor of today’s central banks.

Borrowing marks a time when citizens become not only debtors of the state, but creditors as well, profoundly altering the social relations between the state and its citizens. There effects were distributional–from the public sector at-large to the wealthy citizens and institutions who held the bonds. Over time, this group became more and more influential. Borrowing allows nations to bring resources forward in time. It also allows borrowing from a wider range of people and institutions than just banks.

Warfare has also been the reason for abandoning precious metal standards. The need to issue adequate money to fight wars has led to the suspension of convertibility of money and the rise of fiat currencies. Every time any sort of fixed standard has been tried, warfare undermines it.

Trading Empires are the major source for financial innovations. It’s no coincidence that major financial innovations occur in thassalocracies reliant upon long-distance trade. First the Italian city-states such as Venice and Genoa, then the Spanish and Portuguese empires, then the United Provinces (Dutch Republics), and finally the English Whig merchants who invented the modern monetary system.

Why were trading empires such a fertile source for innovations such as insurance and limited-liability corporations? Because trading voyages require enormous sums of investment upfront and the outcome is highly uncertain.

Consider the enormous length of time it took these wind-powered trading voyages. It took 12-18 months to make it to the Indies, and then you had to procure the cargo. That meant it could be 3-4 years before a profit is was realized. That meant that trading voyages required a very high level of capitalization; investors did not get an immediate return on their funding. They also required large amounts of infrastructure: ships were expensive, trading forts were expensive, soldiers were expensive, and so large amounts of resources had to be brought together. This was beyond the capacity of any single entity, so resources needed to be pooled. In addition, unlike one-off trading voyages, trade with the Indies required a permanent infrastructure rather than resources to fund a single voyage. You needed a trade with long-term continuity to realize a profit; single-purpose funding would not do.

It is these requirements that led to financial innovations, from medieval Italian commenda (a temporary limited partnership) to the limited-liability joint-stock corporation, where ownership is negotiable and is wholly separated from direct management.

Money played a huge role in the evolution of Western philosophy and mathematics. European mathematics achieved a high degree of sophistication due to the need to deal with multiple currencies at the same time as the Church’s prohibition on usury. The earliest mathematical treatises were all concerned with practical matters in trade and jurisprudence, not abstract science. Rather than sophisticated mathematics being developed to explain physical phenomena, it was first developed to manage trade risks and calculate transaction costs. Later on, these math techniques began to be applied to the natural world. Often, early scientists began their mathematical training in commerce. Newton and Copernicus both wrote treatises on Money. After 1600 the commercial and scientific revolutions both gained steam.

European science did not start in the Renaissance, it existed in the High Middle Ages. The ‘renaissance’ of the ‘long twelfth century’ resulted in what the historian Joel Kaye describes as, “the transformation of the conceptual model of the natural world…[which] was strongly influenced by the rapid monetisation of European society taking place [between 1260-1380].” and played a pivotal role in the development of European science. Thirteenth century scholars, “[were] more intent on examining how the system of exchange actually functioned than how it ought to function…” It seems that Fibonacci did not just influence medieval merchants, those scholars keeping an eye on merchant’s dubious dealings, also, became obsessed with mathematics… Who was the first quant? (Magic, Maths and Money)

Going even further back in time, many of the distinctive features of ancient Greek society (and hence Western civilization) such as science, philosophy and democracy, may have their origins in the use of money and trade in the Greek world:

The first ever pervasive monetisation in history (of the Greek polis) made possible for the first time various features of Greek culture that have in asense persisted throughout monetised society up to the present. I confine myself here to two examples. One is the idea that the abstract is more real than the concrete, which was a basis of much ancient philosophy. Another is the absolute isolation of the individual: this is especially manifest in Greek tragedy, where, for instance, Oedipus is entirely alienated from the gods and from his closest kin. Both these features are familiar to us, but do not occur in pre-monetary society. Radical Anthropology, Richard Seaford interview (PDF)

Loans create deposits, not vice-versa. This is called the “endogenous theory of money.” It claims that the amount of money is constrained only by the number of willing borrowers in the economy, and not the amount of reserves held by the central bank.

In short, the endogenous money approach reverses two causalities proposed by orthodoxy: 1) reserve creates deposits; and 2) deposits create loan. On the contrary, the endogenous money holds that loans create deposits that then create the need for the central bank to accommodate with reserve. In other words, banks first make loans, and then seek reserves to meet central bank regulations…

…Suppose Henry decides to hire Joshua to build a condo. In theory, Henry could issue his own money/IOU to Joshua in exchange for Joshua’s labor time. The problem is, Joshua would probably not accept Henry’s own liability (Henry dollar) because Henry cannot sufficiently indebt the rest of the population to create a demand for his own IOU. Instead, Joshua agrees to exchange his labor only for the liability of the state (U.S. dollars). Therefore, Henry needs somehow to convert his own IOU to the state IOU in order to get Joshua’s labor. Now Henry walks into a bank and asks for a loan, the loan officer does not check the bank’s reserves at the central bank and comes back to tell Henry, “sorry, we are out of money!” If the bank thinks Henry’s project is good, it creates a Henry loan simply by crediting the Henry’s deposit account. To meet the reserve requirement, the bank then borrows reserves from other banks that have excess reserves or directly from the central bank. What distinguishes the bank’s IOUs and Henry’s IOUs is that the former is directly convertible to the central bank/state IOUs while the latter is not. Vincent Huang, On the Nature of Money

The government is not revenue constrained. The above leads to the conclusion that in order to collect taxes, the government must first issue the money-thing it wishes to collect. This leads to the conclusion that rather than taxes funding spending, spending funds taxes! If the government (public sector) collects more in taxes than it spends, it reduces the money supply and causes the private sector to go into deficit in the equivalent amount (the “sectoral balances” approach).

A sovereign issuer of currency can never “run out” of money, nor can it go “bankrupt.” It can, however, be short of key resources, productive capacity, willing borrowers, or faith in the governing institutions. In such cases, excess money in the economy could lead to inflation, which is the real constraint on issuing money. Taxation serves as a way of “un-printing” money to bring inflation under control.

Although the finer points of MMT can get quite involved, the most basic takeaway is very simple. For societies with currency-issuing governments:

If something can be done, it is “affordable”.

If we have access to the raw materials, the labor power, the skills, the equipment and the facilities needed to produce something, then we can afford to produce it. The cost of doing so is not financial. The cost is a real cost: the exertion of human effort and know-how, the wear and tear on facilities and equipment, and the depletion of natural resources.

On one level, it is bizarre that this basic takeaway of MMT is not already mainstream. If the idea is heterodox, it is only because we are currently living in a very topsy-turvy world, in which up is presented to us as down, black as white, with everything reversed. In reality, it should be much harder to believe the opposite: that what we are capable of is impossible. If it’s Doable, it’s Affordable (hetereconomist)

What constitutes “money” is not so simple. Many things can be used as money. Stocks can be thought of a kind of money (since they are an IOU). Equity can be used as money. Items with intrinsic value (or perceived intrinsic value) can be used as money. Gift cards are a type of money. So are airline points. No doubt John Law’s theories derived in part from his observations at the gambling tables of Europe. There he observed that all sorts of things could serve as money in a pinch: coins, stocks, bonds, jewelry, certificates of deposit, deeds to land, checks, even hastily scribbled IOU notes. Anything that is accepted in payment, whether gold, stocks, bonds, cash, or IOUs, can be used as money, he concluded.

As MMT theorists say, anyone can create money, the challenge is getting it accepted. As we saw, private monies circulated alongside state money and borrowing before the two were combined in England, where bills of exchange became enforceable by contract law outside of merchant courts. Because the state’s liabilities and credit are generally the most reliable (except in cases of state failure), its money generally becomes the ‘money thing’ at the top of the pyramid—the ultimate means of settlement for various debts.

Recall that money represents a promise/IOU and that these promises can be created by anyone. The ‘secret’ to turning these promises into money is getting other individuals or institutions to accept them. Therefore, the ‘hierarchy of money’ can be thought of as a multi-tiered pyramid where the tiers represent promises with differing degrees of acceptability. At the apex is the most acceptable or ‘ultimate’ promise…The ‘simplified hierarchy’ can be envisioned as a four-tiered pyramid, with the debts of households, firms, banks and the state each representing a single tier…All money in the hierarchy represents an existing relationship between a creditor and a debtor, but the more generally acceptable debts will be situated higher within the hierarchy…as the decisive money of the system, both the state’s promises and banks’ promises rank high among the monies of the hierarchy. Although bank money is part of the ‘decisive’ money of the system, its acceptance at state pay-offices really requires its conversion into state money (i.e., bank reserves). That is, bank money is converted to bank reserves so that (ultimately) the state actually accepts only its own liabilities in payment to itself. The debt of the state, which is required in payment of taxes and is backed by its power to make and enforce laws, is the most acceptable money in the pyramid and, therefore, occupies the first tier. Stephanie Bell, The role of the state and the hierarchy of money, p. 10-12

The test of ‘moneyness’ depends on the satisfaction of both of two conditions. First, the claim or credit is denominated in an abstract money of account. Monetary space is a sovereign space in which economic transactions (debts and prices) are denominated in a money of account. Second, the degree of moneyness is determined by the position of the claim or credit in the hierarchy of acceptability. Money is that which constitutes the means of final payment throughout the entire space defined by the money of account. Geoffrey Ingham, The Emergence of Capitalist Credit Money p. 214

In our society, money has multiple uses: means of exchange, store of value, unit of account, and settlement of debts. That these things are all embodied in a single item we call “money” is not a natural phenomenon but a feature of capitalist credit money which allows this system to function as it does. That invention took a long time and it’s probably not over yet.

The Origin of Money 10 – The Birth of Modern Finance

 Money Becomes Metal

It is one of the great ironies of history that at the same time the modern financial system and banking was being invented, Enlightenment thinkers discarded thousands of years of monetary history and declared money to be based on the intrinsic value of precious metals alone.

Events like the Kipper and Wipperzeit had convinced scholars in Europe that a stable value of coins depended on issuing coins with constant and fixed amounts of precious metal. This, they reasoned, would prevent the rapid hyperinflation and deflation that were wreaking havoc on monetary systems throughout Europe.

…This monetary terrorism had its roots in the economic problems of the late 16th century and lasted long enough to merge into the general crisis of the 1620s caused by the outbreak of the Thirty Years’ War, which killed roughly 20 percent of the population of Germany. While it lasted, the madness infected large swaths of German-speaking Europe, from the Swiss Alps to the Baltic coast, and it resulted in some surreal scenes: Bishops took over nunneries and turned them into makeshift mints, the better to pump out debased coinage; princes indulged in the tit-for-tat unleashing of hordes of crooked money-changers, who crossed into neighboring territories equipped with mobile bureaux de change, bags full of dodgy money, and a roving commission to seek out gullible peasants who would swap their good money for bad. By the time it stuttered to a halt, the kipper- und wipperzeit had undermined economies as far apart as Britain and Muscovy, and—just as in 1923—it was possible to tell how badly things were going from the sight of children playing in the streets with piles of worthless currency.

“Kipper und Wipper”: Rogue Traders, Rogue Princes, Rogue Bishops and the German Financial Meltdown of 1621-23 (Smithsonian Magazine)

In England, this concept was most forcibly argued by John Locke. A pound was a specific amount of silver, he declared, and should be held inviolable.

The reason he did this was because he wanted to argue that property rights were natural and absolute phenomena, and did not rest on any sort of monarchial authority or social contract. In line with this reasoning, he needed money to also be a “natural thing” not anchored in social relations and certainly not under the control of a sovereign.

At this time, England’s coinage was in rough shape. Much of the coinage had remained unchanged in a hundred years and clipped coins circulated alongside newer issues. People tended to save the good coins and spend the clipped ones, causing a loss of faith in the currency.

It was increasingly clear that the Mint had to offer recoinage …But at what rate? Mercantilists, who tended to be inflationist, clamoured for debasement, that is, recoinage at the lighter weight, devaluating silver coin and increasing the supply of money. In the meanwhile, the monetary problem was aggravated by a burst of bank credit inflation created by the new Bank of England, founded in 1694 to inflate the money supply and finance the government’s deficit. As the coinage problem came to a head in that same year, William Lowndes (1652–1724), secretary of the treasury and the government’s main monetary expert, issued a “Report on the Amendment of Silver Coin” in 1695, calling for accepting the extant debasement and for officially debasing the coinage by 25 percent, lightening the currency name by a 25 percent lower weight of silver.

[John] Locke had denounced debasement as deceitful and illusionist: what determined the real value of a coin, he declared, was the amount of silver in the coin, and not the name granted to it by the authorities. Debasement, Locke warned…is illusory and inflationist: if coins, for example, are devalued by one-twentieth, “when men go to market to buy any other commodities with their new, but lighter money, they will find 20s of their new money will buy no more than 19 would before.” Debasement merely dilutes the real value, the purchasing power, of each currency unit.

Threatened by the Lowndes report, Locke’s patron, John Somers, who had been made Lord Keeper of the Great Seal in a new Whig ministry in 1694, asked Locke to rebut Lowndes’s position before the Privy Council. Locke published his rebuttal later in the year 1695…Locke superbly put his finger on the supposed function of the Mint: to maintain the currency as purely a definition, or standard of weight of silver; any debasement, any change of standards, would be as arbitrary, fraudulent, and unjust as the government’s changing the definition of a foot or a yard. Locke put it dramatically: “one may as rationally hope to lengthen a foot by dividing it into fifteen parts instead of twelve, and calling them inches.”

…Locke’s view triumphed, and the recoinage was decided and carried out in 1696 on Lockean lines: the integrity of the weight of the silver denomination of currency was preserved. In the same year, Locke became the dominant commissioner of the newly constituted board of trade. Locke was appointed by his champion Sir John Somers, who had become chief minister from 1697 to 1700. When the Somers regime fell in 1700, Locke was ousted from the board of trade, to retire until his death four years later. The Lockean recoinage was assisted by Locke’s old friend, the great physicist Sir Isaac Newton (1642–1727) who, while still a professor of mathematics at Cambridge from 1669 on, also became warden of the Mint in 1696, and rose to master of the Mint three years later, continuing in that post until his death in 1727. Newton agreed with Locke’s hard-money views of recoinage.

John Locke vs. the Mercantilists and Inflationists (Mises Institute)

Because the price paid by the Royal Mint for gold and silver was fixed and no longer allowed to adjust freely based on supply and demand, the effect this had was for gold to be shipped to England, where the Mint paid a premium for it, and silver to leave the country for continental Europe, where it was worth more. This led to a shortage of silver coins in England, causing economic contraction.

…the Bank of England’s formation also coincided with the reconceptualization of money as simply precious metal in another form—a fable told most prominently by John Locke. In earlier centuries, everyone accepted that kings could reduce the metal content of coins and, indeed, there were good economic reasons to do so. Devaluing coins (raising the nominal price of silver) increased the money supply, a constant concern in the medieval and early modern periods, while revaluing coins (keeping the nominal price of silver but calling in all old coins to be reminted) imposed deflation on the economy. But Locke was the most prominent spokesperson for hard money—maintaining the metal content of coins inviolate. The theory was that money was simply metal by another name, since each could be converted into the other at a constant rate.

The practice, however, was that the vast majority of money—Bank of England notes, bills of exchange issued by London banks, and bank notes issued by country banks—could only function as fiat money. This had to be the case because the very policy of a constant mint price had the effect of driving silver out of coin form, vacuuming up the coin supply. If people actually wanted to convert their paper money into silver or gold, a financial crisis could be prevented only through a debt-financed expansion of the money supply by the Bank of England—or by simply suspending convertibility, as England did in the 1790s.

… at the same time that the English political system invented the modern monetary system, liberal theorists like Locke obscured it behind a simplistic fetishization of gold. The fable that money was simply transmutated gold went hand in hand with the fable that the economy was simply a neutral market populated by households and firms seeking material gain. This primacy of the economic over the political—the idea that government policy should simply set the conditions for the operation of private interests—is, of course, one of the central pillars of the capitalist ethos. Among other things, it justified the practice of allowing private banks to make profits by selling liquidity to individuals (that’s what happens when you deposit money at a low or zero interest rate)—a privilege that once belonged to sovereign governments.

Mysteries of Money (The Baseline Scenario)

The Great Monetary Settlement

By the late 1600’s two major forms of currency circulated: the government money issued in coin form, and the capitalist credit money issued by private bankers. Both were forms of transferable debt, but were used in very different spheres of exchange:

By the late seventeenth century, the two forms of money were available but unevenly spread across Europe – private credit and public metallic coinage. However, they remained structurally distinct and their respective producers – that is, states and capitalist traders – remained in conflict…England was best placed…to effect any integration of the different interests that were tied to the different moneys…[1]

Unlike its cousins on the continent, England’s finances were fairly stable, and its debt manageable. That is until 1672, when the Stop of the Exchequer was declared by King James II. This was essentially a default by England on its debts. The crown refuted the tallies owed to them, causing tally sticks to fall into disrepute and clearing the way for paper instruments to replace them as signifiers of state debt:

Charles II’s debt default in 1672 was critically important in hastening the adoption of public banking as a means of state finance and credit money creation. Since the fourteenth century, English kings had borrowed, on a small scale, against future tax revenues. The tally stick receipts for these loans achieved a limited degree of liquidity ‘which effectively increased the money supply beyond the limits of minting’.

However, compared with state borrowing in the Italian and Dutch republics, English kings, like all monarchs, were disadvantaged by the very despotic power of their sovereignty. Potential creditors were deterred by the monarch’s immunity from legal action for default and their successors’ insistence that they could not be held liable for any debts that a dynasty might have accumulated. [2]

The rising Whig merchant class wanted a monarch who would put the country’s finances on a more sound basis. Since they were overwhelmingly Protestant, they decided that putting a Protestant on the throne in place of the Catholic James Stuart would be the perfect excuse for overthrowing the monarchy. It was, in essence, a coup d’etat by the banking and merchant classes.

With an impending war with the Dutch, an annual Crown income of less than £2 million, and accumulated debts of over £1.3 million, Charles II defaulted on repayment to the tally holders in the Exchequer Stop of 1672. This event…culminated in the invitation to William of Orange to invade and claim the throne…[3]

An alliance of the Whigs and Tories got the husband of James’ sister Mary, the Dutch prince William of Orange, for the job. William and Mary took the throne in the last major invasion of England. It was a mostly bloodless revolution, but not entirely peaceful, and all sorts of rebellions would roil parts of the British Isles for decades (the Jacobite risings), mainly in the outer regions of the empire (e.g. Scotland, Ireland, etc.)

The bloodless coup would have profound effects for the history of the financial system. William brought “Dutch finance” across the channel to England, where it would be used to reorganize the state’s finances.

Because the revolution had been backed and funded by Whig parliamentarians, they called the shots. It was the end of England’s absolute monarchy and the beginning of the “king-in-parliament,” an unusual fusion of monarchial power and public accountability. They made William sign a “Bill of Rights” in 1689 and one of the things it specified was that the ability to raise funds would be strictly delegated to parliament. In other words, no more arbitrary taxes or defaults.

William subsequently dragged England into several wars on the continent:

Roey Sweet: “So the reason why the national debt is rising at this time, and by 1714 it’s about 48 million [pounds], is that Britain’s been involved in two long and expensive wars. Following the Glorious Revolution, William of Orange brings Britain into the Nine Years War against Louis the 14th, and then from 1701 Britain’s been involved in the War of the Spanish Succession which is a battle essentially to try and prevent the Bourbons from gaining ascendancy in Europe by uniting the Spanish and the French empires. So Britain has been fighting this, and it’s seen as a Whig war…and there’s a suspicion that it’s being prolonged purely for Whig interests. And so [Chancellor of the Exchequer Robert] Harley wants to try and end the war and also to get the debt into manageable proportions.” [4]

William needed to borrow to fight his wars, and his credit score was awful. His debt load from conducting the Glorious Revolution was already very high, meaning that no one wanted to loan to him. The interest rates he was looking at were in the neighborhood of modern-day credit cards—18-20 percent.

The prevention of any recurrence of default was a paramount consideration which parliament put to the new Dutch king in the constitutional settlement of 1689. In the first place, William was intentionally provided with insufficient revenues for normal expenditure and, consequently, was forced to accept dependence on parliament for additional funds. Second with William’s approval, and the expertise of his Dutch financial advisors, the government adopted long-term borrowing in the form of annuities (Tontines). These were funded by setting aside specific tax revenues for the interest payments. [5]

England managed its debt in a variety of ways, many of them similar to the methods used on the continent. But one new technique was coming to bear. By this time, in order to exploit the resources of the New Word and conduct trading operations where long-term investments were required, Europeans had invented the joint-stock company—a company where ownership was diversified among a group of unrelated individuals and ownership could be bought and sold at will.

The legal ingredients that comprise a corporation came together in a form we would recognise in England, on New Year’s Eve, in 1600. Back then, creating a corporation didn’t simply involve filing in some routine forms – you needed a royal charter. And you couldn’t incorporate with the general aim of doing business and making profits – a corporation’s charter specifically said what it was allowed to do, and often also stipulated that nobody else was allowed to do it. The legal body created that New Year’s Eve was the Honourable East India Company, charged with handling all of England’s shipping trade east of the Cape of Good Hope. [6]

Joint-stock companies had been originally formed to undertake long-distance trading expeditions and to exploit the resources of the New World. Now they would be pressed into service to reorganize and manage the nation’s debt. The idea was to use such  companies to manage the state’s finances. They would be chartered for this purpose:

Melvin Bragg: How was the government handling its debt before the South Sea Company was set up?

Anne Murphy: The government is handling its debt in three ways.

It’s created lottery schemes which are very popular, and they’re attractive to a broad spectrum of individuals. So it can raise money that way.

It sells annuities which again are very popular, but they’re very costly, and they’re quite inflexible.

And the government is also using the moneyed companies to support its debt raising activities. The first one of those is called the Bank of England which is set up in 1694. The Bank of England does two things: it lends to government, and also it’s one of the first companies that does the debt for equity swaps that the South Sea Company is to become so famous for, later.

[…]

Melvin Bragg: Was that seen at the time as something that was okay; that a private company taking over part of a national debt was fine?

Anne Murphy: It’s actually just a change of lender, really. What’s being switched here is the many, many lenders–the individuals who bought annuities or who bought lottery tickets from the government–for one lender: the Bank of England or the South Sea Company. So it’s not that a private company is in essence taking over the debt. What it’s doing is just consolidating the debt in one set of hands rather than many sets of hands.

And this helps because it makes administration easier and it brings costs down, and that’s what the government wants. So it’s a desirable thing to do. [7]

The modern money system began when governments started using joint-stock corporations to manage their finances in exchange for “special” privileges–specifically the privilege of extending credit denominated in the government’s official currency. The government, in essence, became a debtor to these private corporations, which are the ancestors of our modern banks. The debt was then monetized and circulates to this day as money. The Bank of England, funded by the subscribers from the merchant classes, bought the state’s debt and used it as backing for their banking operations. The merchant bankers, in essence, kidnapped the state’s money for their own uses.

From 1694 to 1697, the directors of the new Bank of England laid the true foundations for the financial revolution by lending the government £1.2 million, at the then attractive rate of 8 per cent, in order to secure their monopoly on joint-stock banking, raising the funds by selling Bank stock. Though redeemable on one year’s notice from 1706, the loan was in fact perpetual. In 1698, the New East India Company made a similar 8 per cent perpetual loan to secure its charter, as did the newly merged United East India Company in 1709.

From 1704 to 1710, the exchequer also issued irredeemable annuities…and…a series of highly popular lottery loans. Meanwhile, in 1711, the newly formed South Sea Company bought up…short-term floating debts and converted them into so-called perpetual stock with a 5 per cent return; and in 1720, it converted another £13.99 million in other loans and annuities into 5 per cent perpetual stock, a venture that led to its collapse in 1721 in the famous ‘Bubble’. Thereafter, while redeeming £6.5 million in South Sea stock and annuities, the Bank of England, on behalf of the government, issued several series of redeemable ‘stock’, many containing the popular lottery provisions, with generally lower rates of interest…

The Bank of England wasn’t the world’s oldest bank, nor even was it the first state bank. But what made it unique was the idea of the merchant classes loaning to the government, and in return gaining a measure of control over the nation’s finances. The multiple and conflicting systems of money and borrowing would be fused together for the first time in one supranational institution. Felix Martin calls this “The Great Monetary Settlement:”

The Bank’s primary role would … be to put the sovereign’s credit and finances on a surer footing. Indeed, its design, governance, and management were to be delegated to the mercantile classes precisely in order to ensure confidence in its operations and credit control. But in return the sovereign was to grant important privileges. Above all, the Bank was to enjoy the right to issue banknote-a licence to put into circulation paper currency representing its own liabilities, which could circulate as money. There was to be, quite literally, a quid pro quo. [8]
… the idea of the hybrid Bank of England found a powerful group of supporters in the circle of ambitious Whig grandees who were soon to dominate the first party-political administration of the country. They realised that [Projector William] Paterson’s Project could deliver a Great Monetary Settlement.

If they and the private money interest they represented would agree to fund the king on terms over which they, as the Directors of the new Bank, would have a statutory say, then the king would in tum allow them a statutory share in his most ancient and jealously guarded prerogative: the creation of money and the management of its standard. To be granted the privilege of note issue by the crown, which would anoint the liabilities of a private bank with the authority of the sovereign-this, they realised, was the Philosopher’s Stone of money. It was the endorsement that could liberate private bank money from its parochial bounds. They would lend their credit to the sovereign-he would lend his authority to their bank. What they would sow by agreeing to lend, they would reap a hundredfold in being allowed to create private money with the sovereign’ s endorsement. Henceforth, the seigniorage would be shared. [9]

With the foundation of the Bank of England, the money interest and the sovereign had found an historic accommodation…This compromise is the direct ancestor of the monetary systems that dominate the world today: systems in which the creation and man agement of money are almost entirely delegated to private banks, but in which sovereign money remains the “final settlement asset, the only credit balance with which the banks on the penultimate tier of the pyramid can be certain of settling payments to one another or to the state. Likewise, cash remains strictly a token of a credit held against the sovereign, but the overwhelming majority of the money in circulation consists of credit balances on accounts at private banks. The fusion of sovereign and private money born of the political compromise struck in 1694 remains the bedrock of the modern monetary world.  [10]

This effectively created modern finance. The state’s debt was monetized by private banks, who gained the ability to loan the state’s “official” money through the extension private credit. No longer would money creation and manipulation be exclusively a tool of the sovereign. The two different money systems—government coinage and bills of exchange, were fused into one here for the first time. Because it was backed by state debt (and ultimately tax revenue), the bank’s money became by far the most trustworthy legal means of settlement, and soon it became the predominant one—the final “money thing” at the apex of the pyramid.

In effect, the privately owned Bank of England transformed the sovereign’s personal debt into a public debt and, eventually in turn, into a public currency.

This fusion of the two moneys, which England’s political settlement and rejection of absolutist monetary sovereignty had made possible, resolved two significant problems that had been encountered in the earlier applications of the credit-money social technology.

First, the private money of the bill of exchange was ‘lifted out’ from the private mercantile network and given a wider and more abstract monetary space based on an impersonal trust and legitimacy…

Second, parliament sanctioned the collection of future revenue from taxation and excise duty to service the interest on loans…The new monetary techniques conferred a distinct competitive advantage, which, in turn, eventually ensured the acceptability of England’s high levels of taxation and duties for the service of the interest on the national debt.

The most important, but unintended, longer-term consequence of the establishment of the Bank of England was its monopoly to deal in bills of exchange. Ostensibly, the purchase of bills at a discount before maturity was a source of monopoly profits for the Bank. But it also proved to be the means by which the banking system as a whole became integrated and the supply of credit money (bills and notes), influenced by the Bank’s discount rate.

The two main sources of capitalist credit money that had originated in Italian banking practice -that is, the public debt in the form of state bonds and private debt in the form of bills of exchange – were now combined for the first time in the operation of a single institution. But of critical importance, these forms of money were introduced into an existing sovereign monetary space defined by an integrated money of account and means of payment based on the metallic standard. [11]

The bank of England would issue banknotes, which were liabilities of the bank that could circulate as money. Banknotes were originally records of deposits of coin (sterling) redeemable at the banks. Eventually banknotes simply became records of deposits unlinked to any other coins or commodities. They circulated as paper records of debits and credits, similar to the tally sticks which they replaced (the old tallies were burned en masse):

In 1694, the Bank of England stepped in. Originally a private company, it was founded to create money backed by its gold holdings that could be exchanged for Treasury pledges over future taxes. In contrast to the old tally stick system, these pledges, known as ‘gilt-edged’ stock, or gilts, came with redemption dates and paid a fixed rate of interest.

These changed characteristics of a fixed date and rate of return made the pledges resemble debts. However, the difference is that these pledges are ownership claims created by an individual over his own income, whereas a debt claim is created by one individual over another individual’s income. The correct analogy is to think of gilt-edged stock as akin to interest-bearing shares or equity bought by investors in UK Incorporated, with a redemption date.

The position today is quite similar, except that the Bank of England is now State owned and the pound sterling is not backed by gold but by faith alone.

The fiscal myth of tax and spend shared by virtually all schools of economics is that tax is first collected and then spent. This has never been the case: the reality… has always been that government spending has come first and taxation later. The reality is that taxation acts to remove money from circulation and to prevent inflation: it does not fund and never has funded public spending.

The Myth of Debt (UCL)

The second method to finance the debt mentioned above was a debt-for-equity swap. This was tried in both England and France. While it failed in a bursting stock bubble in both countries, the differences would have profound consequences for world history.

In England, the monetary system would remain fairly intact. In France, by contrast, it would take down the entire financial system and cripple the nation economically for a generation. The end result would be an Industrial Revolution in England, and revolt, revolution and dictatorship in France.

Remarkably, this would all take place in just 4 years–from 1716 to 1720. One result would be the issuance of the first true paper money in Europe. The other would be the first major stock bubble and collapse.

John Law’s System

John Law was the son of an Edenborough goldsmith. Goldsmiths, like pawnbrokers before them, functioned as low-level proto-bankers. The issued receipts against the gold deposited with them. Occasionally they would issue receipts in excess of the gold stored in their vaults, knowing that not everyone would wish to redeem their gold at the same time. These receipts circulated as proto-money, but are not the direct ancestor of the banknotes we use today as some have claimed.

In 1694, when the Bank of England was being founded, John Law killed a man in a duel over a woman. Law was living large in England at the time. Now an outlaw, he first went to hide out in Scotland, and when the Acts of Union were passed in 1707, he fled for the continent. He made his way to Genoa, and then to Amsterdam, where he was able to observe their financial systems and banking practices first hand.

Eventually he made his way to France where he became a professional gambler, dandy, and bon-vivant. Through an unlikely series of circumstances and networking, he wound up being a personal friend of Phillip II, the Duc de Orleans, a high-ranking aristocrat who was the regent of France for Louis 15th, the future heir to the throne of France, who was still a teenager.

Just as in England, the finances of the French state were a disaster due to funding  wars all over the continent and the profligacy of the king. Versailles didn’t come cheap.

Europe’s most powerful nation had several major financial problems: 1.) There was not enough money in circulation because of a shortage of coins (a ‘liquidity crisis’) 2.) The French government’s debt was effectively unpayable. The interest rates were staggering and the billets d’etat were what we might today call “junk bonds” and 3.) The privatized and localized tax system was horribly inefficient, preventing the state from collecting taxes effectively. It was riddled with graft and corruption—only a fraction of what was collected made its way into state coffers. The rest ended up in the hands of a corrupt money interest, who resisted any attempts at reform.

When Louis the 14th, the “Sun King,” died, France was in a state of bankruptcy. Continuous warfare had left France short of money and facing a sizeable state debt. Furthermore, the tax revenue collection system had been farmed out to the private sector, leaving the financiers (gens de finance)…the veritable controllers of the financial system. They exerted control by managing the tax farms and lending money to the state. In effect, the state was heavily mortgaged to the financiers. [12]

Law used his friendship with the regent to propose a radical reorganization of the French state finances. Law had seen the English system at work. When he fled Scotland, he spent time in both Genoa and Amsterdam and was able to observe up-close the functioning of their banking and financial systems. This gave him the foundation for his own ideas.

[Law’s] theory consisted in two propositions. One was that the world had insufficient supplies of metal money to do business with. The other was that, by means of a bank discount, a nation could create all the money it required, without depending on the inadequate metallic resources of the world…Law did not invent this idea. He found the germs of it in a bank then in existence— the Bank of Amsterdam. This Law got the opportunity to observe when he was a fugitive from England.

The Bank of Amsterdam, established in 1609, was owned by the city. Amsterdam was the great port of the world. In its marts circulated the coins of innumerable states and cities. Every nation, many princes and lords, many trading cities minted their own coins. The merchant who sold a shipment of wool might get in payment a bag full of guilders, drachmas, gulden, marks, ducats, livres, pistoles, ducatoons, piscatoons, and a miscellany of coins he had never heard of.

This is what made the business of the moneychanger so essential. Every moneychanger carried a manual kept up to date listing all these coins. The manual contained the names and valuations of 500 gold coins and 340 silver ones minted all over Europe. No man could know the value of these coins, for they were being devalued continually by princes and clipped by merchants. To remedy this situation the Bank of Amsterdam was established.

Here is how it worked. A merchant could bring his money to the bank. The bank would weigh and assay all the coins and give him a credit on its books for the honest value in guilders. Thereafter that deposit remained steadfast in value. It was in fact a deposit. Checks were not in use. But it was treated as a loan by the bank with the coins as security. The bank loaned the merchant what it called the bank credit. Thereafter if he wished to pay a bill he could transfer to his creditor a part of his bank credit. The creditor preferred this to money. He would rather have a payment in a medium the value of which was fixed and guaranteed than in a hatful of suspicious, fluctuating coins from a score of countries. So much was this true that a man who was willing to sell an article for a hundred guilders would take a hundred in bank credit but demand a hundred and five in cash.

One effect of this was that once coin or bullion went into this bank it tended to remain there. All merchants, even foreigners, kept their cash there. When one merchant paid another, the transaction was effected by transfer on the books of the bank and the metal remained in its vaults. Why should a merchant withdraw cash when the cash would buy for him only 95 per cent of what he could purchase with the bank credit? And so in time most of the metal in Europe tended to flow into this bank.

It was…a one hundred percent bank–[f]or every guilder of bank credit or deposits there was a guilder of metal money in the vaults. In 1672 when the armies of Louis XIV approached Amsterdam and the terrified merchants ran to the bank for their funds, the bank was able to honor every demand. This established its reputation upon a high plane. The bank was not supposed to make loans. It was supported by the fees it charged for receiving deposits, warehousing the cash, and making the transfers.

There was in Amsterdam another corporation—the East India Company. A great trading corporation, it was considered of vital importance to the city’s business. The city owned half its stock. The time came when the East India Company needed money to build ships. In the bank lay that great pool of cash. The trading company’s managers itched to get hold of some of it. The mayor, who named the bank commissioners, put pressure on them to make loans to the company—loans without any deposit of money or bullion. It was done in absolute secrecy. It was against the law of the bank. But the bank was powerless to resist.

The bank and the company did this surreptitiously. They did not realize the nature of the powerful instrument they had forged. They did not realize they were laying foundations of modern finance capitalism. It was Law who saw this…Here is what Law saw. It is an operation that takes place in our own banks daily. The First National Bank of Middletown has on deposit a million dollars. Mr. Smith walks into the bank and asks for a loan of $10,000. The bank makes the loan. But it does not give him ten thousand in cash. Instead the cashier writes in his deposit book a record of a deposit of $10,000. Mr. Smith has not deposited ten thousand. The bank has loaned him a deposit. The cashier also writes upon the bank’s books the record of this deposit of Mr. Smith. When Mr. Smith walks out of the bank he has a deposit of ten thousand that he did not have when he entered. The bank has deposits of a million dollars when Mr. Smith enters. When he leaves it has deposits of a million and ten thousand dollars. Its deposits have been increased ten thousand dollars by the mere act of making the loan to Mr. Smith. Mr. Smith uses this deposit as money. It is bank money.

That is why we have today in the United States about a billion dollars in actual currency in the banks but fifty billion in deposits or bank money. This bank money has been created not by depositing cash but by loans to the bank depositors. This is what the Bank of Amsterdam did by its secret loans to the East India Company, which it hoped would never be found out. This is what Law saw, but more important, he saw the social uses of it. It became the foundation of his system…[13]

He argued that money was not any particular object, in his words, it was not the value for which goods are exchanged but by which goods are exchanged. For that reason, it could be anything. Law reasoned that the demand for money was greater than the supply, and like any other commodity the supply needed to be increased. An increase in the money supply would cause economic expansion and drive down interest rates. To get around the supply and demand problems encountered with gold and silver, he would retire them and replace them with paper instead.Phase one of Law’s plan would increase the amount of money circulating by introducing paper money in place of metal. Law’s bank would take the coins and issue paper money based on the deposits. The paper money would then retain its value. This was the beginning of true paper money as we know it today:

…his new proposal laid out plans for a private bank, funded by himself and other willing investors, which would issue notes backed by deposits of gold and silver coins and redeemable at all times in coins equivalent to the value of the coin at the time of the notes’ issue, “which could not be subject to any variation.” Thus, Law pledged, his notes would be more secure than metal money, a hedge against currency vacillations, and therefore a help to commerce. Moreover, paper notes would increase the amount of circulating money and trade would be boosted. In short, he vowed, his bank would offer hope and the promise of a better future. [14]

The regent helped by making his well-publicized deposits and ensured that everyone knew he was using the bank for foreign transactions. Foreigners followed his lead, and at last found somewhere in Paris to discount their bills of exchange with ease and at reasonable prices. The influx of foreign cur rency alleviated the shortage of coins, and, with the slow trickle of banknotes Law printed and issued to depositors, boosted the money supply sufficiently for commerce to begin to pick up. Traders liked the banknotes because the guarantee of being paid in coin of fixed value meant that they knew exactly what something would cost or what price they would receive. The notes began to command a premium, like those issued by the Bank of Amsterdam. [15]

The bank was a success, expanding the money supply and goosing the French economy as planned. In 1717 the regent ordered that all public funds be deposited in the Banque Generale. The notes of the bank became authorized for payment of taxes. The center of French finance moved from Lyon to Paris. Law controlled the issuance of banknotes so that at least 25 percent of the circulating value of the notes could be redeemed in gold or silver. To further remove the link with metal, it was forbidden for most people to own specie or use it for transactions. The Bank was eventually bought out by the government and renamed the royal bank (Banque Royale).

In December 17 18, the Banque Generale became the Banque Royale, the equivalent of a nationalized industry today. Law continued to direct it, and under his leadership over the next months, the finances of France leaned more heavily on it. New branches opened in Lyon, La Rochelle, Tours, Orleans, and Amiens. To ensure that everyone made use of paper money, any transactions of more than 600 livres were ordered to be made in paper notes or gold. Since gold was in short supply, this obliged nearly everyone to use paper for all major transactions. Meanwhile. for the leap of confidence they had shown in purchasing shares in the bank in its early uncertain days, and perhaps to buy his way into their world, Law rewarded investors lavishly. Shares that they had partly bought with devalued government bonds were paid out in coin. Both he and the regent had been major shareholders and were among those who profited greatly from the bank’s takeover.

Few recognized the dangers signaled by the bank’s new royal status. Hitherto Law had kept careful control of the numbers of notes issued. There had always been coin reserves of around 25 percent against circulating paper notes. Now, with royal ownership and no shareholders to ask awkward questions, the bank became less controllable. The issuing and quantity of printed notes and the size of reserves would be decided by the regent and his advisers. The temptation to print too much paper money too quickly would thus be virtually unchecked.

Within five months of its royal takeover…eight printers, each of whom earned only 500 livres a year, were employed around the clock printing 100-, 50- and 10· livre notes. A further ominous change followed: notes were no longer redeemable by value at date of issue but according to the face value, which would change along with coins if the currency was devalued: the principle that underpinned public confidence in paper had been discarded and one of Law’s most basic tenets breached. But as the eminent eighteenth-century economist Sir James Steuart later incredulously remarked, “nobody seemed dissatisfied: the nation was rather pleased; so familiar were the variations of the coin in those days, that nobody ever considered anything with regard to coin or money, but its denomination… this appears wonderful; and yet it is a fact.” [16]

Once the bank was established, phase two was to create a joint-stock company to acquire, manage, and ultimately retire, the state’s debt. It would also take over tax collection and the management of state monopolies.

The growing success of the General Bank enabled Law to address the second crisis, management of the national debt. A new radical plan was necessary to restructure France’s financial situation. Law decided that the best way to accomplish this was to convert the government debt into the equity of a huge conglomerate trading company. To do so he needed to establish a trading company along the lines of British trading companies such as the East India Company and the South Sea Company. [17]

While the monarchy was cash poor, it did possess one major asset whose value was almost limitless—a huge chunk of the North American continent. Law’s solution for the debt problem was to use that to create a monopoly company with exclusive rights over the settlement and development of North America, and have investors trade their debt for equity in that company; what today is called a “debt for equity swap.” Instead of unpayable debt, investors could trade that in for shares in a company that offered seemingly unlimited potential. Once again Law and the royal court would be early investors, prompting everyone else to jump on the bandwagon. To make the shares more attractive, Law initiated a “buy now pay later’ scheme—only 10% down would get you a share. Even the general public could buy in, and an informal stock market in trading Mississippi Company shares sprang up on the Rue Quincampoix in Paris outside Law’s apartment.

The company went on a mergers-and-acquisitions spree, buying up all the rival trading companies. It also bought the rights to collect the taxes from the rival financiers. It gained permission to run several state monopolies.

Law was granted a charter to create the Compagnie de la Louisiane ou d’Occident (Company of Louisiana and the West). This company was given a twenty-five year exclusive lease to develop the vast French territories along the Mississippi in North America. This meant exploitation of the Mississippi region, which in the French point of view, represented all of North America watered by the Mississippi River and its tributaries. As part of the deal, Law was required to settle 6,000 French citizens and 3,000 slaves in the territory. To sweeten the transaction the company was awarded a monopoly for the growing and selling of tobacco. [18]

In May 1719 [the Company of the West] took over the East India and China companies, to form the Company of the Indies (Compagnie des Indes), butter known as the Mississippi company. In July Law secured the profits of the royal mint for a nine-year term. In August he wrested the lease of the indirect tax farms from a rival financier, who had been granted it a year before. In September the Company agreed to lend 1.2 billion livres to the crown to pay off the entire royal debt. A month later law took control of the collection (‘farm’) of direct taxes. [19]

Finally, the Banque Royale and the Mississippi Company merged. Essentially all of the French state’s finances were managed by this one huge conglomerate, owned by the government, with Law at the helm. It issued money, collected the taxes, managed the state’s debt, and owned much of North America.

In 1719, the French government allowed Law to issue 50,000 new shares in the Mississippi Company at 500 livres with just 75 livres down and the rest due in nineteen additional monthly payments of 25 livres each. The share price rose to 1,000 livres before the second installment was even due, and ordinary citizens flocked to Paris to participate. Based on this success, Law offered to pay off the national debt of 1.5 billion livres by issuing an additional 300,000 shares at 500 livres paid in ten monthly installments.

Law also purchased the right to collect taxes for 52 million livres and sought to replace various taxes with a single tax. The tax scheme was a boon to efficiency, and the price of some products fell by a third. The stock price increases and the tax efficiency gains spurred foreigners to Paris to buy stock in the Mississippi Company.

By mid-1719, the Mississippi Company had issued more than 600,000 shares and the par value of the company stood at 300 million livres. That summer, the share price skyrocketed from 1,000 to 5,000 livres and it continued to rise through year-end, ultimately reaching dizzying heights of 15,000 livres per share. [20]

Law’s System reached its apex, and the price of the Company’s share peaked, at the beginning of 1720. Two main elements crowned the system. The first was a virtual takeover of the French government, by which the Company substituted the liabilities (shares) for the national debt. The second was the substitution of the Company’s other liabilities (notes) for metallic currency. At the end of the operation, the Company, owned by the former creditors of the State, collected all the taxes, owned or managed most overseas colonies, monopolized all overseas trade, and freely issued fiat money which was sole legal tender. Its CEO also became minister of finance on January 5, 1720. [21]

The government debt was retired, the money supply was expanded, and interest rates fell. But there was a problem.

Pop Go The Bubbles

John Law’s newly nationalized state bank was extending credit in order to buy Mississippi Company shares far in excess of the amount of gold and silver it had stashed in its vaults, and his enemies knew it. The excess money from all the shares floating around began to leak into the wider financial system, causing inflation. The value of the banknotes was no longer fixed but allowed to float. Confidence in the system was always thin.

The old guard sensed their opportunity. They demanded the gold and silver back in return for their paper money, causing a run on the bank. When faith in the Bank disintegrated, so too did faith in Mississippi Company stock (since both were now one in the same institution).

Some early investors, realizing that their hopes of getting rich in Mississippi were greatly exaggerated, began to sell their shares and exchange their paper currency for gold, silver and land. As share prices soared throughout the summer of 1719 some of the more level-headed realized that the bull market was based on little more than “smoke and mirrors” and the ever increasing production of paper notes. Feeling that a crash would sooner or later be inevitable, they cashed in.

… When in early 1720 two royal princes decided to cash in their shares of the Mississippi Company, others followed their example. The downward spiral had begun. Law had to print 1,500,000 livres in paper money to try to stem the tide. By late 1720 a sudden decline in confidence occurred which sent share prices down as rapidly as they had risen. When panic set in, investors sought to redeem their bank and promissory notes en masse and convert them into specie. The “bubble” burst when the Banque Royale could no longer redeem their notes for lack of gold and silver coin. Bankruptcy followed. Political intrigue and the actions of rival bankers contributed to the downfall of the scheme. Those not quick enough to redeem their shares were ruined.

In an effort to slow the run on the Bank Royale, officials resorted to various nefarious schemes. These included counting the money out slowly and only in small denomination coins, inserting clerks in the line who would return the money they withdrew, and by shortening banking hours. At one point the bank refused to accept anything but 10 livre notes. None of these expedients were able to build confidence or to slow the panic-stricken investors for long. In a last-ditch effort to restore confidence in the bank, Law ordered the public burning of bank notes as they came in for redemption. This was meant to convince the public, that because of their growing scarcity, they would be worth more. A huge enclosure was set up outside the bank for this purpose. Several times a day, with great ceremony, the notes were consigned to the flames. This went on during the months of July and August 1720 while paper money continued to lose its value throughout the Summer.

The general public turned on Law and would have lynched him if they could. He was burned in effigy and the mere mentioning of his name could arouse a fury. In October, a coachman was slapped by a passenger during an argument over a disputed fare. The cabbie had the wit to denounce his fare as John Law, whereupon the crowd pounced upon the passenger. The poor man barely saved himself by hiding from his pursuers in a church. [22]

The fall of the company managing the government’s finances caused massive damage to the French economy. Money went back to being metal.

By June 1720 the note issue of the Banque Royale had reached a staggering 2,696,000,000 livres. This sum was approximately twice the money in circulation before Law’s bank opened its doors. The increase in the money in circulation created an inflationary spiral which could not be reversed once the population became leery of Law’s Mississippi Scheme. The entire complex development of the bank’s other schemes for colonial companies, monopolies and tax collection came into question. Law’s plan for his bank and the issue of paper money was sound in and of itself; however, the issue was carried to tremendous sums that Law had never anticipated.

At the end in 1721 the notes had ceased to circulate and specie gradually took their place. The country painfully returned to a specie footing as in years past. This severe lesson in paper money inflation had permanent and long lasting effects upon France. The popular distrust of paper money and big banks kept France financially backward for many years thereafter. France was not to see circulating paper money again until the French Revolution of 1789-1795 necessitated it. [24]

Because France’s finances were not on a firm foundation, it could no longer borrow to expand the money supply. The only remaining option was to raise taxes. But in order to do this, they needed to call a meeting of France’s “parliament,”–a body which did not meet on a regular basis. While English nobility remained primarily in their own estates in the countryside, most of the French nobility was in the French court, totally segregated from the commoners. They had no idea what they were unleashing:

“The immediate precipitating cause of the French Revolution is a lot of political grandstanding around the monarchy’s debt and deficit. This is very much like the debt ceiling crisis that we saw in 2011. The issue was less about whether the monarchy’s finances were actually viable, and more about people using the subject of money to push their political point.”

“So at the point at which the king basically has no money left in the coffers, and can’t persuade the establishment to verify and approve new taxes, he called the first meeting of the Estates General, a body that hasn’t met in 175 years, so that they can produce some new taxes. And that’s really generally considered to be the beginning of the French Revolution. So the French Revolution starts in a crisis about budgets and taxes.” [25]

Much of the money fleeing Paris found its way to England where it inflated the South Sea Bubble. Like the Mississippi Company, it was also the use of a joint-stock company to consolidate, and ultimately retire, the state’s debt. Instead of taxes, it was backed by exclusive contracts from the government to conduct trade in the South Seas. It met a similar fate:

…after the re-coinage, silver continued to flow out of Britain to Amsterdam, where bankers and merchants exchanged the silver coin in the commodity markets, issuing promissory notes in return. The promissory notes in effect served as a form of paper currency and paved the way for banknotes to circulate widely in Britain. So when panicked depositors flocked to exchange banknotes for gold coin from the Sword Blade Bank (the South Sea Company’s bank), the bank was unable to meet demand and closed its doors on September 24. The panic turned to contagion and spread to other banks, many of which also failed. [26]

It’s shares also cratered in value, yet the bubble had “only” seen a tenfold rise in share prices instead of the twentyfold rise in France. Because the South Sea company remained separate from the Bank of England and the Treasury (unlike in France, where they were all one in the same), the damage to the British Economy was limited:

When stock prices finally came back to earth in London, there was no lasting systemic damage to the financial system, aside from the constraint on future joint-stock company formation represented by the Bubble Act. The South Sea Company itself continued to exist; the government debt conversion was not reverse; foreign investors did not turn away from English securities. Whereas all France was affected by the inflationary crisis Law had unleashed, provincial England seems to have been little affected by the South Sea crash. [24]

The Bank of England acquired the South Sea Company’s stock. Unlike France, Britain’s currency held its value, and it was able to pay back its debts. Money flowed into England, including from overseas. British debt was widely marketed and held both domestically and internationally:

Finally, between 1749 and 1752, the chancellor of the exchequer…began to convert all outstanding debt and annuity issues – those not held by the Bank of England, the East India Company, and the reconstituted South Sea Company – into the Consolidated Stock of the Nation, popularly known as Consols…

Consols were fully transferable and negotiable, marketed on both the London Stock Exchange and the Amsterdam bourse; along with Bank of England and East India Company stock, they were the major securities traded on the London Stock Exchange in the late eighteenth and early nineteenth centuries. Though Consols were both perpetual but redeemable annuities, thus identical to Dutch losrenten, their instant and longenduring popular success was attributable to the firmly held belief, abroad as well as at home, that the government would not exercise its option to redeem them…Unchanged to this day, they continue to trade on the London Stock Exchange…

The result of the financial revolution was a remarkably stable and continuously effective form of public finance, which achieved an unprecedented reduction in the costs of government borrowing: from 14 per cent in 1693 to 3 per cent in 1757. [25]

The Aftermath

Two things ensured Britain’s predominance in financial affairs: the last major pitched battle fought on British soil was the Battle of Culloden in 1746. Britain was peaceful, unified, and politically stable far longer than just about anywhere else on earth at the time. The second was the invention of the heat engine and the exploitation of England’s vast coal reserves. The triangular trade and vast amount of cotton allowed Britain to set up factories and industrialize. In fact, government debt may have funded the Industrial Revolution:

Only twice in the period from 1717 to 1931, did the British suspend the convertibility of their currency. Each time they needed more money to fight a war than the tight hand of convertibility would permit. They suspended the convertibility to fight Napoleon and to fight the Kaiser. Each war produced paper money and inflation, as wars tend to do.

After Waterloo, sterling met every test of a key currency. The government was stable, the institutions honored and intact. The Royal Navy sailed the world: trade followed the flag. Britain was first into the industrial revolution, so its manufactured goods spread over the world. The battles were always at the fringes of the empire.

Every time there was a small crisis about the pound, the monetary authorities would raise the interest rates sharply. That might depress the domestic economy, but the high interest rates would draw in foreign exchange, and the pound would retain its value. Britain bought the raw materials, the commodities. and sent back the manufactured goods; and since the price of raw materials gradually declined. The pound increased in value.

The British government issued “consols,” perpetual bonds. Fathers gave them to their sons, and those sons gave them to their sons, and the bonds actually increased in value as time went on. “Never sell consols,’ said Soames Forsyte, Galsworthy’s man of property.

The world brought its money to London and changed it into sterling. London banked it and insured it. Cartographers colored Britain pink on world maps, and the world was half pink, from the Cape to Cairo, from Suez to Australia, In 1897, at Victoria’s Diamond Jubilee, the fleet formed five lines, each five miles long, and it took. four hours for it to pass in review at Spithead.

British capital went everywhere. It financed American railroads and great ranches in the western United States. British investors held not only American ranches. but Argentine ones, too. Their companies mined gold in South Africa and tin in Malaya, grew hemp in Tanganyika and apples in Tasmania, drilled for oil in Mexico, and ran the trolley lines in Shanghai and the’ Moscow Power and Light Company. [26]

Carroll Quigley saw the Napoleonic Wars as a battle of the old mercantile, bullion-based monetary system, based around agriculture and handicrafts, versus the British system of commercial bank credit money and industrial manufacturing. With the final defeat of Napoleon, the British money system became the basis for all the money in the world today:

This new technique of monetary manipulation became one of the basic factors in the Age of Expansion in the nineteenth century and made the fluctuations of economic activity less responsive to the rate of bullion production from mines, by making it more responsive to new factors reflecting the demand for money (such as the interest rate). This new technique spread relatively slowly in the century between the founding of the Bank of England and Napoleon’s creation of the Bank of France in 1803. The Napoleonic Wars, because of the backward, specie-based, financial ideas of Napoleon were, on their fiscal side, a struggle between the older, bullionist, obsolete system favored by Napoleon and the new fractional-reserve banknote system of England. [27]

In order to facilitate international trade, Britain instituted the gold standard. The gold standard was an agreement among nations to convert their currencies to gold at fixed rates, thus ensuring money earned overseas would hold its value relative to domestic currencies. The idea was that shipping gold bars from trade deficit countries to trade surplus countries would allow domestic money supplies to “self-adjust.” Trade deficits would be settled by shipping gold from deficit countries to surplus ones. Since the amount of money in your economy was based on how much gold you had, countries shipping gold out would have less money circulating, leading to deflation. This would make their exports more attractive. On the other hand, countries gaining gold reserves would issue more money causing inflation making their exports less attractive relative to the deficit counties on the world market. Over time, everything would just sort of balance out. That was the theory, anyway:

Britain adopted the gold standard in 1844 and it became the common system regulating domestic economies and trade between them up until World War I. In this period, the leading economies of the world ran a pure gold standard and expressed their exchange rates accordingly. As an example, say the Australian Pound was worth 30 grains of gold and the USD was worth 15 grains, then the 2 USDs would be required for every AUD in trading exchanges.

The monetary authority agreed to maintain the “mint price” of gold fixed by standing ready to buy or sell gold to meet any supply or demand imbalance. Further, the central bank (or equivalent in those days) had to maintain stores of gold sufficient to back the circulating currency (at the agreed convertibility rate).

Gold was also considered to be the principle method of making international payments. Accordingly, as trade unfolded, imbalances in trade (imports and exports) arose and this necessitated that gold be transferred between nations (in boats) to fund these imbalances. Trade deficit countries had to ship gold to trade surplus countries. For example, assume Australia was exporting more than it was importing from New Zealand. In net terms, the demand for AUD (to buy the our exports) would thus be higher relative to supply (to buy NZD to purchase imports from NZ) and this would necessitate New Zealand shipping gold to us to fund the trade imbalance (their deficit with Australia).

This inflow of gold would allow the Australian government to expand the money supply (issue more notes) because they had more gold to back the currency. This expansion was in strict proportion to the set value of the AUD in terms of grains of gold. The rising money supply would push against the inflation barrier (given no increase in the real capacity of the economy) which would ultimately render exports less attractive to foreigners and the external deficit would decline.

From the New Zealand perspective, the loss of gold reserves to Australia forced their Government to withdraw paper currency which was deflationary – rising unemployment and falling output and prices. The latter improved the competitiveness of their economy which also helped resolve the trade imbalance. But it remains that the deficit nations were forced to bear rising unemployment and vice versa as the trade imbalances resolved.

The proponents of the gold standard focus on the way it prevents the government from issuing paper currency as a means of stimulating their economies. Under the gold standard, the government could not expand base money if the economy was in trade deficit. It was considered that the gold standard acted as a means to control the money supply and generate price levels in different trading countries which were consistent with trade balance. The domestic economy however was forced to make the adjustments to the trade imbalances.

Gold standard and fixed exchange rates – myths that still prevail (billy blog)

The gold standard, the self-regulating market, and haute finance were the foundations of the Hundred Year’s Peace lasting up until the First World War.The Hundred Year’s Peace ushered in the final transition from civil society to a fully-fledged market society. Rather than being a sideshow, all of society’s relations now became coordinated by the market. The moral economy was crushed (by force if necessary), and the market and money based capitalist one replaced it. Millions died in this transition, whitewashed from history as “moral failures” even as the suffering under Communism is constantly referred to. Money and banking were at the center of the nexus. Controlling the money supply became absolutely necessary to the smooth functioning of this system. Unfortunately, it was not managed well.

The prevention of providing adequate currency caused panics and depressions throughout the nineteenth century. However, it did engender a hundred years’ of relative peace between the great powers. Nations broke into trading spheres, and the violence was the violence of empire, as well as the institutional violence imposed by the market system itself (hunger, homelessness, starvation, poverty, prisons, jails, alienation, conscription, etc.). In wartime and depressions, however, the gold standard tended to be abandoned. It always rested on peaceful international relations and government agreements; in no was was gold ever “natural” money.

Nineteenth-century civilization rested on four institutions. The first was the balance-of-power system which for a century prevented the occurrence of any long and devastating war between the Great Powers. The second was the international gold standard which symbolized a unique organization of world economy. The third was the self-regulating market which produced an unheard-of material welfare. The fourth was the liberal state. Classified in one way, two of these institutions were economic, two political. Classified in another way, two of them were national, two international. Between them they determined the characteristic outlines of the history of our civilization.

Of these institutions the gold standard proved crucial; its fall was the proximate cause of the catastrophe. By the time it failed, most of the other institutions had been sacrificed in a vain effort to save it. [28]

Mismanagement of the “new” market society was the proximate cause of two World Wars and the Cold War, killing millions. Once again, it threatens to tear the world apart. But that’s a story for another time.

Next: Concluding notes.

[1] Wray, et. al.; Credit and State Theory of Money, p. 209

[2] ibid.

[3] ibid.

[4] In Our Time – The South Sea Bubble (BBC)

[5] Wray, et. al.; Credit and State Theory of Money, p. 210

[6] How a creative legal leap helped create vast wealth (BBC)

[7] In Our Time – The South Sea Bubble (BBC)

[8] Felix Martin; Money, the Unauthorized Biography, pp. 116-117

[9] Felix Martin; Money, the Unauthorized Biography, pp. pp. 117-118

[10] Felix Martin; Money, the Unauthorized Biography, p. 120

[11] Wray, et. al.; Credit and State Theory of Money, p. 211

[12] William N. Goetzmann and K. Geert Rouwenhorst, eds. The Origins of Value: The Financial Innovations that Created Modern Capital Markets, pp. 230-231

[13] John Flynn’s Biography of John Law http://www.devvy.com/pdf/biography_john_law.pdf, pp. 5-7

[14] Janet Gleeson; Millionaire: The Philanderer, Gambler, and Duelist Who Invented Modern Finance, p. 113

[15] Janet Gleeson; Millionaire: The Philanderer, Gambler, and Duelist Who Invented Modern Finance, p. 116-117

[16] Janet Gleeson; Millionaire: The Philanderer, Gambler, and Duelist Who Invented Modern Finance,  pp. 132-133

[17] William N. Goetzmann and K. Geert Rouwenhorst, eds. The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 231

[18] John Flynn’s Biography of John Law
http://www.devvy.com/pdf/biography_john_law.pdf, p. 5-6

[19] Niall Ferguson; The Ascent of Money, p. 141

[20] Crisis Chronicles: The Mississippi Bubble of 1720 and the European Debt Crisis (Liberty Street)

[21] Francois R. Velde; Government Equity and Money: John Law’s System in 1720 France, p. 21

[22] John E. Sandrock; John Law’s Banque Royale and the Mississippi Bubble, pp. 8-9

[23] Niall Ferguson; The Ascent of Money, p. 157

[24] John E. Sandrock; John Law’s Banque Royale and the Mississippi Bubble, p. 13

[25] Rebecca Spang: Stuff and Money in the Time of the French Revolution – MR Live – 2/21/17 (YouTube)

[26] Adam Smith; Paper Money, pp. 116-117

[27] Carroll Quigley; The Evolution of Civlizations, p. 377

[28] Karl Polanyi; The Great Transformation, chapter one.

The Origin of Money 9 – Bonds and the Invention of the ‘National Debt’

The Venetian government is the first we know of which became a debtor to its own citizens, or conversely, where citizens became creditors on the government. As with most innovations in finance, it was the need to raise funds for war that drove the need to raise revenue quickly.

Other city-states had to compete with Venice, and the system spread, first to Genoa, and then to other republics in Northern Italy like Florence, Milan and Sienna. These city-states were all expanding militarily, and they needed money to do it. Since they were republics, they had advantages that the absolute monarchies of Northern Europe did not have, including accountability to their citizens. The merchant classes essentially borrowed from themselves to fund the wars.

These methods of short and long term debt financing spread to Northern Europe but were done on the municipal, not state level, since states were largely still absolute monarchies who could, and did, repudiate their debts on a regular basis.

In Northern Europe tax collection was highly decentralized during the Middle Ages, and national governments relied on municipal and provincial tax receipts for revenue. Many localities in Western Europe turned to securities (annuities, lotteries, tontines, etc.) for short-term and long-term borrowing which were allowable under the Church’s ban on usury. Both France and Spain eventually incorporated these into the nation’s overall financial structure, however, these were still primarily local, not state liabilities. Both governments used debt instruments for borrowing, but these were intermediated by banks and unlike the Italian republics, borrowing costs were high because they were less reliable. The kings of France and Spain, unrestrained by effective parliaments, were serial defaulters.

The Seven United Provinces (today’s Belgium and the Netherlands), which, like the Italian City-states, were trading empires run by a wealthy merchant oligarchy, used these new methods of financing and banking to fund their rebellion against Spain as well as expand their burgeoning overseas trading empire. These securities eventually became negotiable, and markets emerged for buying, selling, and trading these debts. The United Provinces is likely the first place where these became national liabilities. The center of financial innovation shifted from Northern Italy to Holland.

From there “Dutch finance” spread across the Channel to England during the Glorious Revolution of 1688. To manage his mounting war debt, William of Orange took out a loan from the merchant bankers of England in exchange for certain prerogatives from the crown. England was the first major country to consolidate its debt, nationalize it, and monetize it, therefore setting the stage for the public/private hybrid system of money creation and banking that we use today.

Italy Invents the State Bank

It all started with the Crusades. Seaports like Venice and Genoa were launching points for the armies marching south to conquer the Holy Land. The vast amounts of money flowing into these cities during this time allowed them to remove themselves from the feudal order and become self-governing communes. The shipping expertise gained by ferrying soldiers back and forth to the Middle East allowed the Venetians and Genoese to develop the skills to become Europe’s primary merchants and traders, importing exotic goods from the Islamic world into western Europe, and becoming fabulously wealthy in the process.

It was through the Islamic trade centered around the Silk Road and the Indian ocean—the first modern “global economy”–that the Italians learned all sort of innovations that we saw last time, from paper to base-10 place notation, to algebra, to checks, to bills of exchange. These ideas would be used to usher in the “commercial revolution” of the late Middle Ages. They would also make Northern Italy the crucible for European banking and finance.

To fund their expansion, these thassalocracies needed money. Trading empires, as Paul Colinveax would remind us, require superior military technique. At this time, military empires relied mainly not on conscripts (most people in these republics were merchants and artisans), but on professional soldiers, i.e. mercenaries. As Carroll Quigley put it, “the existence of mercenary armies made money equivalent to soldiers and thus to power.” (p. 373)

For much of the fourteenth and fifteenth centuries, the medieval city-states of Tuscany – Florence, Pisa and Siena – were at war with each other or with other Italian towns. This was war wages as much by money as by men. Rather than require their own citizens to do the dirty work of fighting, each city hired military contractors (condottieri) who raised armies to annex land and loot treasure from its rivals. [2]

The main way states raised money during this period, as we saw last time, were taxes and seignorage. Taxes were levied almost exclusively on commercial activity for most of history (since most other activity took place outside of the commercial/money economy). This was unlikely to be as effective in an entrepot dependent upon shipping and trade. Feudal rents and dues were levied by kings, but were less available to city-states outside of the feudal system. Siegnorage was a major way of raising revenue as we saw previously, but for a merchant-based society, devaluing the currency was less likely to be helpful or popular.

The solution arrived at was to borrow money from the city’s wealthy merchant and banking classes.

During the thirteenth and fourteenth centuries major cities such as Florence, Genoa, Milan, and Venice were able to extend their territorial control; those of Venice and Genoa attained the importance of maritime empires.

The formation of a territorial state came at enormous costs. How did urban governments raise the money needed to cover such expenses? Since increasing or raising new taxes required time and, above all, public acceptance, the easiest way was to borrow from the wealthiest citizens.[3]

Despite the ban on usury, no medieval European government – municipal, territorial, or national – was able to function without borrowing, given that its powers to tax and exact rents were limited, while it was often engaged in costly wars. But such loans were usually for short terms, often at punitive rates of interest.

During the twelfth century, the Italian progenitors of the ongoing Commercial Revolution developed what became a system of municipally funded debts, debts that subsequently became permanent. Genoa took the lead, in 1149, when it agreed to give a consortium of the city’s lenders control over a compera, a consolidated fund of tax revenues to be used in paying the city’s creditors.

Venice followed suit in 1164, by securing a loan of 1,150 silver marci against the tax revenues from the Rialto market for twelve years. In 1187, in return for a loan of 16,000 Venetian lire, to finance the doge’s siege of Zara, creditors were given control over the salt tax and certain house rents for thirteen years; thereafter, the Salt Office was made responsible for all such loan payments…by 1207, the Venetians had adopted what had already become the hallmark of public finance in the Italian republics: a system of forced loans, known locally as prestiti, whose interest charges were financed by additional taxes on salt, the Rialto market, and the weigh-house.

Between 1262 and 1264, the Venetian Senate consolidated all of the state’s outstanding debts into one fund later called the Monte Vecchio – mountain of debt – and decreed that debt-holders should receive annual interest at 5 per cent, which the Ufficiale degli Prestiti was required to pay twice yearly from eight specified excise taxes. These prestiti debt claims (with interest payments) were assignable through the offices of the procurator of San Marco and, by 1320 at the latest, a secondary market for them had developed. [4]

A loophole in the medieval prohibition on usury allowed this to take place. Although we regard usury and interest as one in the same, in fact medieval law made a distinction between the two:

Usury is sometimes equated with the charging of interest, but by the thirteenth century it was recognised that the two ideas were different.

Usury derives from the Latin usura, meaning ‘use’, and referred to the charging of a fee for the use of money. Interest comes from the Latin intereo, meaning ‘to be lost’, and originated, in the Roman legal codes as the compensation someone was paid if they suffered a loss as a result of a contract being broken. So a lender could charge interest to compensate for a loss, but they could not make a gain by lending.

It is easier to understand this with a simple example. A farmer lends a cow to their cousin for a year. In the normal course of events, the cow would give birth to a calf and the cousin would gain the benefit of the cow’s milk. At the end of the loan, the farmer could expect the cow and the calf to be returned. The interest rate is 100%, but it is an interest since the farmer, if they had not lent the cow to their cousin, would have expected to end the year with a cow and a calf. Similarly, if the farmer lent out grain, they could expect to get the loan plus a premium on the basis that their cousin planted the grain, he would reap a harvest far greater than the sum lent. [5]

These concepts gave birth to the idea of the medieval census:

A census originated in the feudal societies as an “obligation to pay an annual return from fruitful property”. What this means is that the buyer of the census would pay a landowner, for example, for the future production from the land, such as wheat or wine, over a period of time.

As economic life in western Europe became based on money transactions rather than barter transactions, censii lost the link to specific produce, cartloads of wheat or barrels of wine. The buyer of the census would accept regular cash payment instead of the actual produce, and this was legitimate in the eyes of the canon lawyers as long as the lump-sum paid buy [sic] the buyer ‘equated’ with the value of the ‘fruitful property’ being produced by the seller.

Anyone who could became involved in censii. A labourer might sell a census based on the future revenue from their labour, states sold them based on the future revenue from taxes and monopolies, and the Church invested bequests by buying censii. Censii issued by governments, usually linked to specific tax revenues, became known as rentes. Censii could be ‘temporary’, lasting a few years, or ‘permanent’, until one of the parties died.

In today’s terms, temporary censii resemble modern mortgages, permanent censii resemble the ‘annuities’ pensioners live off today. They could be ‘redeemable’, by one or both parties, meaning that the contract could be cancelled. [6]

The Venetian government required a “forced loan” from their wealthiest citizens in line with their income (i.e. it was progressive) to fund the war effort. Since the loans were forced loans, interest was compensation for the lost money, which was allowable under the Church’s anti-usury doctrine. The government paid an “interest” of 5 percent per year in biannual installments of 2.5 percent to compensate for the lost money. To do this, the government allocated dedicated revenue streams from commercial taxes to pay the interest.

Prestiti were a development from the rentes created by states. Around the twelfth century the Italian city-states of Venice, Genoa and Florence began to forcefully sell temporary rentes to their rich citizens. By the mid-thirteenth century the different issues of rentes were consolidated into a mons (mountain) and everyone who had been made to buy a rente was given a share, proportionate to their contribution, in the mons. [7]

The loans were basically irredeemable—there was no pledge by the government to pay back the principal in a fixed amount of time. These were not bearer bonds; rather, the names of the creditors were recorded in government ledgers at the loan office (Camera degli imprestiti). They were assignable in that the revenue stream could be transferred to a third party with the consent of the owner, but they were not negotiable, however, at least at first. You could not simply sell your bonds on the open market without the knowledge of the original debtor (the government), i.e. they were not easily transferable. Nor were they legal tender which could be used in lieu of cash.

Venice created its mons, the monte vecchio, in 1262 and the shares, known as prestiti, entitled the holder to be paid 5%, a year, of the sum they lent, which was written on the prestiti and known as the ‘face value’. While there was no obligation for the states to pay the coupon, the annual payment, there was an expectation that they would if it could be afforded and the mountain itself was paid back as and when funds allowed. [8]

Eventually, as borrowing costs grew to encompass more and more of state revenue, dedicated agencies were established in order to manage the consolidated debt these states owed to their citizens and others:

During the last quarter of the thirteenth century the demand for loans on Venetian citizens grew: they had to deposit a part of their assessed wealth into state coffers, the sums were registered on public books, and tax revenues were devoted to paying interest. By 1274 Genoa adopted a similar measure, and some loans were consolidated and managed by a single state agency.

The republics of Venice and Genoa were thus the first to transform their floating debt into a consolidated debt; later, some Tuscan communities would follow suit.
The main features of such a system were extraordinary financing through irredeemable forced loans; moderate interest rates; credits that were heritable, negotiable and usable payment; an amount consolidated and managed by a specific authority; and specific tax revenues designated for paying interest. [9]

The Genoese set up a dedicated private bank to manage the public debt around 1400 called the Casa di San Giorgio. Today it is recognized by financial historians as the first modern state bank, and in time, it became more powerful than the state itself! Many European monarchs regularly used it for borrowing, and it even funded some of the first expeditions to the New World (Christopher Columbus’ childhood home was nearby):

On March 2 1408, eight men gathered in the great hall of the Casa di San Giorgio, a trading house on what was then the main street in Genoa, a few metres from where the waters of the Ligurian Sea lap the Italian shore. They were merchants, rich and powerful representatives of the city’s most influential families, and they were meeting to discuss a matter of the utmost gravity. The once-glorious republic of Genoa had fallen on hard times. After years of war with Venice and a crushing defeat at the battle of Chioggia in 1381, the state was effectively bankrupt. The task was to rescue it.

A few months earlier, towards the end of 1407, Genoa’s Council of Ancients had authorised the Casa di San Giorgio to carry out this job. It would be accomplished by creating a bank that would facilitate the repayment of Genoa’s debts in return for interest at 7 per cent and the right to collect taxes and customs owed to the city. The purpose of the meeting that spring day was to declare the Banco di San Giorgio open for business.

..The Banco di San Giorgio would, in time, become as powerful as the republic that created it – more powerful, according to Niccolò Machiavelli. It would survive for nearly 400 years. It would become the world’s first modern, public bank, not just a forerunner of the Bank of England but its prototype…in a short space of time, it became so entwined with the republic of Genoa that the bank and the state were indistinguishable.

Machiavelli described the relationship as “a state within a state”. The Banco di San Giorgio grew so influential that it replaced the Fuggers, the German banking dynasty, as the source of financing for Europe’s cash-starved, perpetually warring monarchs. A century and a half after it was created it had restored Genoese power and influence as a maritime and commercial state to such an extent that the period from 1557 to 1627 was termed the Age of Genoa by Fernand Braudel, the great French historian…Christopher Columbus, Genoa’s most illustrious son, would be a customer…[10]

The management of state finances became increasingly concentrated in the hands of a professional bureaucracy which was separate from direct control by the state. The republics made very sure that the money was paid back reliably. This made loaning to them much more reliable than loaning to monarchs, and they were able to raise more revenue for their operations:

One reason that this system worked so well was that they and a few other wealthy families also controlled the city’s government and hence its finances. This oligarchical power structure gave the bond market a firm political foundation. Unlike an unaccountable hereditary monarch, who might arbitrarily renege on his promises to pay his creditors, the people who issued the bonds in Florence were in large measure the same people who bought them. Not surprisingly, they therefore had a strong interest in seeing that their interest was paid. [11]

Because of their dependability, these government-backed IOUs soon became highly desirable places for rich merchants and nobles to store their wealth, much as they are today, secured by the government’s promises to pay. The guaranteed returns provided a reliable income stream for those able to purchase the bonds. The merchant classes and various institutions bought up the bonds and used them as collateral, endowments for charities, even gifts and dowries, and passed them down to their assignments and heirs.

Over time, as issuing bonds became more common, more and more people became dependent on bonds for their income. Much like today, many of the holders of bonds were not just individuals but institutions and endowments who relied on the bonds as a source of income. This parallels today, where holders of bonds are often institutional holders like retirement accounts and insurance companies:

Throughout the sixteenth and seventeenth centuries it seems that most of the bonds were in the hands of guilds and ecclesiastical and charitable institutions that looked to state debt to assure a sound, even if relatively low, return. The economic importance of the redistribution of money through the government debt can not be neglected…Both in Florence and Genoa, government creditors drew a significant share (about one-fifth) of their income from bonds. Accordingly, a flow of money spread through the city and revived the local economy. [12]

Initially, only citizens of the Republic could buy bonds, but over time, bonds were issued to outside sources. Nonetheless, it appears that the debt in Italian city-states was held mainly by its own citizens, and not by foreign creditors. Buying bonds was seen as a sort of civic duty for the city’s wealthy individuals:

To loan to the commune was regarded as a duty, part of belonging to the urban community. Loans were connected, to a certain extent, with the concept of charity and gifts to the res publica.

Some governments, such as Florence, at first forbade foreigners to held state bonds, while it seems that in Venice since the thirteenth century foreigners were allowed to buy government credits. Some devices, nevertheless, were adopted in order to bypass such prohibitions; the easiest solution was to grant citizenship to those who were willing to buy government bonds…At any rate, the foreign presence among bondholders seems to have been a limited phenomenon: by the early fifteenth century about one tenth of the Florentine debt was held by foreigners; in 1629, 92 percent of the principal of S. Giorgio belonged to Genoese citizens and institutions…Unlike some Italian princely states, such as Milan and the papal state, and German cities, the urban governments of Venice, Florence and Genoa succeeded in raising enormous amounts of money from their citizens and very seldom borrowed from foreigners…[13]

Today, governments sell bonds directly to the public in what is called a primary market. From there, they are traded by investors in secondary markets. At this time, there was no primary market for bonds—only a select few insiders could loan to governments. But soon a thriving secondary market emerged where such debts were bought and sold. The prices of bonds varied, depending on the reliability of the debtor (the state). Because interest was paid on the face value of the bond, if you could buy a bond on the cheap, you would be assured a nice payout. This was effectively an end-run around the Church’s ban on usury:

Quickly a market for Prestiti emerged, where holders who needed ready cash would trade them with people who had a surplus of cash and wanted to save. During times of peace and prosperity they had a high price, but during war and uncertainty, they traded at a low price.

For example, Venetian prestiti traded for their face value around 1340 when the Republic paid off a lot of the mons, but in 1465, during a disastrous war with the Ottoman Turks, they fell to 22% of face. The Florentine prestiti actually had a built in facility where a holder could go to the state and sell them for 28% of their face value, however their market price was never so low as to make this profitable.

The legitimacy of the prestati was debated by the canon lawyers. On the one hand the coupons, the regular cash payments can be seen as compensation for the forced nature of the original loan. The lender had no choice and so does suffer a loss. However, if a prestiti with a face of 100 ducats was sold for 22 ducats, the buyer would be receiving interest at a rate of 5∕22 = 23%; in what way had this buyer of the prestiti been forced to enter into the contract? An interest payment of 23% in these circumstances seemed to be “asking for more than what was given”.

Prestiti are important in that are one of the earliest representations of an actively traded financial instrument. The prestiti does not represent bushels of wheat or barrels of oil, it is a contract where by a state promises to pay a specified amount of money. Whether or not the state does pay out on the contract, is unknown and uncertain, hence the value of the contract is also unknown and uncertain. [14]

In the end, the ability to have people voluntarily lend to the government provided advantages that were simply too great to ignore. Such governments were able to raise large amounts of cash quickly; they were able to raise money from a much wider circle than just the immediate tax base; and they were able to overcome limitations in the amount of specie circulating. This made state borrowing very effective and the places that engaged in it very powerful. In addition, bonds provided reliable places for wealthy citizens to store wealth outside of banks, and the interest payments helped local economies flourish. Money was becoming an important source of military power, too. Luciano Pezzolo summarizes the advantages of bond issuance by Italian city-states:

First, the enormous concentration of capital in some Italian cities allowed governments to transform, through public credit, private wealth into military power, to build a territorial state, and to control a wider economic area…Italian governments collected money from taxpayers at 5 to 7 percent, whereas the major European monarchies of the Renaissance were compelled to borrow at a much higher price.

Second, the debts took on a political function. To be creditors in the government meant sharing the destiny of the regime, and consequently supporting it. In Florence, the Medicean regime tied itself to an oligarchy that profited from the management of government debt. Thus, debt helped create stability.

Third, the social structure was supported by state debt: the considerable bond income drawn by charitable and social institutions and redistributed it the poor maintained a paternalistic policy that was a pillar of the urban political and social system.

Fourth, both government bonds and interest provided an effective surrogate of cash money in the later Middle Ages during a period of bullion shortage. The trade of bonds and interest claims opened up sophisticated forms of speculation and implemented financial techniques that are quite familiar to modern brokers.

Finally, the means devised by governments to finance the deficit offered new forms of social security and investment (dowries, life annuities, lotteries) that are at the roots of [the] later financial system. [15]

In this, we can discern something like David Graeber’s military-coinage-slavery complex emerging around the bond markets:

1.) Governments would raise money for military operations by dedicating future expected revenue streams to loan repayments, effectively becoming debtors to their citizens. That is, they could borrow against future revenues.

2.) The proceeds from the territorial/commercial expansion would be used to pay interest on the loans.

3.) The interest money would then flow back into the domestic economy, causing economic expansion at home, as more people became dependent on the government debt as a store of value and a source of income.

4.) Economic expansion abroad and at home would allow governments to deliver better services to its citizens, ensuring broad popular support.

5.) The dependency on regular payouts by lenders would encourage them to support the political stability of the regime.

6.) City-states which avoided default were able to gain a fundraising advantage over their rivals. Hence, there was a strong incentive to make reliable payments and not to default.

Thus, the concept of the “national debt” was born. This gave rise to a brand new “money interest” whose wealth was held in government debt rather than coin.

Debt Financing Spreads to Northern Europe

Now contrast this with Northern Europe. Most nation-states were still under the feudal system. It would have made no sense for a ruler to borrow from himself, since they theoretically “owned” everything in the kingdom. Instead of borrowing from their citizens, therefore, these kingdoms continued to rely upon other sources of income.

Under the feudal system tax collection was highly decentralized and done mainly at the local level. Wealthy kingdoms, such as France, used tax farming (publican) methods very similar to those of ancient Rome:

Fiscal revenues consisted of a mixture of direct (income or wealth) taxes, indirect (consumption) taxes, and feudal dues arising from the royal demesne. The assessment and collection of these revenues was decentralized. For direct taxes, a global amount was set by the government, and then broken down into assessments for each province, where local authorities would proceed with the next level of assessment, and so on to the local level.

For indirect taxes, collection was carried out by tax farmers on behalf of the government. The procedure was much like the one in place since Medieval times for running the royal mints. The right to collect a given tax was auctioned to the highest bidder. The bidder offered a fixed annual payment to the king for the duration of the lease. Meanwhile, he took upon himself to collect the tax, hiring all the necessary employees. Any shortfall in revenues from the promised sum was made up by the entrepreneur; conversely, any revenue collected above and beyond the price of the lease was retained as profit by the entrepreneur…

Spending is decentralized as well to various treasurers. Each tax had an associated bureaucracy of collectors and treasurers, either government employees or officers (direct taxes) or employees of the tax farmer. The treasurers spent some of the monies they collected, upon presentation of payment orders emanating from the government, and turned over the remainder, if any, to the royal treasury in Paris. [16]

Although it’s anathema under modern economic dogma, government monopolies on various business activities were considered a legitimate way to raise revenue.

Government monopolies, such as salt and recently introduced tobacco, were also farmed out in the same fashion. Indeed, the ability to create monopolies was one of the king’s resources; one of the more outlandish examples being the exclusive right to sell snow and ice in the district of Paris, sold for 10,000L per year in 1701. [17]

Another method was through the sale of political offices. Governments would create offices and sell them at a profit, and the salary paid was essentially interest on the lump sum payment for the original position:

An officer was someone who held a government position not on commission or at the king’s leave, but as of right, and enjoyed various privileges attached to the position (in particular the collection of fees related to his activities). Offices were sold, and the king paid interest on the original sale price, which was called the wages of the office (gages). A wage increase was really a forced loan, requiring the officer to put up the additional capital. Officers could not be removed except for misconduct; however, the office itself could be abolished, as long as the king repaid the original sum. Thus, offices as a form of debt also carried the same repayment option as annuities. [18]

And, as in Italy, the census evolved into annuities which were sold by municipalities as a way of long-term borrowing.

Offices and annuities (which I will generically call bonds, and whose owners I will call bondholders) could be transferred or sold, but with fairly high transaction costs. Both were considered forms of real estate, and could be mortgaged. In the late 17th century the French government, like others in Europe, had begun experimenting with life annuities, tontines, and lottery loans, but on a limited basis, and had not yet issued bearer bonds. Even the short-term debt described above was registered in the sense that the payee’s name was on the instrument, and could be transferred only by endorsement.

A final form of borrowing combined tax creation and lending. The procedure consisted in creating a new tax for some limited time and immediately farming its collection in exchange for a single, lump-sum payment representing the tax’s net present value. [20]

Besides, absolute monarchs could always repudiate their debts, and there was not much recourse for creditors since monarchs had their own armies and made the laws. The kings who did take out loans for military campaigns ended up paying very high interest rates for this reason.

By the early sixteenth century, the Habsburg Emperor, French kings, and princes in the Low Countries had all affirmed their powers to regulate municipal public finances, especially rentes, and the municipal taxes that were used to pay annual rent charges. But this method of financing governments still remained municipal, because only municipalities sold rentes, so that the national institutions required for a funded, permanent public debt had yet to be created…the first national monarchy to establish a permanent, funded national debt based on rentes, by the early sixteenth century, was … the newly unified Habsburg kingdom of Spain.

Both the French and Spanish crowns sought to raise money … but they had to use towns as intermediaries. In the French case, funds were raised on behalf of the monarch by the Paris hôtel de ville-, in the Spanish case, royal juros had to be marketed through Genoa’s Casa di San Giorgio (a private syndicate that purchased the right to collect the city’s taxes) and Antwerp’s heurs, a forerunner of the modern stock market. Yet investors in royal debt had to be wary. Whereas towns, with their oligarchical forms of rule and locally held debts, had incentives not to default, the same was not true of absolute rulers. [21]

Despite this ability to borrow, by the 1500-1600’s France and Spain had become serial defaulters.

…the Spanish crown became a serial defaulter in the late sixteenth and seventeenth centuries, wholly or partially suspending payments to creditors in 1557 , 1560, 1575 , 1596, 1607, 1627 , 1647, 1652 and 1662. [22]

The Netherlands, by contrast, used these financial techniques to fund their war of independence from Spain and in the process became the financial center of northern Europe.

Part of the reason for Spain’s financial difficulties was the extreme costliness of trying and failing to bring to heel the rebellious provinces of the northern Netherlands, whose revolt against Spanish rule was a watershed in financial as well as political history. With their republican institutions, the United Provinces combined the advantages of the city state with the scale of a nation-state. They were able to finance their wars by developing Amsterdam as the market for a whole range of new securities: not only life and perpetual annuities, but also lottery loans (whereby investors bought a small probability of a large return). By 1650 there were more than 6 5,000 Dutch rentiers, men who had invested their capital in one or other of these debt instruments and thereby helped finance the long Dutch struggle to preserve their independence. [23]

The center of European trade moved from the Mediterranean to the North Atlantic starting in the mid-1400’s with the advent of pelagic shipping vessels and the discovery of new routes to Asia by circumnavigating Africa. Portugal and Spain took the lead here. Spain’s “discovery” of the American continent ensured that trade would now be centered on the Atlantic coast, and the Islamic trade in the Mediterranean withered and became less significant, especially after the fall of Constantinople to the Turks in 1453. Eventually, European maritime trade became centered in Antwerp. When the Spanish conquered the southern Netherlands, what we now call Belgium, in 1585, they took Antwerp, which was the main port for Northern Europe. Many of the more highly skilled merchants fled to Amsterdam, which would then become ground zero for the financial revolution.

The reason for the primacy of the Dutch Republic in trading and finance might simply boil down to geography. Holland and the Netherlands are below sea level, which is why they are called the Low Countries. The land had forcibly been reclaimed from the sea by dykes over the centuries. This made the Dutch dependent upon fishing, shipping and trading far more than just about anywhere else, since the water table was too high for farming and there was not much arable land. Yet at the same time the population density of these areas was quite high. So their entire economy had to be dependent almost exclusively on shipping and trade since there were no other options, unlike in France, Spain, Portugal and England.

The Dutch utilized much of the same methods of borrowing as the rest of Europe, but much more effectively:

The Netherlands successfully liberated itself from Spain between 1568 and 1648. The Dutch established the Dutch east India Company in 1602 and the Dutch West India Company in 1621. The Netherlands didn’t have to pay for an expensive court, fought their wars at home rather than abroad, profited from international trade, and saved money. The Amsterdam Exchange dealt not only in shares of the Dutch East India Company and Dutch West India Company, but in government bonds as well.

Most securities were in the form of Annuities issued by the individual provinces, the United Provinces and the towns. This is the essential way in which Dutch lending differed from Italian lending. The Italian credit system relied upon a system of private international banking. The Medicis and other commercial bankers would lend their funds to states, knowing the risks involved. The Italians also had officially chartered banks that intermediated deposits and loans.

Outside of the Italian city-states, loans to heads of state were basically personal loans that clearly ran the risk of default. Spanish, French and English kings borrowed when they had to, defaulted when they couldn’t pay, but had no system of drawing upon the savings of the public. The Dutch, on the other hand, developed state finance based upon the government’s ability to pledge its revenues against the annuities they had issued. Having no royal court, and relying upon local governments, the Dutch paid off loans on time with little risk of default. As risk declined, interest rates fell to 4%, the lowest they had ever been in history, and a rate consistent with the low level of default risk that governments enjoy today. [24]

The Dutch also set up a bourse where national debts could be traded as negotiable securities. They set up a state bank to manage trade. They also developed the modern corporation, where corporate shares were freely tradable, hence establishing the first stock market (the Amsterdam exchange).

The Dutch Republic became the main place where international debts could be bought and sold in secondary markets. While it was neither the first bank or exchange, what made it unique was the fact that this was consolidated in one specific location, with government backing, as well as the scale of operations. Securities from all over became speculative commodities. This was the beginning of trading debts and money that engendered speculative bubbles like Tulip mania. In fact, you could even gamble with assets that you didn’t actually own, setting up the stage for the modern Casino Capitalism.

The novelty at the beginning of the seventeenth century was the introduction of a stock market in Amsterdam. Government stocks and the prestigious shares in the Dutch East India Company had become the objects of speculation in a totally modern fashion. It is not quite accurate to call this the first stock market, as people often do. State loan stocks had been negotiable at a very early date in Venice, in Florence before 1328, and in Genoa, where there was an active markets in the luoghi and paghe of the Casa di San Giorgio, not to mention the Kuxen shares in the German mines which were quoted as early as the fifteenth century at the Leipzig fairs, the Spanish juros, the French rentes sur l’Hotel de Ville (municipal stocks) (I522) or the stock market in the Hanseatic towns from the fifteenth century. The statutes of Verona in 1318 confirm the existence of the settlement or forward market (mercato a termine). In 1428, the jurist, Bartolomeo de Bosco protested against the sale of forward loca in Genoa. All this evidence points to the Mediterranean as the cradle of the stock market.

But what was new in Amsterdam was the volume, the fluidity of the market and the publicity it received, and the speculative freedom of transactions. Frenetic gambling went on here – gaming for gaming’s sake: we should not forget that in about 1634, the tulip mania sweeping through Holland meant that a bulb ‘of no intrinsic value’ might be exchanged for ‘a new carriage, two grey horses and a complete harness’! Betting on shares however, in expert hands, could bring in a comfortable income… Exchanges and growing rich while the merchants said they Were becoming poorer. In every centre, Marseilles or London, paris or Lisbon, Nantes or Amsterdam, brokers, who were little hampered by the regulations, took many liberties with them.

But is is also true that speculation on the Amsterdam Stock Exchange had reached a degree of sophistication and abstraction which made it for many years a very special trading-centre of Europe, a place where people were not content simply to buy and sell shares, speculating on their possible rise or fall, but where one could by means of various ingenious combinations speculate without having any money or shares at all. This was where the brokers came into their own… All the same, such practices had not yet attained the scale they were to reach during the following century, from the time of the Seven Years War, with the increased speculation in shares in the British East India Company, the Bank of England and the South Sea, above all in English government loans…Share prices were not oficially published until 1747 however, whereas the Amsterdam Exchange had been billing commodity prices since 1585.

Several other changes took place as well. To resolve the multiple currencies circulating, state banks became established by governments, and monetary exchange ever more centered around bank credits rather than government-issued monies. You would deposit your coins in the bank and be given a credit for it, which would hold its value, protected from the arbitrary currency fluctuations decreed by sovereigns. Credit creation led to fractional reserve banking. Joint-stock companies were applied to banking, and even made loans to governments.

The seventeenth century saw the foundation of three distinctly novel institutions that, in their different ways, were intended to serve a public as well as a private financial function.

The Amsterdam Exchange Bank (Wisselbank) was set up in 1609 to resolve the practical problems created for merchants by the circulation of multiple currencies in the United Provinces, where there were no fewer than fourteen different mints and copious quantities of foreign coins. By allowing merchants to set up accounts denominated in a standardized currency, the Exchange Bank pioneered the system of cheques and direct debits or transfers that we take for granted today. This allowed more and more commercial transactions to take place without the need for the sums involved to materialize in actual coins. One merchant could make a payment to another simply by arranging for his account at the bank to be debited and the counterparty’s account to be credited.

The limitation on this system was simply that the Exchange Bank maintained something close to a 100 per cent ratio between its deposits and its reserves of precious metal and coin…A run on the bank was therefore a virtual impossibility, since it had enough cash on hand to satisfy nearly all of its depositors if, for some reason, they all wanted to liquidate their deposits at once. This made the bank secure, no doubt, but it prevented it performing what would now be seen as the defining characteristic of a bank, credit creation.

It was in Stockholm nearly half a century later, with the foundation of the Swedish Riksbank in 1656, that this barrier was broken through. Although it performed the same functions as the Dutch Wisselbank, the Riksbank was also designed to be a Lanebank, meaning that it engaged in lending as well as facilitating commercial payments. By lending amounts in excess of its metallic reserve, it may be said to have pioneered the practice of what would later be known as fractional reserve banking, exploiting the fact that money left on deposit could profitably be lent out to borrowers…

The third great innovation of the seventeenth century occurred in London with the creation of the Bank of England in 1694. Designed primarily to assist the government with war finance (by converting a portion of the government’s debt into shares in the bank), the Bank was endowed with distinctive privileges. From 1709 it was the only bank allowed to operate on a joint-stock basis; and from 1742 it established a partial monopoly on the issue of banknotes, a distinctive form of promissory note that did not bear interest, designed to facilitate payments without the need for both parties in a transaction to have current accounts. [25]

This last innovation – the use of private corporations such as banks to consolidate and manage the government’s debt, is at the heart of the modern financial system. The money we use is the government’s liability, backed by its ability to collect taxes. Yet now private banks would continue to be allowed to create credit by extending loans denominated in the same unit of account that the government required to pay the taxes, the ultimate form of financial settlement.

We’ll take a look at how that happened next time.

SOURCES:

[1] Not used.
[2] Niall Ferguson; The Ascent of Money, p. 69
[3] William N. Goetzmann and K. Geert Rouwenhorst, eds.: The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 147
[4] John H. Munro: The medieval origins of the ’Financial Revolution’: usury, rentes, and negotiablity. http://mpra.ub.uni-muenchen.de/10925/ p. 514
[5] http://magic-maths-money.blogspot.com/2011/07/structured-finance-in-twelfth-century.html
[6] ibid.
[7] ibid.
[8] ibid.
[9] ibid.
[10] https://www.ft.com/content/6851f286-288d-11de-8dbf-00144feabdc0
[11] Niall Ferguson; The Ascent of Money, p. 72
[12] William N. Goetzmann and K. Geert Rouwenhorst, eds.: The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 147
[13] ibid., p. 158
[14] http://magic-maths-money.blogspot.com/2011/07/structured-finance-in-twelfth-century.html
[15] William N. Goetzmann and K. Geert Rouwenhorst, eds.: The Origins of Value: The Financial Innovations that Created Modern Capital Markets, p. 163
[16] Francois R. Velde; Government Equity and Money: John Law’s System in 1720 France, p. 5-6
[17] Francois R. Velde; Government Equity and Money: John Law’s System in 1720 France, p. 5-6
[18] Francois R. Velde; Government Equity and Money: John Law’s System in 1720 France, p. 8
[19] Niall Ferguson; The Ascent of Money, pp. 73-74
[20] Francois R. Velde; Government Equity and Money: John Law’s System in 1720 France, p. 8
[21] John H. Munro: The medieval origins of the ’Financial Revolution’: usury, rentes, and negotiablity. http://mpra.ub.uni-muenchen.de/10925/ p. 73-74
[22] Niall Ferguson; The Ascent of Money, p. 74
[23] Niall Ferguson; The Ascent of Money, pp. 74-75
[24] http://www.businessinsider.com/700-years-of-government-bond-yields-2013-12
[24a] Fernand Braudel: Civilization and Capitalism Volume 2: The Wheels of Commerce, pp 100-102
[25] Niall Ferguson; The Ascent of Money, p.Pp. 48-49

The Origin of Money 8 – Bills of Exchange and Banking

We saw last time that seignorage was used by medieval sovereigns to raise revenue. But this led to all sorts of problems because the values of the coinage were constantly being adjusted against the monetary standard. Even where there was a consistent monetary standard, there was no “official” currency equivalent to that standard, so a multitude of different coins circulated, with a multitude of shifting values. We also saw that when bullion and exchange values got too far out of whack, this led to chronic shortages of coins. This made trade difficult.

To overcome both the shortage of circulating money, and the constant variations in the value of the coins issued by states, what the merchant classes did was create a private, parallel currency system based around trade credit. This was done using bills of exchange, which were discounted by a clique of pan-European bankers centered mainly in Italy.

The net effect of this was the creation of a parallel money system based around debits and credits recorded by bankers in their ledgers using double-entry bookkeeping, without any coins changing hands. These credits would circulate as paper documents and be periodically settled at trade fairs. The bills could be converted into the local currencies at varying exchange rates. The volume of trade in late medieval Europe was far to great for the circulating coins to be adequate. Bills of exchange allowed trade to take place without using government-issued coins, which were clunky and cumbersome, not to mention uncertain.

The modern bill of exchange originated in Islamic trade and most certainly entered Europe through the Italian maritime city states during the thirteenth century.

In basic terms, exchange by bill required two networks – one of traders and one of bankers. A trader would draw a bill on a local banker, which he would then use as a means of payment for the specific goods imported from outside the local economy. The exporter of the goods would then present the bill for payment to his local representative of the banking network.

In their simplest form, the bills directly represented the value of the goods in transit. Their adoption facilitated long-distance trade, but there is nothing in these economic advantages themselves that would suggest that the bills would develop into credit money. Indeed, this is precisely what did not happen in Islam.

Exchange by bill per arte was the means by which the ‘nations’ of bankers enriched themselves by exploiting the unique opportunities afforded by the particular structure of the late mediaeval geopolitical and monetary systems. In doing so they expanded the early capitalist trading system. The bill of exchange system allowed an increase in trade without any increase in the volume or velocity of coins in the different countries; but this was an unintended systemic consequence of the exchange bankers’ entirely self-interested exploitation of the particular circumstances…Exchange by bill was also one of the practices that eventually led to issue of credit money by states…[1]

Bilateral exchange agreements had existed since Classical times, but until the advent of written contracts, they could not be disconnected from their original context and used as a means of third-party settlement.

Bills of exchange were documented in a “pure” unit of account, and thus were disconnected from precious metals and coins. That meant they could be issued without the limitations of gold and silver.

But until they could be used in the settlement of third-party debts outside of the limited network of exchange bankers, they could not function as a true currency. During the sixteenth century, some bills began to “leak” out of the banking system and be used in the settlement of other debts. Eventually a rule change allowed for the transferability of liabilities of the bill of exchange, making drawing a bill a more widely used means of payment after 1600.

But before any of this could happen, however, two relatively mundane and overlooked innovations had to be established. These were paper, and double-entry bookkeeping.

Paper and Double-Entry Bookkeeping

Before paper, people in medieval Europe wrote on parchment, which was made from the skins of animals. Parchment was expensive—a single bible required the skins of 250 sheep. However, most people didn’t couldn’t read (because they were farmers and didn’t need to), so there wasn’t much call for books. The main book was the Bible, meticulously handcopied by monks in monasteries, so the limited supply of writing media was no big deal.

Paper, like so many medieval innovations, was invented in China and came to Europe through the Arab world. It could be produced much more cheaply, and as a commercial class arose, the need for paper became more acute, leading to mass production:

The oldest known piece of paper was made in Shangsi Province in China around 49 BC. That’s about the same time sheepskin was replacing papyrus in the Roman world. So what is paper, really?

You make paper by spreading out a slurry of organic fibers and draining off the water. Paper is a kind of felt made of overlapping fibers. At first the Chinese made paper from hemp. They used it for wrapping and decoration — not for writing. They’d already been wrapping themselves in felt clothing.

In AD 105, one Ts’ai Lun used paper to replace bamboo blocks as a writing surface. He made it from fibers of bark, bamboo, and hemp. By AD 500, the Chinese had experimented with rattan and mulberry and had finally settled on bamboo paper…

Pergamon, in western Turkey, had become a parchment-based intellectual center, and parchment would become Europe’s writing material. But, in the 8th century, intellectual ascendancy passed to Baghdad, and it came to rest on the new writing medium of paper.

Historian Jonathan Bloom drives home the importance of that fact. Before we had cheap and abundant paper, arithmetic involved erasing and shifting numbers — operations that could be done on slate, but not paper. In AD 952, Arab mathematician al-Uqlidisi used Indian algorithms to create neat once-through methods that could be done on paper. Paper drove the creation of our methods for doing multiplication and long division.

The use of paper slowly crept westward. Cairo was making paper by the 10th century, Tunisia and Islamic Spain by the 11th. Paper didn’t cross the Pyrenees into Europe. Rather, it entered by way of Islamic Sicily. It was being made in Italy by 1268.

Both Hebrew and Islamic scripture had first been put on parchment. Both religions were reluctant to put scripture on anything so modest as paper, despite its strength and durability. The flow of paper into Europe was also slowed by Christians, who called it an infidel technology. Central Europe didn’t take up paper until the 14th century, and England only at the end of the 15th.

No. 894: INVENTING PRINTING (Engines of Our Ingenuity)

No. 1456: PAPER IN SAMARKAND (Engines of Our Ingenuity)

The mass production of paper may have spurred the development of mechanization of production in Europe:

When Christian Europeans finally did embrace paper, they created arguably the continent’s first heavy industry. Initially they made paper from pulped cotton. This requires some kind of chemical to break down the raw material. The ammonia from urine works well, so for centuries the paper mills of Europe stank as soiled garments were pulverized in a bath of human piss. The pulping also needs a tremendous amount of mechanical energy. One of the early sites of paper manufacture, Fabriano in Italy, used fast-flowing mountain streams to power massive drop hammers. Once finally macerated, the cellulose from the cotton breaks free and floats in a kind of thick soup. The soup is then thinly poured and allowed to dry where the cellulose reforms as a strong, flexible mat.

50 Things that made the modern economy – Paper (BBC)

One of the very first things the Europeans did on this new, cheap material was carry out mathematical operations with the new Hindu/Arabic number system which was being imported the Arab world. This was popularized by one Leonardo Bonacci of Pisa, better known as Fibonacci:

Leonardo’s father, Guglielmo Bonacci, was a merchant looking after the Pisan interests in the Algerian port of Bejaia. While we might not imagine that medieval finance was very sophisticated, we would be wrong. The historian Alfred Crosby describes a series of transactions undertaken by an Italian merchant, Datini, which, although they took place two hundred years later, would have been similar to the types of transactions Guglielmo Bonacci would have been involved in…Datini would have engaged in forward contracts, loan agreements and transactions in at least five currencies (Arogonese, Pisan, Florentine, Venetian, North African). To make a profit, he needed to be an expert at ‘commercial arithmetic’, or financial mathematics.

Leonardo was born in Pisa around 1170 and educated, not only in Bejaia but, as far afield as, Egypt, Syria, Constantinople and Provence. He would write a number of books on mathematics, but his first and most influential was the Liber Abaci (‘Book of Calculation’), which appeared in 1202. The Liber was heavily influenced by the Arabic book ‘The Comprehensive Book on Calculation by Completion and Balancing’ written around 825 CE by al-Khwarizmi, who was himself motivated to write the book because

men constantly require in cases of inheritance, legacies, partition, law-suites and trade [a number]

and his book provided the easiest way of arriving at that number, using al-gabr (‘restoration’) and al-muqabala (‘balancing’). Fibonacci collated these Arabic techniques into a single textbook for merchants…facing the increasingly complex financial instruments and transactions emerging at the time.

The impact of the Liber Abaci was enormous. Fibonacci became an adviser to the most powerful monarch of the time, Frederick II, Holy Roman Emperor and King of Sicily. More significant, Abaco or rekoning [sic] schools sprang up throughout Europe teaching apprentice merchants how to perform the various complex calculations needed to conduct their business. [Luca] Pacioli, who taught Leonardo da Vinci maths, was a well known graduate. Less well known is the fact that Copernicus came from a merchant family and in 1526, seventeen years before his more famous, “epoch-making” ‘On the Revolutions of the Heavenly Spheres’, he wrote ‘On the Minting of Coin’ about finance.

The practical usefulness of the reckoning schools was that, by using positional numbers and algebra, merchants could execute complex financial calculations that would typically include an illicit interest charge, hidden from the mathematically unsophisticated, university based, Church scholars. The merchant bankers were using mathematics to keep one step ahead of the regulator and the effectiveness of the non-university mathematics would not have been lost on the sharper scholastics, observing market practice.

Who was the first Quant? (Magic, Maths and Money)

It’s difficult to imagine the financial techniques noted above without the use of our arithmetic calculations being able to be carried out on cheap, accessible paper. These two inventions—paper and base-ten positional notation, were to be fused into the invention that made modern accounting possible: double-entry bookkeeping. This allowed accounts to once again be free of cumbersome gold and silver, or even hazelwood tally sticks.

You’re a medieval businessman — trading wool, pepper, cloth. Money is owed you, you have debts, and it all needs to be recorded. But there’s a problem. You track it with a diary, using Roman numerals. For arithmetic you have only some finger-counting methods. Your records would curl a modern accountant’s hair.

Alfred Crosby writes about an explosion of trade in the High Middle Ages. No longer was European trade a mere matter among farmers and villagers. By 1400, after the Plague, Europe was enormously capital-intensive — its ships moved goods internationally. None of that could happen without bringing money under control.

And so there developed, according to one historian, an atmosphere of calculation. Scholars were learning the new mathematics of algebra — that game where quantities are balanced across an equal sign — where quantities are positive on one side and negative on the other.

So Crosby goes looking for the invention of the new algebra of record keeping — the method called double-entry bookkeeping, where we list debits on one side and credits on the other. It’s the method marked by the absolute requirement that those two columns sum to zero. It’s the basis for tracking all our vast financial affairs today. He finds that, in 1300, a Florentine bookkeeper began listing debits and receipts in different ledgers. In 1340, an accountant from Genoa listed payouts and receipts on the left and right sides of a single page. For two centuries, the method slowly evolved.

No. 1229: DOUBLE-ENTRY BOOKKEEPING (Engines of Our Ingenuity)

Economic historians can pinpoint roughly when this occurred by using the record books of Francesco Datini, which survive to the present day. Datini’s books show the process of changing over from a diary to a sophisticated accounting of inputs and outputs, escribed on paper:

Datini’s meticulously kept account books span almost fifty years and clearly show the transition from single-entry to double-entry bookkeeping. His surviving ledgers from 1367 to 1372 do not use the double-entry system, while those from 1390 onward do.

Datini was innovative not just in his early adoption of the new style of bookkeeping; when in 1398 he and a partner opened a bank in Florence, they accepted a new form of payment only just coming into Europe: cheques. Like many business practices new to medieval Europe, the cheque had long been used by Arab merchants, who gave us the English word ‘cheque’. As early as the ninth century a Muslim merchant could cash a cheque in China drawn on his bank in Baghdad.

Datini also dealt in bills of exchange, which were notes for the exchange at a future date of florins for one of the many different currencies circulating in Europe at this time, when every city minted its own coins. These bills first appeared in Europe in the twelfth century and became a powerful new financing tool. In Datini’s day, charging interest on a loan at a fixed rate was outlawed by the Church, which deemed it usurious (demanding interest rates on loans was no permitted anywhere in Europe until 1545, when Henry VIII legalised it in England.) Bills of exchange became popular because, while they attracted a profit, the eluded the Church’s ban on usury.

Paradoxically, their popularity rested on their unreliability. Bills of exchange were effectively gambles on exchange-rate variations, and the chance of making a profit from them was so uncertain, so precarious, that the Church did not recognize their profits as interest and therefore allowed their use.

Datini was one of the new breed of Italian international merchant bankers who in the fourteenth century created vast trading empires and networks of credit from London to Constantinople. In the next century these Italian international merchant bankers, most notably the Medici of Florence, would use their immense wealth to commission works of architecture, art and scholarship–and effectively finance the Renaissance. [2]

It was in Venice that Arabic numerals and double-entry bookkeeping first became commonplace, hence this method came to be known throughout Europe as the “Venetian method” of finance:

…By the 1430s the merchants of Venice had perfected a system of double-entry account keeping in two columns which became known as bookkeeping el modo de vinegia or alla viniziana: the Venetian method. It is this Venetian method that, through its extraordinary resilience and mutability, has come down to us today, transformed over several centuries from a rudimentary business tool into an efficient calculating machine. [3]

This system was popularized and spread by Renaissance Man Luca Pacioli, a close friend and confidant of Leonardo da Vinci.

The man responsible for its codification and preservation–the author of the world’s first printed bookkeeping treatise–is Luca Bartolomeo de Pacioli, Renaissance mathematician, monk, magician, constant companion of Leonardo da Vinci. As the origin of all subsequent bookkeeping treatises throughout Europe, Luca Pacioli’s bookkeeping tract is not only the source of modern accounting but also ensured the medieval Venetian method survived into our own times. And so accountants have named Luca Pacioli the ‘father of accounting’…[4]

While this was the beginning of the sophisticated use of double-entry bookkeeping in Europe using ledgers and Arabic numerals, the concept goes back a long way:

Double entry is used because of the basic fact that every movement of value has two aspects, and both should be recorded in a proper set of accounts. For the giver of value the transaction is a credit, for by giving value he has earned a credit, he is owed the equivalent. For the receiver the transaction is a debit, because he is a debtor for the value.

The basic rules of double-entry bookkeeping are as follows:
1) debit value in, credit value out;
2) debit receipts, credit payments;
3) debit assets, credit liabilities;
4) debit losses, credit profits.

Every transaction has to be recorded twice, or a multiple of twice, in any set of accounts, each as a debit and as a credit. There are no exemptions to this rule. The need to record things twice seems to have occurred to those responsible for accounts at least 4,000 years ago. When a sheep was due to the temple from a peasant, the temple would record the sheep as owed by the peasant, and list it as a part of the income of the temple. When the sheep actually appeared, the peasant’s record would be credited, the debt wiped out, and the temple would add the sheep to the list of the sheep it owned.

The accounts of that era went no further along the road of developing the full sophistication of a modern accounting system, but, as has been mentioned earlier, the basic element of a double record seems to have been there. [5]

These techniques were deployed by Italian bankers all across the continent, and it’s no coincidence that most financial centers in Europe such as London have a “Lombard Street” in their financial district even today.

Finance and Science

According to Tim Johnson, the sophisticated mathematical techniques engendered by finance at this time pushed forward the development of mathematics in Northern Europe, and eventually led to the scientific revolution.

Fibonacci’s mathematics revolutionised European commercial practice. Prior to the Liber Abaci, merchants would perform a calculation, using an abacus, and then record the result. The introduction of Hindu/Arabic numbers in the Liber enabled merchants to “show their working” as an algorithm, and these algorithms could be discussed and improved upon. Essentially after Fibonacci mathematics ceased to be simply a technique of calculation but became a rhetorical device, a language of debate.

Lady Credit (Magic, Maths and Money)

Financial techniques had to be sophisticated, due to not only the church’s ban on usury but also the multitude of shifting currencies all over Western Europe. As Johnson notes, many of the mathematicians who made great strides in mathematics and physics at this time came out of the financial system. Leonardo of Pisa’s treatise on math was explicitly described as helping merchants and traders carry out business transactions. Many advancements were attempts at calculating probabilities.

The most influential single Abaco graduate has to be the Dutchman, Simon Stevin. Stevin, who was born in 1548 in Bruges, had originally worked as a merchant’s clerk in Antwerp then as a tax official back back in Bruges, where he wrote his first book Tafelen van Interest (‘Tables of interest’) which he published in 1582, before moving to the University of Leiden in 1583. About this time, he was appointed as adviser to Prince Mauritz of Nassau, who was leading the Dutch revolt against the Spanish, and eventually became the Dutch Republic’s Finance Minister.

As well as being active in government, Stevin carried out scientific experiments, and it is believed his bookeeping [sic] inspired his physics. His most famous experiment showed that heavy and light objects fell to the earth, in the absence of air resistance, at the same speed, an experiment that disproved a belief of Aristotle and is usually attributed to Galileo dropping things from the Tower at Pisa some years later.

One of Stevin’s most important posts was as the director of the Dutch Mathematical School, established in 1600 by Mauritz to train military engineers. In this capacity, in 1605, he published a textbook for the School, the ‘Mathematical Tradition’, which was a comprehensive overview of mathematics and included a whole section on ‘Accounting for Princes in the Italian manner’.

In a very short period, the Dutch Mathematical School became the centre for merchants’ training in north western Europe. This success, in turn, forced the authorities at the University of Leiden, which provided the School with its facilities, to take practical sciences, in particular maths, a bit more seriously. The Dutch Mathematical School would inspire the soldier Descartes to study maths and would train Huygens and a whole generation of European scientists.

In addition, it was Stevin’s promotion of the use of decimals, to aid accounting, that inspired Newton to think of functions as power-series, giving birth to the discipline of Analysis. Newton essentially finished his work in physics with the publication of Principia in 1687, his last significant work, Optiks, published in English in 1704, was based substantially on research undertaken in the early 1670s. After almost a decade of troubles, Newton moved into finance in April 1696 when he was appointed Warden of the Royal Mint. This was a largely ceremonial post, but Newton took to it so much that he became the Mint’s operational manager, its Master, in 1699.

Johnson attributes this to “reverse Quants”: instead of highly-trained mathematicians going to work in finance, at this time it financial mathematicians who went to work in academia. This allowed academia to push forward calculations that applied to the real world much further in Europe than elsewhere. Both Copernicus and Isaac Newton worked in the money system.

…the migration from academic careers in science to finance appear to be embedded, it is not a modern phenomena. However, possibly more significant is the less well-appreciated role of the ‘reverse-quants’ in the development of science. The influence is captured by events in France in 1304-1305 when economic instability and a market failure led the French King, Philip the Fair, to issue decrees fixing the price of bread. His decrees failed spectacularly, and this was seen by contemporary observers as evidence that ‘nature’ ruled, and not the authority of the King, and that market prices where an objective, ‘scientific’ measure. This enabled the likes of [Thomas] Bradwardine to re-assess the role of mathematics in science. Later, people trained in commercial arithmetic – financial mathematics – such as Copernicus and Stevin, were able to challenge the authority of Aristotelian science, and argue that the Earth revolved around the Sun and that heavy and light objects fall at the same speed.

We saw this before, when the use of money spurred the ideas of Greek science and philosophy–the idea of an unlimited, underlying substance underpinning all phenomena. He concludes:

European science did not start in the Renaissance, it existed in the High Middle Ages. The ‘renaissance’ of the ‘long twelfth century’ resulted in what the historian Joel Kaye describes as the transformation of the conceptual model of the natural world ,…, [which] was strongly influenced by the rapid monetisation of European society taking place [between 1260-1380]. and played a pivotal role in the development of European science. Thirteenth century scholars [were] more intent on examining how the system of exchange actually functioned than how it ought to function..

Who was the first Quant? (Magic, Maths and Money)

Some Debt Becomes Money

Alfred Mitchell-Innes described the “primitive law of commerce” as the exchange of a commodity for a credit. It was this that was at the heart of the private money creation scheme developed by Italian bankers. Debts and credits would always match up, meaning that theoretically the amount of money circulating would always equal the value of goods in transit.

It has been observed time and time again in the last 400 years that banks can create credit very freely, because they know that the drawing down of a loan automatically creates the deposit which balances the lending. When a bank has agreed to lend, the moment that the loan is drawn down by the payment of a cheque drawn upon it, a deposit to match it is also created at the receiving bank. Therefore the moment a borrowing takes effect, the saving to match it must arise as well. Even if the borrowing is to finance a capital project, the saving to match that capital investment must come into being automatically the moment the loan is drawn down to make a payment. As all money is effectively transferable debt, then money can be created by creating debt. Once it is realised that all money is some form of debt, it becomes obvious that money can only be created by creating debts…[6]

In the aggregate the accounts of banks are always in balance. So in theory a bank can grant unlimited loans in the knowledge that the amount lent will always appear somewhere as a deposit to balance the lending. The snag for the bank granting the loan would seem to be that the deposit might be made in another bank. Actually this is no problem at all. If one bank has a loan not backed by a deposit, another bank will have a deposit which is unlent. The two have to meet up; the bank with the excess lending will borrow, directly or indirectly, the excess deposit from the other bank….’A banker is one who centralises the debts of mankind and cancels them against one another. Banks are the clearing houses of commerce.’ To put it in the simple words of the treasurer of a large modern bank, ‘If we are short, we know the money has to be somewhere. Our only problem is to find it, and pay the price asked for it.'[7]

Felix Martin describes the basics of this system:

The system was simple. An Italian merchant wishing to import goods from a supplier in the Low Countries could purchase a credit note known as a bill of exchange from one of the great Florentine merchant houses. He might pay for this note either in the local sovereign money or on credit.

By buying such a bill of exchange, the Italian merchant achieved two things. First, he accessed the miracle of banking: he transformed an IOU backed by only his own puny word for one issued by a larger, more creditworthy house, which would be accepted across Europe. He transformed his private credit into money.

His second achievement was to exchange a credit for a certain amount of Florentine money into one for a certain amount of the money of the Low Countries where he was making his purchase. [8]

The bill of exchange itself was denominated in a private monetary unit created specially for the purpose by the network of exchange bankers: the ecu de marc. There were no sovereign coins denominated in this ecu de marc. It was a private monetary standard of the exchange-bankers alone, created so that they could haggle with one another over the value of the various sovereign moneys of the continent. Somewhat bizarrely to modem eyes, the foreign exchange transaction included in the bill of exchange therefore involved two exchange rates-one between Florentine money and the ecu de marc, the other between the ecu de marc and the money of the Low Countries…

The end result was to overcome a previously insurmountable series of obstacles. The exchange-banker would accept the importer’s credit in payment, knowing him and his business well from the local market. Meanwhile, the supplier in the Low Countries would accept the exchange-banker’s credit as payment, knowing that it would be good in its tum to settle either a bill for imports or for some local transaction-and satisfied that he was being paid in the local money.

Of course, the banker ran the risk that the exchange rates of the two sovereign moneys against the imaginary ecu de marc might change in between his issuing the bill of exchange and its being cashed in the Low Countries, but he made sure that his fees and commissions made this a risk worth taking. [9]

This wasn’t a sideshow: vast amounts of trade were conducted all over the continent using this method. This puts a wrinkle in the whole “money is gold” approach. With the bills of exchange we see that, fundamentally, money is credit and it always had been. From the stone money of Yap, to the tally sticks of Europe, we see that:

Money, then, is credit and nothing but credit. A’s money is B’s debt to him, and when B pays his debt, A’s money disappears. This is the whole theory of money: Debts and credits are perpetually trying to get into touch with one another, so that they may be written off against each other, and it is the business of the banker to bring them together. [10]

This is the essence of banking. As Felix Martin notes, “Strip away all the mystery of banking, and what are left with is an institution that matched debts and credits. It makes money by one of two ways: by discounting bills and by issuing loans.”

Here’s Alfred Mitchell-Innes description of the process of discounting bills of exchange. You might have to reread this a number of times in order to “get it”; I know I did! But once you do, you’ll see that it’s clear that this is the underlying process behind money and banking, and not storing or exchanging gold and silver:

The process of discounting bills is as follows: A sells goods to B, C and D, who thereby become A’s debtors and give him their acknowledgments of indebtedness, which are technically called bills of exchange, or more shortly bills. That is to say A acquires a credit on B, C and D.

A buys goods from E, F and G and gives his bill to each in payment. That is to say E, F and G have acquired credits on A. If B, C and D could sell goods to E, F and G and take in payment the bills given by A, they could then present these bills to A and by so doing release themselves from their debt. So long as trade takes place in a small circle, say in one village or in a small group of near-by villages, B, C and D might be able to get hold of the bills in the possession of E, F and G.

But as soon as commerce widened out, and the various debtors and creditors lived far apart and were unacquainted with one another, it is obvious that without some system of centralizing debts and credits commerce would not go on. Then arose the merchant or banker, the latter being merely a more specialized variety of the former.

The banker buys from A the bills held by him on B, C and D, and A now becomes the creditor of the banker, the latter in his turn becoming the creditor of B, C and D. A’s credit on the banker is called his deposit and he is called a depositor. E, F and G also sell to the banker the bills which they hold on A, and when they become due the banker debits A with the amount thus cancelling his former credit. A’s debts and credits have been “cleared,” and his name drops out, leaving B, C and D as debtors to the bank and E, F and G as the corresponding creditors.

Meanwhile B, C and D have been doing business and in payment of sales which they have made, they receive bills on H, I and K. When their original bills held by the banker become due, they sell to him the bills which H, I and K have given them, and which balance their debt. Thus their debts and credits are “cleared” in their turn, and their names drop out, leaving H, I and K as debtors and E, F and G as creditors of the bank and so on.

The modern bill is the lineal descendant of the medieval tally, and the more ancient Babylonian clay tablet…[11]

Loans are simply a variation on the same process, except they anticipate future sales:

Now let us see how the same result is reached by means of a loan instead of by taking the purchaser’s bill and selling it to the banker. In this case the banking operation, instead of following the sale and purchase, anticipates it. B, C and D before buying the goods they require make an agreement with the-banker by which he undertakes to become the debtor of A in their place, while they at the same time agree to become the debtors of the banker: Having made this agreement B, C and D make their purchases from A and instead of giving him their bills which he sells to the banker, they give him a bill direct on the banker. These bills of exchange on a banker are called cheques or drafts.

If this is familiar, it should be. As far back as the ancient Near East, promissory notes promised not to pay a specific person, but the bearer of the financial instrument (usually a stone tablet). This meant that liabilities could be transferred, and the stone tablet became a kind of proto-money, without the need of any sort of circulating medium like coins. As long as there was a unit of account, an agreement, and away for debts and credits to pair up, commerce could take place. The antecedent to the Bill of Exchange already existed in Babylon in 2500 B.C.:

The lending system of ancient Babylon was evidently quite sophisticated. Debts were transferable, hence ‘pay the bearer’ rather than a named creditor. Clay receipts or drafts were issued to those who deposited grain or other commodities at royal palaces or temples. Borrowers were expected to pay interest (a concept which was probably derived from the natural increase of a herd of livestock), at rates that were often as high as 20 percent. Mathematical exercises from the reign of Hammurabi (1792-1750 BC) suggest that something like compound interest could be charged on long-term loans…

It would not be quite correct to say that credit was invented in ancient Mesopotamia. Most Babylonian loans were simple advances from royal or religious storehouses. Credit was not being created in the modern sense…Nevertheless, this was an important beginning. Without the foundation of borrowing and lending, the economic history of our world would scarcely have got off the ground. And without the ever-growing network of relationships between creditors and debtors, today’s global economy would grind to a halt…[13]

As Geoffrey Gardiner notes, “If an obligation is assignable, it can be used both as a medium of exchange and as a store of value. If the obligation is not only assignable but is expressed in terms of the standard measure of value, it can properly be regarded as money…by nature all money is assignable debt. A pound note is theoretically a debt of the Bank of England. A bank deposit is a debt of the bank. A holding of gold is a portable form of debt.” [12] In fact, he argues that monetization of trade credit was the primary form of money since the very beginnings of civilization, a role that has been tragically ignored by conventional economists due to their focus on precious metals:

The process of converting a debt into a means of exchange can be called ‘monetising debts.’ If one looks at the history of economics one can surely see that the monetising of debts, usually trade debts, has been the most important process, the most important invention, in the history of commerce, ever since differentiation of labour first took place sometime in prehistory. One must agree with Mitchell Innes that gold and silver were not the essentials of a money system. That role was fulfilled by the documentary credit which originated in trade credit [14]

The petty loan sharks and money changers like the Medici scaled up to become rich and influential banking houses by using the power of the Venetian method and bills of exchange to underwrite international commerce.

In 1385 Giovanni [De Medici] became manager of the Roman branch of the bank run by his relation Vieri di Cambio de’ Medici, a moneylender in Florence. In Rome, Giovanni built up his reputation as a currency trader. The papacy was in many ways the ideal client, given the number of different currencies flowing in and out of the Vatican’s coffers. As we have seen, this was an age of multiple systems of coinage, some gold, some silver, some base metal, so that any long-distance trade or tax payment was complicated by the need to convert from one currency to another…

Of particular importance in the Medici’s early business were the bills of exchange (cambium per literas) that had developed in the course of the Middle Ages as a way of financing trade. If one merchant owed another a sum that could not be paid in cash until the conclusion of a transaction some months hence, the creditor could draw a bill on the debtor and either use the bill as a means of payment in its own right or obtain cash for it at a discount from a banker willing to act as broker.

Whereas the charging of interest was condemned as usury by the Church, there was nothing to prevent a shrewd trader making profits on such transactions. That was the essence of the Medici business. There were no cheques; instructions were given orally and written in the bank’s books. There was no interest; depositors were given discrezione (in proportion to the annual profits of the firm) to compensate them for risking their money. [15]

Though others had tried before them, the Medici were the first bankers to make the transition from financial success to hereditary status and power. They achieved this by learning a crucial lesson: in finance small is seldom beautiful. By making their bank bigger and more diversified than any previous financial institution, they found a way of spreading their risks. And by engaging in currency trading as well as lending, they reduced their vulnerability to defaults. [16]

In time, bills of exchange became disconnected from the initial issuer and the connection to specific goods. allowing it to circulate as proto-money. What really made bills of exchange into money was a change in the law allowing for its transferability. The Joint Liability Rule meant that the bill would always find someone willing to cover its liability, preventing the bills from becoming worthless. Bills began to spread beyond just the bilateral transactions mediated by merchant bankers thanks to the Joint Liability Rule:

“The term Bill of Exchange (BofE) refers to a financial instrument whereby a merchant (the issuer) ordered his agent abroad (the payer) to make a payment in a different currency on his behalf to another merchant (the beneficiary), often in a third location, at a set date in the future. The beneficiary could further transfer his claim to another party, an endorser, in exchange for currency, debt or merchandise.

…a seventeenth century legal innovation, the Joint Liability Rule (JLR), enabled the medieval BofE to develop into the dominant means of payment and credit in the early modern period. The JLR specified that in case of default, all endorsers, in addition to the issuer and payer, could be held legally liable for reimbursement. Through the endorsement on the back of the bill, each successive endorser not only surrendered his financial claim to the bill but also acknowledged his full liability for reimbursement in the event of default.

…the powerful mechanism of Joint Liability permitted merchants to conduct a larger volume of trade through BofE than would have been possible otherwise. My findings uncovered an European-wide and anonymous market for bills of exchange that provided liquidity and credit to a local merchant house. Bills originated and were settled in a geographic area that extended all over Europe, north of Africa, Ottoman Empire up to Syria, and the Caribbean Islands. Despite evidence of ongoing problems of adverse selection and moral hazard, I showed that bills worked to broaden trade in the sense that agents used them across business networks…

Bills of exchange displaced state currencies for the payment among the merchant classes. In essence, it was a competing currency system run through private banks, and one that posed a threat to state finance as more and more capital concentrated in the hands of the merchants.

My Fair Lady

In Babylonia, debt and credits were matched up by the temples. In Rome, they were matched up in the banks along the Via Sacra. In the Middle Ages, they were matched up at the great trade fairs.

Economic historians look at the great trade fairs of the middle ages which took place in the towns like Champagne, Lyon and Piacenza as the beginnings of capitalism. Goods were brought from all over the world and sold to a new class of wealthy townsfolk, i.e. the burghers or “bourgeoisie” who relied on money transactions rather than social relations to conduct their business affairs. And they were always looking to increase their money. In these “free towns,” the feudal system disintegrated, and social relations were coordinated by money and prices. Most medieval free cities had a market, a mint, and a fairground. They also had a class of money-changers who would eventually become merchant bankers.

The debts and credits were settled at the conto, which was held on the final day of the fairs:

As they continually wrote and accepted bills of exchange to finance trade between the great European cities, the exchange bankers would accumulate credit and debit balances.

The circle of exchange-bankers was a close-knit one, and willingness to allow outstanding balances to build up was therefore high. Nevertheless, to ensure a clear picture of who owed what to whom, it was necessary to have periodic offsets. These could be done bilaterally on an ad hoc basis; but the regular fairs provided a natural opportunity for a more generalised clearing-and this is precisely what they gradually became.

Every quarter, the clique of great merchant houses would meet at the central fair of Lyons in order to square their books. On the first two days of the fair there was a frenzy of buying and selling, of writing new bills or cancelling old ones, at the end of which all delegates’ books were closed for the quarter and the resulting balances between the houses were verified. The third day-the of Exchange” – was the heart of proceedings. The exclusive cadre of exchange-bankers would convene alone to agree on the conto: the schedule of exchange rates between the ecu de marc and the various sovereign moneys of Europe.

This schedule was the pivot of the entire financial system, since it was at these exchange rates that any outstanding balances had to be settled on the final day of the fair the “Day of Payments”-either by agreement to carry over balances to the next settlement date, or by payment in cash. [17]

In fact, it is sometimes argued that the primary purpose of the fairs was not buying and selling at all! Rather, periodic trade fairs originated as meeting places where debt and credits were assessed and settled. Over time, an ever-increasing trade in goods grew up around them, which eventually came to obscure the historical origins of the fairs.  In other words, the buying and selling was a peripheral development to the main activity of settling accounts. It was not gold or silver that was changing hands, so much as trade credits!

In these “economic zones” market exchanges prevailed, walled off by authorities through strict laws and regulations from the prevailing social forms of the countryside, which were more based in custom and tradition. Far from being “free trade,” such places were heavily regulated by authorities to ensure fair dealing.

Such concepts go back very far indeed, all the way back to the ritual temples and plazas of the Stone Age where suchexchanges took place. We’ve seen that feasting events were typically where the settling of debts and credits took place in pre-agricultural societies, for example the Sepik Coast Exchange in Papua New Guinea. In one memorable passage, Alfred Mitchell-Innes describes the role of fairs from ancient times in the development of money and commerce:

The clearing houses of old were the great periodical fairs, whither went merchants great and small, bringing with them their tallies, to settle their mutual debts and credits…The origin of the fairs…is lost in the mists of antiquity. Most of the charters of which we have record, granting to feudal lords the right to hold a fair, stipulate for the maintenance of the ancient customs of the fairs, thus showing that they dated from before the charter which merely legalized the position of the lord or granted him a monopoly. So important were these fairs that the person and property of merchants traveling to them was everywhere held sacred. During war, safe conducts were granted to them by the princes through whose territory they had to pass and severe punishment was inflicted for violence offered to them on the road.

It was a very general practice in drawing up contracts, to make debts payable at one or other of the fairs, and the general clearance at which the debts were paid was called the pagamentum. Nor was the custom of holding fairs confined to medieval Europe. They were held in ancient Greece under the name of panegyris and in Rome they were called nundinae, a name which in the middle ages was also frequently used. They are known to have been held in Mesopotamia and in India. In Mexico they are recorded by the historians of the conquest, and not many years ago at the fairs of Egypt, customs might have been seen which were known to Herodotus.

At some fairs no other business was done except the settlement of debts and credits, but in most a brisk retail trade was carried on. Little by little as governments developed their postal systems and powerful banking corporations grew up, the value of fairs as clearing houses dwindled, and they ceased to be frequented for that purpose, long remaining as nothing but festive gatherings until at last there linger but few, and those a mere shadow of their golden greatness.

The relation between religion and finance is significant…The fairs of Europe were held in front of the churches, and were called by the names of the Saints, on or around whose festival they were held. In Amsterdam the Bourse, was established in front of or, in bad weather, in one of the churches. They were a strange jumble, these old fairs, of finance and trading and religion and orgy…There is little doubt to my mind that the religious festival and the settlement of debts were the origin of all fairs and that the commerce which was there carried on was a later development. If this is true, the connection between religion and the payment of debts is an additional indication if any were needed, of the extreme antiquity of credit. [18]

The great French historian Fernand Braudel describes the role these fairs played in the Middle Ages in the transition from feudalism to capitalism:

the real business of the fairs, economically speaking, was the activity of the great merchant houses. They it was who perfected this instrument and made the fairs the meeting-place for large-scale trade. Did the fairs invent, or re-invent credit?…it is certainly the case that the fairs developed the use of credit… The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun: such were the miracles of scontro, compensation. A hundred thousand or so ‘ecus d’ or en or’  – that is real coins – might at the clearing-house of Lyons settle business worth millions; all the more so as a good part of the remaining debts would be settled either by a promise of payment on another exchange (a bill of exchange) or by carrying over payment until the next fair: this was the deposito which was usually paid for at 10% a year ‘(2,5% for three months). So the fair itself created credit.

If the fair is envisaged as a pyramid, the base consists of the many minor transactions in local goods, usually perishable and cheap, then one moves up towards the luxury goods, expensive and transported from far away: at the very top of the pyramid came the active money market without which business could not be done at all- or any rate not at the same pace. It does seem that the fairs were developing in such way as, on the whole, to concentrate on credit rather than commodities, on the tip of the pyramid rather than the base. [19]

This goes to our core point: money is transferable credit (or debt). Once these debits and credits could circulate, that is, pass from once person to another, then you’ve got money. Once again, money is a tool to discharge social obligations, in this case, it allowed merchants and creditors to settle their accounts with one other.

These fairs took place all over Europe, but typically one major “financial center” for these dominated, the location of which changed over time with the volume of trade. Eventually, as trade expanded, the fairs declined, replaced by permanent institutions located in the trading cities. The first place this happened was Amsterdam in the Netherlands. Amsterdam established a permanent merchant bank. It would later establish the first joint-stock companies and stock market as well (the Amsterdam Exchange).

The fairs were linked together, and communicated with each other. Whether handling goods or credit” they had been organized to make circulation easier…Goods, money and credit were caught up in this circular movement. Money was of course at the same time providing the energy for other, larger circuits and usually tended towards a central point, from which it would set off again. In the West, where a dear recovery began with the eleventh century, ‘ .. one centre finally came to dominate the European system of payments. In the thirteenth century it was the Champagne fairs…the system reconstituted itself as best it could around Geneva in the fifteenth century, then at Lyons; and as the sixteenth century drew to a close, around the Piacenza fairs, that is around Genoa. Nothing so much reveals the functions of these successive systems as the breaks marking the changeover from one to another.

After 1622 however, no single fair would ever constitute the obligatory centre of economic life, dominating the rest, For it was now that Amsterdam, which had never really been a city of fairs, began to assert itself, taking over the previous superiority of Antwerp: it was becoming organized as a permanent commercial and financial centre. The fortune of Amsterdam marks the decline if not of the commodity fairs of Europe, at any rate of the great credit fairs. The age of fairs had seen its best days. [20]

The place where payments cleared passed from itinerant bankers at fairs to the stately colonnaded buildings in classical style as commerce became ever-more important to the European economy. Once banks became essential to commerce, they eventually became essential to states to conduct their fiscal operations as well. The modern world begins when governments access the miracle of banking to fund their own operations, especially war funding. In so doing, they caused private banknotes to become “official” currencies, backed by the state’s debt.

This happened first in the Italian City-states immediately prior to the Renaissance during 1100-1400. These city states, run by merchants and bankers, turned to the burgeoning financial markets to fund their operations, especially wars—remember that soldiers are mainly professional mercenaries at this time, and not citizen-soldiers (which comes under Napoleon). So any aspiring empire needed money to pay for war and mercenaries.

The way their got it was to borrow from their wealthiest citizens. And in so doing, they created the notion of “national debt.” That’s what we’ll be looking at next time.

SOURCES:

[1] Wray; credit and state theory of Money, pp. 198-199

[2] Jane Gleeson-White; Double Entry: How the Merchants of Venice Created Modern Finance, pp.24-26

[3] Jane Gleeson-White; Double Entry: How the Merchants of Venice Created Modern Finance, pp.24-26

[4] Jane Gleeson-White; Double Entry: How the Merchants of Venice Created Modern Finance, pp. 27-28

[5] Wray; credit and state theory of Money, p. 134

[6] Wray; credit and state theory of Money, pp. 151-152

[7] Wray; credit and state theory of Money, pp. 136-137

[8] Felix Martin; Money: The Unauthorized Biography, p. 106

[9] Felix Martin; Money: The Unauthorized Biography, pp 106-107

[10] Wray; Credit and state theory of Money, pp. 239

[11] Wray; Credit and state theory of Money, pp. 45-46

[12] Wray; Credit and state theory of Money, p. 132

[13] Niall Ferguson; The Ascent of Money, p. 30-31

[14] Wray; Credit and state theory of Money, pp. 169-170

[15] Niall Ferguson; The Ascent of Money, p. 43

[16] Niall Ferguson; The Ascent of Money, pp. 47-48

[17] Felix Martin; Money: The Unauthorized Biography, p. 107

[18] Wray; Credit and state theory of Money, pp. 40-41

[19] Fernand Braudel; The Wheels of Commerce, pp. 90-91

[20] Fernand Braudel; The Wheels of Commerce, p. 92

The Origin of Money 7 – Medieval Money

The Great Recoinage

As this article notes, the Crisis of the Third Century caused a disruption in Rome’s internal trade network. The effect this had was a shrinking of markets and reversion to more locally-based economies as the Roman political system broke down. Although it recovered somewhat under Diocletian, the path toward the Middle Ages was being paved.

For many centuries after the fall of Rome, during the so-called “Dark Ages”, the use of money and markets all but disappeared along with the Roman state. This alone should be proof that these are not ‘natural’ phenomena separate from political governance, but rather enabled and fostered by them. If libertarians are correct, we would have expected money and trade to flourish in the absence of “oppressive” taxes and government regulations.

Instead, what happened was a collapse of local and international trade and a dramatic fall in living standards. People returned to subsistence farming, economies reverted to barter, advanced technology was lost (e.g. concrete, wheel-turned pottery), and the Roman patronage system mutated into feudalism, with the villas transitioning into the self-sufficient manors of medieval Manorialism:

Immediately after the fall of Rome in the middle of the fourth century AD, its money disappeared. From a narrowly economic standpoint, the demand for media of exchange and payment sharply contracted. Imperial trade and production diminished, and mercenary soldiers’ wages no longer needed to be paid. But most importantly, the fiscal flows that constituted the social and political relations of the Roman Empire ceased to exist.

This situation held particularly on the Celtic margins of the former empire, where coinage became redundant for two centuries after having been in continuous use for over five hundred years. As the archaeological finds of large ‘hoards’ of money imply, it was no longer routinely needed and, given the very small silver content of the coins of the late Roman empire, it is likely that they were literally dumped. The two basic functions of money as a unit of account and means of payment were unable to operate. The social and political system that was ‘accounted for’ by the abstract money of account no longer existed. [1]

During the Carolingian Renaissance after A.D. 800, there was a “great recoinage” of Europe as coins were introduced back into circulation by Charlemagne. What he did was to reintroduce the standard units of account–Pounds, shillings and pence (we’ll use English terms, but the French equivalents are livre, sous and deniers). Much like the Mesopotamians earlier, the unit of account was fixed against a weight of silver; one livre was equivalent to one pound of silver. What he did not do, however, was introduce a “standard” currency that was equivalent to these units.

Instead Charlemagne licensed out the exclusive right to mint coins and issue money to his vassals; one might call this an early form of “franchising.” The metallic content of the coins varied greatly , but what they were worth was dictated by the ruling body that issued them in reference to the standard. If the ruler said their coins were worth, say, 1/2 a livre, or one sous, then that’s what they were worth, and so on. What this meant was that, although the standard was consistent throughout the realm, the worth of the coins issued by various mints was all over the board:

…the use of a standard money of account across the Christian ecumene did indeed eventually provide the foundation for a trans-European market… three kinds of coin were struck, but with countless variations in weight and fineness – by scores of authorities in many hundreds of mints…These circulated freely across European Latin Christendom; and all were evaluated against a benchmark money of account…[2]

Once again, the standard units of account, as determined by governments, is what allowed market transactions to take place by fixing the prices of things against one another for taxation purposes:

Charlemagne reinvented the Roman empire in the West, and part of this process was the re-introduction of the Roman monetary system into an ‘un-monetised’ feudal economy where exchange was rare, that is one without currency circulating.

Because coin was scarce, Charlemagne’s bureaucrats specified the exchange rate between common goods and money in order that the taxpayers could pay there [sic] tax. If you were a small holder and had been assessed for one shilling tax, if you did not engage in the market economy you would not have a shilling, so the government told you a shilling equated to a cow.

This fixed the prices of cows, an unintended consequence, since Charlemagne’s bureaucrats probably couldn’t care less about what was happening in the market place. However the impact was enormous – there was no incentive to move goods from places of abundance to places of scarcity…

Lady Credit (Magic, Maths and Money)

A standard unit of account allowed for taxes to be assessed and market transactions to occur, but because there were so many different types of currencies circulating at so many different values, it became very hard for commerce to take place, especially between different political entities. In the old Roman Empire, the same coins were used throughout the empire. In the fractured and decentralized political landscape of post-collapse Europe, however, hundreds of coins circulated with different values, since there was no single, unified, political authority to guarantee their value:

The persistence of Charlemagne’s monetary units formed the basis for this extensive remonetisation, but it also gave rise to its chaotic practical organisation. Whereas the original introduction of money to Europe had taken place under the auspices of a unified Roman political authority, its reconstitution was the definition of piecemeal…[3]

Throughout the feudal period the right of coinage belonged not alone to the king but was also an appanage of feudal overlordship, so that in France there were beside the royal monies, eighty different coinages, issued by barons and ecclesiastics, each entirely independent of the other, and differing as to weights, denominations, alloys and types.

There were, at the same time, more than twenty different monetary systems. Each system had as its unit the livre, with its subdivisions, the sol and the denier, but the value of the livre varied in different parts of the country and each different livre had its distinguishing title, such as livre parisis, livre tournois, livre estevenante, etc.[4]

What a mess! This meant in practice that people a hard time knowing what their money was “really” worth at any given point in time. It made money exchanges and market transactions very difficult.

Now, there are a few crucial concepts you need to understand in order to understand the history of money at this time.

The first thing to understand is this: coins have both an exchange value and a commodity value. Normally the exchange value is greater than the commodity value. The difference in these two is called seignorage. Because sovereigns had the exclusive right to issue coins, the difference between these two values was major source of revenue for medieval monarchs:

Seigniorage, also spelled seignorage or seigneurage (from Old French seigneuriage “right of the lord (seigneur) to mint money”), is the difference between the value of money and the cost to produce and distribute it. Seigniorage derived from specie—metal coins—is a tax, added to the total price of a coin (metal content and production costs), that a customer of the mint had to pay to the mint, and that was sent to the sovereign of the political area.

Seigniorage (Wikipedia)

The coin is a token with its exchange value set by fiat. It’s value comes from it’s ability to pay taxes to the government. The commodity value, by contrast, is set by the market for that particular commodity (gold, silver, copper, bronze, nickel, etc.):

Coins did have a metal value, since they could theoretically be converted into bullion, which had its own price, albeit at some cost. But they also had a coin value, which was simply the value dictated by the sovereign, since coins could be used to pay taxes.

The metal value and the coin value were related, but they were related in the sense that the value of a currency today is related to the economic fundamentals of the country that issues it. That is, the relationship between metal value and coin value was managed by the government using a variety of policy instruments. One of those was setting the number of coins that would be minted from a given quantity of metal (and the number of those coins that would be skimmed off the top for the sovereign).

Mysteries of Money (The Baseline Scenario)

In other words, coins were a fiat currency! The sovereign reserved the right to dictate what the coins were worth. For example, In Renaissance England:

A central principle of late medieval English law, enshrined in the early 17th-century Case of Mixed Money, was that the sovereign had the absolute right to dictate the value of money:

“the king by his prerogative may make money of what matter and form he pleaseth, and establish the standard of it, so may he change his money in substance and impression, and enhance or debase the value of it, or entirely decry and annul it . . .”

If Queen Elizabeth said that worn, clipped coins had the same value as brand-new coins from the mint, even if the former had only half the silver content of the latter, then they had the same value. She could say that because the value of pieces of metal depends on what you can use them for, and so long as you (or someone else) can use them to pay debts and taxes, they have value.

Mysteries of Money (The Baseline Scenario)

The second thing to understand about this period is that the circulating media of exchange did not match the units of account. Think of a dollar or Euro coin (which Europe commonly uses). It has “one dollar” or “one Euro” inscribed on it. It is always worth one Euro. Devaluing the currency means devaluing the coin.

Medieval money, by contrast, did not have a face value written on it. Rather, what the coin was worth according to the standard units of account (pounds, shillings, pence) was determined and published by the state. So you could use pretty much whatever coins you wanted to pay for stuff, as long as the published values added up to the total.

People used all sorts of coins to settle accounts, and coins were constantly being evaluated against one another. Much of the faith in currency was determined by the finances of the issuing state. If their finances were not sound (or if they were in danger of being invaded or overthrown), then their currency wasn’t worth very much. Coins’ value wasn’t determined primarily by their metal content, although coins with more precious metal might retain more value just because the bullion in them was worth something.

The biggest difference is that in the medieval age, base money did not have numbers on it. Specifically, if you look at an old coin you might see a number in the monarch’s name (say Henry the VIII) or the date which it was minted, but there are no digits on either the coin’s face or obverse side indicating how many pounds or shillings that coin is worth. Without denominations, members of a certain coin type could only be identified by their unique size, metal content, and design, with each type being known in common speech by its nickname, like testoon, penny, crown, guinea, or groat. Odd, right?

By contrast, today we put numbers directly on base money. Take the Harriett Tubman note, for example, which has “$20” printed on it or the Canadian loonie which has “1 dollar” etched on one side.

…Back then, sticker prices and debts were not expressed in terms of coins (say groats or testoons) but were always advertised in the abstract unit of account, pounds (£), where a pound was divisible into 20 shillings (s) and each shilling into 12 pence (d). Say that Joe wants to settle a debt with Æthelred for £2 10s (or 2.5 pounds). In our modern monetary system, it would be simple to do this deal. Hand over two coins with “1 pound” inscribed on it and ten coins with “one shilling” on them. Without numbers on coins, however, how would Joe and Æthelred have known how many coins would do the trick?

To solve this problem, Joe and Æthelred would have simply referred to royal proclamation that sets how many coins of each type comprised a pound and a shilling. Say Joe has a handful of groats and testoons. If the king or queen has proclaimed that the official rate is thirty testoons to the pound and eighty groats in a pound, then Joe can settle the £2 10s debt with 60 testoons and 40 groats or any another combination, say 75 testoons. If the monarch were to issue a new proclamation that changes this rating, say a pound now contains forty testoons, then Joe’s debt to Æthelred must be settled with 100 testoons, not 75.

What makes medieval money different from modern money? (Moneyness)

The third major thing to understand is that medieval rulers used their power to dictate the value of currency to raise revenue when they needed to. This served as a proxy form of taxation. In fact, it was the major way the governments of the period raised revenue, since actual tax collection was costly and inefficient in this period as we saw above.

When the state’s coffers were bare, due to the need to pay mercenaries and wage war, or just due to the profligacy of the royal household, then the amount of revenue needed to be increased.

The way they did this was simple. The rulers simply declared that the coins were worth less according to the monetary standard than they were before. In other words, the coinage had been “cried down,” or, conversely, the monetary standard had been “cried up.”

…In an age when the imposition of direct taxes remained a logistical and economic challenge…the levying of seigniorage by the manipulation of the monetary standard represented an invaluable source of revenue. An important feature of the monetary technology of the day made this simple to do.

The dominant technology for representing money was coinage, with silver the metal of choice for higher-value coins, and bronze or other less valuable metals and alloys for smaller denominations. But unlike today’s coins, medieval types were typically struck without any written indication of their nominal value: there was no number stamped on either face-only the face or arms of the issuing sovereign or some other identifying design. The value of the coins was then fixed by edicts published by the sovereign on whose political authority they were minted.

This system had a great advantage for the sovereign. Simply by reducing the tariffed, nominal value of a coin, the sovereign could effectively impose a one-off wealth tax on all holders of coined money.

A certain coin, the sovereign would announce, is no longer good for one shilling, but only for sixpence. The coin had been “cried down”; or equivalently, one could say that the standard had been “cried up.” An offer might then be made to recoin the cried-down issue, upon presentation at the Mint, into a new type. The sovereign could then in addition levy a charge on the re-minting operation.[5]

So, in this situation, issuing coins, and then adjusting the value became the major way for medieval sovereigns to raise revenue, rather than taxation or borrowing. This was a separate phenomenon apart from the precious metal content the coins, which continued to be variable:

Under these circumstances, it is most unlikely that any metallic coin could have served as the standard, monetary policy did not primarily involve manipulation of the metallic content of coins. Rather, it entailed devaluation and revaluation of the money by ‘crying up’ and ‘crying down’ the money of account.

… Medieval sovereigns had few ways of raising revenue apart from the proceeds of their personal domains: levying direct or indirect taxes was far beyond most feudal administrative capabilities. Seigniorage was therefore a uniquely attractive and uniquely feasible source of income-and medieval sovereigns happily indulged in it…when the need arose, a sovereign could raise enormous sums by crying down or even demonetising altogether the current issue of the coinage and calling it in for re-minting off a debased footing.

In 1299, for example, the total revenues of the French crown amounted to just under £2. million: of this, fully one half had come from the seigniorage profits of the Mint following a debasement and general recoining. Two generations later, the recoinage of 1349 generated nearly three-quarters of all revenues collected that year by the king…[6]

Seignorage–the profits made by issuing money–was a major source of revenue for medieval governments, who could not rely upon taxes or selling bonds. Increasing taxes or confiscating property was very unpopular, and could cause a revolt if done to heavy-handedly. And besides, tax collection was fraught with problems. For a good overview, see section II of this review of Seeing Like a State.

The absolute power of medieval monarchs discouraged people from lending to them. Plus, charging usury was forbidden. In fact, many loans to monarchs by major banks were simply annulled! The English king Edward III borrowed a huge sum of money from Italian banks to fund what became the Hundred Years’ War in France, only to default, taking down the banking houses (which paved the way for the rise of scrappy new upstarts like the Medici).

However, the precious metal in the coins did serve as a “floor” under which the coin’s value could not fall. That is, the commodity value served as collateral for the credit of the issuing sovereign. This meant that the coins were always worth something. This facilitated their use among the subjects.

It’s true that certain standards were set by the mint, but these were unrelated to the coin’s exchange value; rather these were mainly to prevent counterfeiting. They also did not affect prices.

It must be said, however, that there is evidence to show that the kings …were careful both of the weight and the purity of their coins, and this fact has given color to the theory that their value depended on their weight and purity.

We find, however, the same pride of accuracy with the Roman mints; and also in later days when the coinage was of base metal, the directions to the masters of the mints as to the weight, alloy and design were just as careful, although the value of the coin could not thereby be affected. Accuracy was important more to enable the public to distinguish between a true and a counterfeit coin than for any other reason. [7]

The problem is that the cost of buying precious metal fluctuates constantly, depending on the vagaries of supply and demand. For example, the vast amounts of New World silver flowing into Europe from the mines in Potosí in Bolivia (along with better mining technology) caused a drastic fall in the price of silver (excess supply), which made profits for coins high. This had macroeconomic effects throughout Europe—More coins were minted causing inflation (the so-called ‘Price revolution’). However, if the exchange value of the coin fell below the bullion value, there was a strong incentive to melt the coins down (or shave or clip them) and sell the precious metal abroad:

How Much Is A Nickel Worth?

It depends on whether you are talking about its use value or its exchange value. Normally, the exchange value of a good used as money is equal to or greater than its use value. If the value of the metal in a nickel is only worth 3 cents melted down and sold in metal markets, you are better off using it in exchange rather than using it as a commodity. But when the use value exceeds the exchange value, the commodity money will go out of circulation. The U.S. mint has issued new regulations in an attempt to prevent this from happening to pennies and nickels.

… Start with $50.00 and purchase 1,000 nickels. Next, sell the 1,000 nickels for their metal content at 7 cents per nickel and collect $70.00. Use the proceeds to buy 1,400 nickels, sell the 1,400 nickels for $90.80, and you’ve nearly doubled you money already.

It’s unlikely that you’d receive the full 7 cents per nickel, but even at, say, 6 cents per nickel (so that the value is $72.00 instead of $90.80 after two rounds) there’s a powerful incentive to smuggle nickels out of the country. And at 2.13 cents per pre-1982 penny, the incentive is even higher.

When the values are reversed, when the exchange value exceeds the use value, you’re not allowed to go in the opposite direction either. For example, you cannot take 3 cents worth of metal and mint your own counterfeit (“plug”) nickels and realize a 2 cent profit on each one. But when the economic incentive is high enough – e.g. turning paper into $20 bills – some people still try.

How Much is a Nickel Worth? (Economists View)

As Mitchell-Innes notes, if coins were just standardized lumps of precious metal issued merely for the convenience of traders, there would have been no need to force people to use them! People would simply exchange the coins for whatever the precious metal in them was worth.

There are only two things which we know for certain about the Carolingian coins. The first is that the coinage brought a profit to the issuer. When a king granted a charter to one of his vassals to mint coins, it is expressly stated that he is granted that right with the profits and emoluments arising therefrom.

The second thing is that there was considerable difficulty at different times in getting the public to accept the coins, and one of the kings devised a punishment to fit the crime of refusing one of his coins. The coin which had been refused was heated red-hot and pressed onto the forehead of the culprit, “the veins being uninjured so that the man shall not perish, but shall show his punishment to those who see him.”

There can be no profit from minting coins of their full face value in metal, but rather a loss, and it is impossible to think that such disagreeable punishments would have been necessary to force the public to accept such coins, so that it is practically certain that they must have been below their face value and therefore were tokens, just as were those of earlier days.[8]

In fact, it was often very difficult for monarchs to get their hands on enough silver to issue coins. This was another reason that market exchanges were rare in the early Middle Ages—there simply wasn’t enough money circulating! Often, the only way to get more silver was to issue coins with less silver, or to melt down and reissue existing coins with less silver. In fact, getting silver may have even been a motivating factor for the Crusades according to Niall Ferguson:

The Roman system of coinage outlived the Roman Empire itself. Prices were still being quoted in terms of silver denarii in the time of Charlemagne, king of the Franks from 768 to 814. The difficulty was that by the time Charlemagne was crowned Imperator Augustus in 800, there was a chronic shortage of silver in Western Europe.

Demand for money was greater in the much more developed commercial centres of the Islamic Empire that dominated the southern Mediterranean and the Near East, so that precious metal tended to drain away from backward Europe. So rare was the denarius in Charlemagne’s time that twenty-four of them sufficed to buy a Carolingian cow. In some parts of Europe, peppers and squirrel skins served as substitutes for currency; in others pecunia came to mean land rather than money.

This was a problem that Europeans sought to overcome in one of two ways. They could export labour and goods, exchanging slaves and timber for silver in Baghdad or for African gold in Cordoba and Cairo. Or they could plunder precious metal by making war on the Muslim world. The Crusades, like the conquests that followed, were as much about overcoming Europe’s monetary shortage as about converting heathens to Christianity.  [9]

This differential between the commodity value and the exchange value set by the sovereign was to have dramatic consequences.

Cry Me Up, Cry Me Down

By adjusting the value of the currency, the effect these edicts had was to raise prices. As Wikipedia puts it, “…By providing the government with increased purchasing power at the expense of the public’s purchasing power, [seignorage] imposes what is metaphorically known as an inflation tax on the public.” People going to the markets suddenly found that their coins were worth less, so producers demanded more of them.

In mediaeval society, currency depreciation would take place all at once, even in a single day. While historians and economists alike have long told stories about monarchs who purposely debased coins (by reducing gold content)…[i]nstead, nominal value was announced by the monarch and maintained at government pay offices. A coin’s nominal value in circulation would be determined by its value in acceptance of payments to government. When the monarch found he had already issued too much credit (such that he was unable to purchase desired goods and services), he would simply reduce the official value of the coins already issued (such that, say, two coins would have to be delivered at public pay offices rather than one).

By doing so, monarchs ‘reduced by so much the value of the credits on the government which the holders of the coins possessed. It was simply a rough and ready method of taxation, which, being spread over a large number of people, was not an unfair one, provided that it was not abused’.

In short, government ‘cried down’ the coins in place of raising tax rates, but in the process this would devalue the market value of the government’s debt – an overnight devaluation that would be manifested as soon as markets adjusted prices upward in terms of government coin. [10]

To help understand this concept, think of a casino. I turn in my hard-earned dollars and get tokens (chips) in exchange that I can use inside the “monetary space” of the casino. Let’s say each dollar gets me a nice plastic or clay chip.

I then go and gamble. In the meantime, the casino has declared that the chips (tokens) are now worth, say 3/4 of a dollar. So, let’s say at the end of a long night at the poker table you end up breaking even–you wind up with the same amount of chips you started with.

You then go to redeem your chips at the window at the end of the night only to find out that they can now only be redeemed for 3/4 the value you came in with–they are worth less. You are now 1/4 poorer, despite having not lost any chips! This should give you some idea of the effects that “crying down” the currency, or “crying up” the standard had in the real world.

Not only that, but the casino’s “debts” to you are simultaneously lowered. Recall that coins were a record of the sovereign’s debt to the holders of the coinage. Thus, by reducing the standard, sovereigns could also lower the debts and liabilities they owed to the holders of the currency, i.e. to the general public. This also had the effect of transferring resources from the subjects to the sovereign:

We can now understand the effect of the “mutations de la monnaie,” which I have mentioned as being one of the financial expedients of medieval French kings. The coins which they issued were tokens of indebtedness with which they made small payments, such as the daily wages of their soldiers and sailors. When they arbitrarily reduced the official value of their tokens, they reduced by so much the value of the credits on the government which the holders of the coins possessed. [11]

But because it was such an effective way of increasing revenue to the crown, it was abused. The temptation was always there when monarchs played fast and loose with their finances, or wanted to make war on their neighbors:

Some kings…whose constant wars kept their treasuries permanently depleted, were perpetually “crying down” the coinage, in this way and issuing new coins of different types, which in their turn were cried down, till the system became a serious abuse. Under these circumstances the coins had no stable value, and they were bought and sold at market prices which sometimes fluctuated daily, and generally with great frequency.

The coins were always issued at a nominal value in excess of their intrinsic value, and the amount of the excess constantly varied. The nominal value of the gold coins bore no fixed ratio to that of the silver coins, so that historians who have tried to calculate the ratio subsisting between gold and silver have. been led to surprising results…The fact is that the official values were purely arbitrary and had nothing to do with the intrinsic value of the coins. Indeed when the kings desired to reduce their coins to the least possible nominal value they issued edicts that they should only be taken at their bullion value.

At times there were so many edicts in force referring to changes in the value of the coins, that none but an expert could tell what the values of the various coins of different issues were, and they became a highly speculative commodity. The monetary units, the livre, sol and denier, are perfectly distinct from the coins and the variations in the value of the latter did not affect the former, though, as will be seen, the circumstances which led up to the abuse of the system of “mutations” caused the depreciation of the monetary unit. [12]

Given these factors, if much of your wealth were held in coin, would you be pissed off? My guess is that you would be. The thing is, so were the holders and users of medieval currencies.

But what this meant in practice was that no one was really sure of the value of their money at any given point in time. This meant in practice that much of the medieval economy remained effectively unmonetized.

Of course, it was those whose business required the use of money—people such as landlords and merchants– who were the most pissed off. Felix Martin calls them the “money interest.” As the medieval economy became increasingly centered around monetary exchanges, this money interest became more powerful, and more determined to rein in the rulers:

The remonetisation of Europe over the so-called “long thirteenth century,” from the late twelfth to the mid-fourteenth century therefore generated two phenomena that would eventually come into conflict.

The first was the emergence of a class of individuals and institutions whose wealth was held, and whose business transacted, in money-a politically powerful “money interest” beyond the sovereign’s court. The second was the growing addiction of sovereigns to the fiscal miracle of the seigniorage-a miracle which grew in proportion with the increasing use of money.

The more activities were monetarised, and the more people were drawn into the money economy, the larger the tax base on which seigniorage was levied. As sovereigns were to discover, this apparently magical source of fiscal financing did in fact have limits. They were not technical, however, but political. At some point, the new money interest was bound to assert itself against the sovereign’s perceived excesses. This point was reached in the mid-fourteenth century. [13]

Cat-and-Mouse Game

Now, recall once again that coins had a commodity value that set the floor under what they were worth. If the standard were cried down too far, the metal in the coins will be worth more than they are worth in exchange. The commodity value will exceed the exchange value.

What, then, would the sovereign do? The only answer was to issue coins with less precious metal in them, to make sure their commodity value remained under their exchange value. This is, a falling exchange value (or, conversely, a rising precious metal value) inevitably meant issuing coins with less precious metal content.

Naturally, this [seignorage] process was unpopular with users of the sovereigns coinage. Fortunately for them, there was one partial, natural defence. High-value coins-minted from silver, for example-had an intrinsic value regardless of the tariff assigned to them: the price at which their metal content could be sold on the open market to smiths and jewellers, or indeed to competing mints. They included, as it were, portable collateral for the sovereign’s promise to pay.

This meant that there was a lower limit to the tariffed value which the issuing sovereign could assign his coinage. If a coin was cried down too far, the collateral would be worth more than the credit the coin represented, and holders could sell it to a smith for its bullion value. On the other hand, the alert sovereign could respond by reducing the silver content of the new type when the coinage was re-minted-a so-called “debasement.”

It was a recipe for a constant game of cat-and-mouse between the coin-issuer and the coin-user, with even a coin’s precious-metal content, which effectively served as collateral for the creditworthiness of its issuer, always vulnerable to erosion by the predations of the sovereign. [14]

If the standard got too far out of whack, the coins would simply be melted down and shipped abroad. Because melting down coins was illegal, people simply tended to “clip” them, shaving a bit off at a time, and collecting the shavings. Sovereigns eventually responded by making coins with edges that were hard to clip. In any case, “bad” money tended to drive out “good” (Gresham’s Law).

The net effect was that if the standard fell too far, there would be a chronic shortage of precious metal circulating in the kingdom, since coins would be melted down and shipped abroad. This would reduce the amount of currency circulating, leading to deflation. Consequently, a fall in the price of silver might cause more coins to be minted, causing inflation. This fluctuation in the metal content of the coins caused by fluctuations in the standard and the price of bullion led to the misconception that “debasing” the currency by issuing less precious metal in them is what caused price movements.

Because heavily indebted states were perennially “crying down” the currency, this gave rise to the erroneous belief that the precious metal content was related to the value of the currency. States with debt problems issued coins with less precious metal in them. But the problem was fundamentally not with the precious metal, but with the state’s finances.

All our modern legislation fixing the price of gold is merely a survival of the late medieval theory that the disastrous variability of the monetary unit had some mysterious connection with the price of the precious metals, and that, if only that price could be controlled and made invariable, the monetary unit also would remain fixed. It is hard for us to realize the situation of those times. The people often saw the prices of the necessaries of life rise with great rapidity, so that from day to day no one knew what his income might be worth in commodities.

At the same time, they saw the precious metals rising, and coins made of a high grade of gold or silver going to a premium, while those that circulated at their former value were reduced in weight by clipping. They saw an evident connection between these phenomena, and very naturally attributed the fall in the value of money to the rise of the value of the metals and the consequent deplorable condition of the coinage. They mistook effect for cause, and we have inherited their error. Many attempts were made to regulate the price of the precious metals, but until the nineteenth century, always unsuccessfully.

The great cause of the monetary perturbations of the middle ages were not the rise of the price of the precious metals, but the fall of the value of the credit unit, owing to the ravages of war, pestilence and famine. We can hardly realize to-day the appalling condition to which these three causes reduced Europe time after time…[15]

As Innes notes, during times of pestilence, war and famine (such as the Crisis of the Late Middle Ages), governments went heavily into debt to fund wars and output production was curtailed. Coinage was debased and prices went up. But the ‘debasing’ of the coinage, i.e. issuing coins with less precious metal in them, was not the cause!

Since coins were a record of government’s debts to the public, the “trust” in coins tended to reflect the faith in the government issuing the coin. If a government were heavily indebted, it would likely cry up the standard, and/or remint the coins. Hence, the value of coins tended to reflect the fundamental financial soundness of the issuer –the currency of heavily indebted states was worth less.

…prices rose owing to the failure of consecutive governments throughout Europe, to observe the law of the equation of debts and credits. The value of the money unit fell owing to the constant excess of government indebtedness over the credits that could be squeezed by taxation out of a people impoverished by the ravages of war and the plagues and famines and murrains which afflicted them…

The depreciation of money in the middle ages was not due to the arbitrary debasement of the weight and fineness of the coins. On the contrary, the government of the middle ages struggled against this depreciation which was due to wars, pestilences and famines – in short to excessive indebtedness. Until modern days, there never was any fixed relationship between the monetary unit and the coinage.

We imagine that, by maintaining gold at a fixed price, we are keeping up the value of our monetary unit, while, in fact, we are doing just the contrary. The longer we maintain gold at its present price, while the metal continues to be as plentiful as it now is, the more we depreciate our money. [16]

Problems with Money

These problems with money led to several reactions. The “money interest” went to great lengths to dissuade the sovereign from exercising his or her seignorage power too liberally. In one case, they even got a prominent medieval scholar, Nicolas Oresme, to write an entire treatise on money.

Oresme’s argument basically boiled down to this–although the sovereign theoretically controlled the value of the currency, in a real sense, the currency “belonged” to the whole community. Thus, by abusing his power, the sovereign prevented orderly commerce from taking place, and caused harm to his subjects. In other words, he was derelict in his duties. It was an early case of the money interest attempting to assert its control over sovereign governments; a problem which continues to this day.

A second solution was to avoid coins altogether and use the older, more “primitive” technology of tally sticks instead.

Even in the heyday of coins, they were hardly the only form of money. For one thing, most everyday transactions were conducted using debt—what we would call trade credit, although it was used by consumers as well as businesses—because the smallest coin was simply too big to pay a day’s wages, let alone buy a beer, at least in England.

For another, as early as the 14th century, carved sticks of wood known as tallies were circulating as money. Tallies began as records of taxes collected, then became receipts the crown gave to tax collectors for advances of coin (the idea being that, at tax time, the collector could show the tally and say, “I already paid”), and finally evolved into tokens that the government used to pay its suppliers (who could then cash them with tax collectors, who would use them at tax time). In most of the 15th century, a majority of tax receipts came in the form of tallies rather than cash. Again, if the government is willing to take something in payment of taxes, it becomes money.

Mysteries of Money (The Baseline Scenario)

“Issuing a tally” became another critical way for medieval sovereigns to raise needed revenue, especially when silver was scarce.

Kings learned to ‘anticipate’ tax revenues by issuing tallies in payment (‘raising a tally’). Holders of the tally stocks were then entitled to collect tax revenue, turning over the stocks to those who paid taxes. These would then be returned to the King as evidence that taxes had been paid.

Both sovereign and private tallies began to circulate widely in Europe during the later middle ages, taking on the characteristics of negotiable and discountable financial instruments, and were increasingly used as the primary means of financing sovereign spending. [17]

The fact that wooden tally sticks have by-and-large not survived to the present day and coins have colors our understanding of money to this day. Clearly people were not exchanging tally sticks for the value of the wood in them.

The other way they got around the problems with sovereign money was to use trade credit instead. What merchants and bankers did was to conduct their business using sophisticated paper instruments called bills of exchange. These bills of exchange, mediated through the great trading houses of Europe, would allow international business to be conducted in this fractured monetary landscape. While they could be converted into the local government currencies, they were denominated in a totally different monetary unit established by the banks themselves called the ecú de marc.

…there was, by definition, no sovereign authority to regulate commerce between countries, and no sovereign money with which to transact. So it was here, in the international sphere, that banking’s potential to accelerate the commercial revolution was first fully realised. The central innovation was the perfection, by the mid-sixteenth century, of the system of “exchange by bills”: a procedure for financing international trade using monetary credit issued by the clique of pan-European merchant bankers, denominated in their own abstract unit of account, recorded in bills of exchange, and cleared at the quarterly fair of Lyons. [18]

The bill of exchange was invented in the Arabic world and probably introduced into Europe by the Knights Templar, making them Europe’s first exchange bankers. The Templars, a religious/military order, also acted as moneylenders and pawn brokers. The true “secret” of the Templars may be how they managed to accomplish this in an era long before mass communication, and the Templar “treasure” may have been the vast hoards of wealth they managed to accumulate through their international banking operations.

The Templars dedicated themselves to the defence of Christian pilgrims to Jerusalem. The city had been captured by the first crusade in 1099 and pilgrims began to stream in, travelling thousands of miles across Europe. Those pilgrims needed to somehow fund months of food and transport and accommodation, yet avoid carrying huge sums of cash around, because that would have made them a target for robbers.

Fortunately, the Templars had that covered. A pilgrim could leave his cash at Temple Church in London, and withdraw it in Jerusalem. Instead of carrying money, he would carry a letter of credit. The Knights Templar were the Western Union of the crusades. We don’t actually know how the Templars made this system work and protected themselves against fraud. Was there a secret code verifying the document and the traveller’s identity?

The Templars were not the first organisation in the world to provide such a service. Several centuries earlier, Tang dynasty China used “feiquan” – flying money – a two-part document allowing merchants to deposit profits in a regional office, and reclaim their cash back in the capital. But that system was operated by the government. Templars were much closer to a private bank – albeit one owned by the Pope, allied to kings and princes across Europe, and run by a partnership of monks sworn to poverty.

The Knights Templar did much more than transferring money across long distances…they provided a range of recognisably modern financial services. If you wanted to buy a nice island off the west coast of France – as King Henry III of England did in the 1200s with the island of Oleron, north-west of Bordeaux – the Templars could broker the deal. Henry III paid £200 a year for five years to the Temple in London, then when his men took possession of the island, the Templars made sure that the seller got paid. And in the 1200s, the Crown Jewels were kept at the Temple as security on a loan, the Templars operating as a very high-end pawn broker.

The warrior monks who invented banking (BBC)

The Templars were violently disbanded (on Friday the thirteenth, 1307), bringing their banking operations to a halt. In their place, “Lombard Banking” originating in Italian city-states like Venice, Florence and Genoa developed the bills of exchange into a private international currency system that existed alongside the coins and tallies issued by local governments. In the process, they became the world’s first modern banks.

The effects this had were profound. What it did was introduce a parallel international currency system which functioned alongside the coins issued by states, but remained outside of any government’s control. It’s this system we’ll take a look at next time.

[1] Wray: State and Credit Theories of Money, p. 189

[2] Wray: State and Credit Theories of Money, p. 191

[3] Felix Martin: Money, the Unauthorized Biography, p. 87

[4] Wray: State and Credit Theories of Money, p. 29

[5] Felix Martin: Money, the Unauthorized Biography, pp.87-88

[6] Felix Martin: Money, the Unauthorized Biography, pp. 88-89

[7] Wray: State and Credit Theories of Money, pp. 28-29

[8] Wray: State and Credit Theories of Money, p. 28

[9] Niall Ferguson: The Ascent of Money, pp. 24-25

[10] Wray: State and Credit Theories of Money, p. 220

[11] Wray: State and Credit Theories of Money, p. 42

[12] Wray: State and Credit Theories of Money, p. 30

[13] Felix Martin: Money, the Unauthorized Biography, p. 89

[14] Felix Martin: Money, the Unauthorized Biography, pp. 88-89

[15] Wray: State and Credit Theories of Money, p. 43

[16] Wray: State and Credit Theories of Money, p. 63

[17] Wray: State and Credit Theories of Money, p. 3

[18] Felix Martin: Money, the Unauthorized Biography, pp. 105-106

The Origin of Money – 5: Money and the Classical World

Depiction of ritual sacrifice from the Parthenon

The First Global Economy

During the Bronze Age trade expanded across the eastern Mediterranean to such an extent that that some historians refer to this as “The first age of globalization.” The ancient palace civilizations achieved maturity—Egyptians, Babylonians, Assyrians, Hittites, Mycenaeans, Persians, Canaanites, and many others developed vast and complex trade and exchange networks with neighboring cultures large and small. Cargo ships plied the seas, rivers and canals, transporting goods from as far afield as India and the British isles. Yet this was still accomplished not through monetary exchange networks or banks, but rather through gift exchange carried out primarily by ruling elites. Rulers attempted to cultivate artificial family ties with other rulers, or sometimes literal ones through intermarriage (the exception being Egypt, which never intermarried), as Eric Cline explains in 1177BC: The Year Civilization Collapsed:

[The Amarna letters]…provide us with insights into trading and international connections in the time of Amenhotep III and Akhenaten during the mid fourteenth century B.C. It is apparent that much of the contract involved “gift giving” conducted at the very highest levels–from one king to another.…Another royal letter, from Akhenaten to Burna-Buriash II, the Kassite king of Babylon, includes a detailed list of the gifts that he has sent…Similar detailed letters with comparable long lists of objects, sometimes sent as part of a dowry accompanying a daughter and sometimes just sent as gifts, come from other kings…We should also note that the “messengers” referred to in these, and other, letters were often ministers, essentially sent as ambassadors, but were frequently also merchants, apparently serving double duty for both themselves and the king.

In these letters, the kings involved often referred to each other was relatives, calling one another “brother” or “father/son,” even though they were usually not actually related, thereby creating “trade partnerships. ” Anthropologists have noted that such efforts to create imaginary family relationships happen most frequently in preindustrial societies, specifically to solve the problem of trading when there are no kinship ties or state-supervised markets. It is not always clear what relationship merits the use of the term “brother,” as opposed to “father’ and ‘son,” but it usually seems to indicate equality in status or in age, with “father/son” being reserved to show respect..[1]

This “global sphere of trading” fell apart during the twelfth and thirteenth centuries B.C., during a period referred to by historians as the “Bronze Age Collapse” Societies all around the Mediterranean region became less complex and decentralized. Many different factors contributed to the collapse; so many that historians tend not to refer to a single cause, but rather a “perfect storm” of events which precipitated the collapse. Among them are:

-Climate change
-Environmental destruction
-Resource depletion (e.g. topsoil, timber)
-Overpopulation.
-Volcanic eruptions
-Earthquakes
-Disease epidemics
-Military invasions of the so-called “Sea Peoples”

The Palace Economies of the Minoans and Mycenaeans faltered and disappeared. In their place, landed estates, often controlling large herds of livestock, became the new centers of power. The Dorian invaders came down from the north and colonized Greece, ushering in a tribal society ruled by an aristocratic warrior elite. This was an early regime of privatization as Michael Hudson describes:

From 1200 BC to about 750 BC in the Mediterranean you have a Dark Age. Apparently you had not only very bad weather around 1200 BC – maybe a small Ice Age and drought – but the weather and crop failures led to mass migrations and invasions. The palaces of Mycenaean Greece were burned and syllabic writing disappeared for nearly 500 years.

Then, when you have alphabetic writing emerging, the person whose title originally meant “local branch manager” of the palace workshop suddenly appears as the basileus, the ruler. But mostly you have landholding aristocracies holding the population in debt serfdom (like the Athenian hektimoroi, “sixth parters” liberated by Solon in 594 BC). It was much like the post-Soviet kleptocrats when Red Managers gave themselves control of their companies. When central power falls apart, local headmen take over. The dissolution of royal power led to privatization – including the privatization of credit, taking it and its rules out of royal hands. So Clean Slates stopped.[2]

Dark Age Greece

This is the culture that is depicted in the foundational tales of Western Literature—the Iliad and the Odyssey. The Greek warrior aristocracy was based around certain key principles:

1.) Absolute loyalty to one’s chief/ruler/king.
3.) Reciprocal gift exchange among aristocrats, especially upon parting.
1.) The sharing out of booty to warriors after the successful sack of a city or the defeat of one’s enemies.
2.) Ritual sacrifice to the gods, especially of oxen, and the partitioning out of roast meat to all adult male members of the tribe.

Greek oligarchs would commonly exchange “prestige goods” such as sacrificial tripods in a form of ceremonial gift exchange. The would also often exchange brides. Bride exchange, reciprocal gift giving among chieftains and distribution of booty to warriors in raids formed the basis for economic life in Dark-Age Greece. In these institutions, we see the same basic mechanisms at work in tribal societies studied by anthropologists today:

These three simple mechanisms for organising society in the absence of money-the interlocking institutions of booty distribution, reciprocal gift-exchange, and the distribution of the sacrifice-are far from unique to Dark Age Greece. Rather, modern research in anthropology and comparative history has shown them to be cypical of the practices of small-scale, tribal societies.

Of course, such pre-monetary social institutions have assumed many forms, reflecting the peculiar circumstances and beliefs of the peoples in question. But the anthropologists Maurice Bloch and Jonathan Parry have identified a widespread twofold classification. Comparative studies a similar pattern of two related but separate transactional orders: on the one hand, transactions concerned with the reproduction of the long-term social or cosmic order; on the other, a sphere’ of short-term transactions concerned with the arena of individual competition. The premonetary institutions of the Homeric world conform to the scheme.

On the one hand, there was the primeval institution of the sacrifice and the egalitarian distribution and communal consumption of its roast meat-a ritual expression of tribal solidarity before deity probably inherited from the most distant Indo-European past. This was the institution that governed the long-term transactional order. The other, there were the conventions of reciprocal gift-exchange and of booty distribution. These were the rules that governed the “short-term transactional order,” concerned not with cosmic order and harmony between the classes but with the more mundane matter of ensuring that the everyday business of primitive society-drinking and hunting when at peace; rape and pillage when at war-did not dissolve into chaos.[3]

The ritual sacrificial meal was particularly notable. Unlike the more hierarchical societies of the Near East, the sacrificial meal enforced a more egalitarian social order in which every individual member of the community had value in relation to their status. There was also the notion of debt to the gods and redistributive justice. Such rituals were under the control of the warrior aristocracy and were conducted in their estates, which also functioned as early temples. Meat was distributed on metal spits, called obols, and ownership of the spit was to affirm one’s status as an adult male member of the tribe:

…the most important redistributive activity was…a highly ritualized communal sacrificial meal. Conducted in honor of a commonly-worshiped divinity, the tradition consisted of a public killing, roasting, and eating of sacrificial animals. The objective of the ritual was to establish solidarity and social cohesion among the members of the community.

Perhaps the most prominent feature of the communal sacrificial model was its egalitarian emphasis, manifest in “just” and “equal” distribution of roasted bull’s meat among the ritual participants…While the ritual employed the principles of collective participation (koinōnia) and “equal distribution to all”, one’s equal share corresponded to one’s social status…The just shares allocated to ritual participants differed not only in quantity, but in quality as well. The more honored parts of the sacrificial animal, such as the limbs, were customarily allotted to religious officials…

…Purporting to allocate just and equal shares to the members of the not-so-equal community, the all-inclusive rituals of communal sacrificial meals aimed to create an appearance of harmonious and consensual social relations, thus concealing the underlying reality of social hierarchies and economic inequalities…

To service the ritual, sacrificial offerings were made, mostly in oxen, whereby religious officials stipulated the precise quality, type and quantity of cattle to be contributed, thereby establishing the first standardized unit of account guaranteed by the authorities… [4]

This “ox-unit standard” resembled the silver standard used in Mesopotamia insofar as the religious authorities determined the “standard of value” by which everything else was measured. This was the origin of pricing systems – ranking values of disparate things against each other, as David Graeber points out:

Why were cattle so often used as money? The German historian Bernard Laum long ago pointed out that in Homer, when people measure the value of a ship or suit of armor, they always measure it in oxen-even though when they actually exchange things, they never pay for anything in oxen. It is hard to escape the conclusion that this was because an ox was what one of­fered the gods in sacrifice. Hence they represented absolute value. From Sumer to Classical Greece, silver and gold were dedicated as offerings in temples. Everywhere, money seems to have emerged from the thing most appropriate for giving to the gods. [5]

Meat-sharing is an ancient concept which goes back to the hunter-gatherer origins of humanity (and earlier). The offering of specially-selected parts of the sacrificial animal to elites is reminiscent of the “thigh-eating chiefs” of the Kachin hill tribes in Burma studied by Edmund Leach, and the role meat distribution played in their society. Such rituals both reaffirmed the tribe’s debts to their ancestral spirits, and reinforced the status hierarchy in the material world. In these cases, the sacrifice indicated a debt was owed to the spiritual world of the gods and ancestors:

The animal sacrifices of the Kachin, called nat galaw, or “spirit making,” were built on the age-old principle of reciprocal gift-giving. One sacrificed to a nat (a nature spirit) to put him in one’s debt, expecting him to return the favor. The nat took only the nsa, “breath or essence,” from the sacrificial animal, leaving the meat to be shared by humans at a feast…When the Kachin were in rank mode, the ritual required an additional step: one hind leg from each animal sacrificed was given to the hereditary chief. This was a form of tribute, justified by the chief’s genealogical relationship to Madai (a highly-ranked nat). The high nat partook of the essence of the animal, while the chief’s family ate the meat. As some Kachin expressed it, they were ruled by “thigh-eating chiefs.” [6]

It’s worth pointing out once again that distinction between religion and the state which is common in our own modern cultures was nonexistent in past societies. Societies were bound by concepts like kinship, tribal affiliation, geographical origin, language, custom, and religion. The impersonal nation-state which binds strangers together through bureaucracy and the rule of law is an imaginary concept which was yet unknown.

Due to the fact that possession of the sacrificial spits–the oboloi–affirmed one’s membership in the tribe, they acquired a certain value as currency. They were commonly placed in tombs and acquired a symbolic value in exchange apart from their metal content:

In contrast to most ancient near-eastern societies, the Greek polis had retained sacrificial ritual that embodied the principle of communal egalitarian distribution. The fact that the Greek word for this distribution (moira) came to mean ‘fate’ indicates the importance of the distributional imperative. Citizenship was marked by participation in communal sacrifice, which also provided a model for the egalitarian distribution of metallic wealth in standardised pieces.

Probably the spits were distributed with meat on them. They were dedicated in sanctuaries and placed in tombs, because they had communal prestige deriving from their role in the communally central ritual of sacrificial distribution. It was because they had this communal prestige that they could work as proto-money. Greek money (in contrast to say Babylonian silver) was not just a generally exchangeable commodity: rather, it had a conventional value that depended on communal confidence (and in that sense was a kind of IOU), and so prefigured modern money, which is merely transferable credit. [7]

From the spits by which sacrificial meat was distributed, it appears that bronze, copper and iron ingots determined by weights were utilized as a form of proto-currency as early as 1100 BC in Greek culture. Sparta maintained its currency in the form of metal ingots and never made the transition to coinage in order to preserve the hierarchical non-monetarized relations of its society: “Plutarch states the Spartans had an iron obol of four coppers. They retained the cumbersome and impractical bars rather than proper coins to discourage the pursuit of wealth.”[8] The use of money would have engendered unacceptable levels of inequality and undermined the esprit d’corps required for Sparta’s distinctive warrior society to function.

The Rise of the Greek Polis

As the Dark Ages waned and the Classical World dawned, a new form of social order emerged: the Greek polis, a self-governing community of landholders centered on a city-state. Victor Davis-Hanson, in his book,The Other Greeks, attributes this development primarily to Greek farming practices.

The Greeks had developed a highly efficient method of mixed farming centered around the cultivation of barley, grapes, and olives, supplemented with gardening and animal husbandry (especially of sheep and goats). Grapes and olives were well-suited to the rocky soil of Greece, and allowed farmers to produce a consistent surplus. While large landowners grew cereals (mainly barley) on level, fertile land using many slaves, the hillsides were terraced and intensively cultivated and irrigated by small landowners in order to grow grapes and olives in small plots of 10 to 20 acres using 1 or 2 slaves.

Over time, this marginal land became highly productive, and the independent small landowners became the center of the political life rather than aristocrats with large estates. This led to a much more egalitarian social structure. Small farms fed by rainfall meant that key resources could not be put under the centralized control of a bureaucratic elite, unlike the irrigation agriculture systems of the Near East. The power of the old warrior aristocracies, with their large herds, landed estates, raiding parties, gift exchange, and ancestral temples, gave way to a different social order–the polis. The relative equality in wealth led these middling yeoman farmers (the ‘Other Greeks’) to create a political structure which protected their common interests–i.e. democracy, where leaders were chosen from among the general (male) population, and key decisions were made by citizens. Rather than justice being meted out by a semi-divine king, justice would be dispensed by an assembly of the people, with fines assessed according to the unit of account and paid with the common currency of the polis:

How would the polis affirm the equal worth of its members? It took the idea of sacrificial meat distribution and extended it, distributing standardized lumps of metal in place of the spits with roast meat on them. These metallic pieces could be used in exchange, much as the handfuls of spits were. As with the spits, the value would derive from the communal confidence of members of the polis, and would circulate as token money with values determined by the civic body.

At first, the pieces of metal distributed were the iron spits utilized for the roasting of the sacrificial animals. The production of such spits began on a large scale during the late eighth century BC (or around 700 BC) leading to their mass production during the entire seventh century BC. The roasting spits continued to circulate, though in smaller quantities, until the first half of the sixth century BC. During this period, the roasting spits (which were destined for communal distribution) came to be standardized in size, reflecting the old sacrificial tradition of “equal portions to all”.

Gradually then, the distribution of roasting spits came to be replaced by the allotment of coinage, which likewise came to be standardized. It is no wonder, then, that obolos, a sixth century BC silver Greek coin, derived its name from obelos meaning an iron spit. Another sixth century BC Greek coin of a larger denomination, drachma, originally meant a handful of six spits…the earliest Greek and Lydian coins did not begin as media of exchange in commerce, but functioned “in the same fashion as the portion of food distributed at the sacred meal”…coinage was distributed by the polis to its male citizens. It has also been established that some of the earliest monetary “transactions” were carried out among unequal social partners, and included sexual “exchange” between men and women…the use of coinage in payment for goods evolved out of its use in payment for personal services.

The administration of distributive justice is…key to understanding the origins and functions of early Greek money and coinage…The unequal distribution of wealth prompted a “decline of faith in the reliability of divine justice”, thereby creating a new social problem of instituting “a political means of payment controlled by humans so that they would not have to rely on the uncertain rewards of the gods”

…Introduced by the city-state as a unit of account for expressing the worth of its male citizens, the purpose of coinage was to resolve the crisis of distributive justice…Rather than facilitate trade, whether foreign or domestic, the initial purpose of coinage was to “(re)establish social justice within the polis”. In contrast to the uncertainty associated with divine justice, coinage could compensate virtue “immediately and precisely”, and payment in “stamped tokens” came to be associated with “just recompense”. Possession of coinage came to signify the acceptance of the civic authority of the polis.

In establishing its own model of distributive justice, the emerging authority of the polis adopted the idealized model of communal egalitarian distribution, but substituted durable metal objects for perishable pieces of meat…The emerging authority of the polis, then, attempted to dismantle the aristocratic model of power by distributing metal pieces to those who accepted the political authority of the polis instead. The distribution of metal pieces into the hands of the citizens would subvert the aristocracy’s monopoly over the use of (precious) metal in the closed sphere of aristocratic gift-giving.[10]

The first coins were issued by civic temples, which functioned as the first treasuries. The public temple usurped the role of the landholder’s private estate and ancestral temple and created a radically new egalitarian social structure which facilitated the use of money. They also reaffirm the link between money and the sacred:

…the temple-state was at the center of the polis and its priests mediated the relationship between subjects and deities. Deities were owed sacrifices and the temples who received these goods and services as sacrifices eventually came to replace the cooked flesh of bulls–which was originally given as a gift for contributing to the temple–with coins made of electrum (a natural gold and silver alloy). Coins essentially represented a receipt that subjects had contributed to the temple…Thus…the origins of money can be found in religious sacrifice and recompense mediated by priestly authorities.[11]

Indeed, contributions to religious societies have been offered as another source of the origins of money, going back to the work of Bernard Laum in the 1920’s:

Bernard Laum…traced money back to the contributions of food and other commodities to guild organisations of a religious character. In his view, their root is to be found in the communal sacrifice. Members of temple brotherhoods were obliged to make ceremonial contributions or kindred payments to the temples or other redistributive households. Laum interpreted these payments as early food money, for whose value the monetary metals later were substituted. But although food contributions bore an administered price in the sense of being standardized in amount, it would be a quantum leap to deem them ‘money.’ Along with injury fines these formalities represent personal liabilities, mainly for restitution or, in time, tax assessment, but not yet the freely negotiated market exchange of commodities.

The media for tax payments would seem to be the bridge concept. The German word for money, Geld, derives from Gothic gild, ‘tax,’ but an early connection to paying fines is indicated by Old Icelandic gjald, ‘recompense, punishment, payment’, and Old English gield, ‘substitute, indemnity, sacrifice’. The idea combines the ethic of mutual aid with the idea of a standardized equality of contributions.

In the first instance religious institutions would have sanctified these contributions and given them the connotation of fixed obligatory payments. Such payments to the community’s corporate bodies appear to have been transformed into tributary taxation when cities were conquered by imperial overlords and turned these institutions into collection agents. This inverted the traditional relationship of voluntary gift givers or sacrificers gaining status by their contributions reflecting openhandedness and wealth. As taxes were coercive levies, their payers lost status by submitting to a tributary position. [12]

The issuance of an official currency stamped with the government’s “seal of approval” (e.g. Lydian lion, Athenian owl, Corinthian horse) was an activity that affirmed the identity and independence of the city. As historians Austin and Vidal-Naquet put it, “In the history of Greek cities coinage was always first and foremost a civic emblem. To strike coins with the badge of the city was to proclaim one’s political independence.”

These coins came to acquire value throughout the Greek world, facilitating trading and markets. Their value derived from the faith placed in the polis, the community of equals. In turn, the issuance of money and the rise of markets came to influence the political development of Greek society:

Besides its egalitarian effects, coined money also promoted individual autonomy, which would tend to dissolve the vertical lines of patronage (based on reciprocity) that we find for instance in Homer (e.g. Odysseus and Eumaios). This was, I suspect, a precondition for democracy, which at Athens arrived a mere generation or so after coinage.

Moreover, control of the central supply of money was (in contrast to now) visible and simple. It was usurped first in various cities by the ‘tyrants’ and then, at Athens, by the people (demos), and remained essential to democracy. Many of the numerous city-states minted their own coinage, and so had this potential for democracy. But Athens was a special case, not least because (almost uniquely) it had its own supplies of silver, and then came in the fifth century to control the money supply of most of the Aegean Sea.

Coinage arrived in Attica later than in the cities of the eastern Aegean, where philosophy originated in the early sixth century BCE. Athens was culturally insignificant until the late sixth century BCE, by which time it finally had coinage en masse and moreover had begun to extract much silver from the mines at Laurium in south-east Attica. In a newly monetised world this silver (together with gold and silver from Thrace) was crucial for the development of festivals and of temples, for the origin and splendour of drama, for the building of a fleet, and eventually for Athens as a cultural center to which (as we see in the dialogues of Plato) philosophers were attracted from various parts of the Greek world.[13]

This strongly affirms the idea that money is a creation of the state, or whatever we wish to term the collective entity to which everyone owes a social obligation which exists in every society over band level (often referred to as the ‘sovereign’ by monetary theorists). Monetary theorists point out, for example, that the prime way for a fledgling political entity such as the Islamic State (IS) to define itself as a “legitimate” government is to issue its own “official” currency which is legal tender in the areas under its control. It then assesses taxes in this unit of account. The unit of account must be established by a supra-market entity before monetization of the economy and internal trading can take place.

Coinage and Metals

It is well-known that the first “official” stamped coins (in the West) were minted in Lydia and Ionia on the coast of present-day Turkey. Metal deposits of electrum, an alloy of gold and silver, were under the control of the royal household. This substance was issued in lumps by the government with stamps certifying the government’s authority. It was illegal for any other entity to issue these stamped coins.

It is often stated that what gave the coins their value was the certification by the state of their metal content. Because they were issued by an “official” government mint, it is claimed, a trader or merchant could be assured that he or she was getting the “correct” amount of metal in the coin without the costly and time-consuming process of weighing the coins. He could be assured by the “seal of approval” that coins did indeed contain the quantity of metal that they desired. In this view, issuing standardized “official” lumps of metal greased the wheels of commerce which had existed long before then, but were encumbered by uncertainty. Put another way, “coins were simply the form in which precious metal traveled.”

This fits with the “metallist” doctrine that markets are spontaneous and self-regulating, and that issuing currency is merely a ‘convenience’ on the part of governments. Even without such issuance, the argument goes, “free” markets would muddle along just fine, just with the added inconvenience of having to weigh out the gold and silver everyone is exchanging goods for. Furthermore, changing the “official” metal content in any way is “debasing” the currency, and should never, ever be done, because the amount of metal in the coin is fixed for all time, and it is this metal which gives the coin its value. Furthermore, paper money is just a promise to redeem a certain amount of precious metal in some form.

The problem with this is that throughout history, there has been no consistent metallic standard for coins. While later Lydian coins eventually became standardized in weight and composition, this was more for convenience of manufacture rather than adherence to some sort of standard (defined by whom?). The early coins were amalgams of gold and silver, with no way of determining the proportion of each:

Evidently, the value of the earliest coins could not derive from their metal component: the earliest Lydian coins were made of electrum, a natural alloy of gold and silver, the internal composition of which is highly variable by nature. This means that a coin’s weight, purity and fineness could not be standardized…the final choice of silver as the minting metal for coinage was a political decision and had little to do with the intrinsic properties of the metal…

Given the association of gold with the old aristocracy, and the crisis of redistribution as manifest by unequal distribution of metallic wealth (most importantly, gold and gold artifacts), the polis chose silver as the minting metal, and silver coinage aimed to represent “the community of citizens” who were all equal as they were made of “the same noble substance”.

Rather, it appears that the nominal exchange value of metal coins was set by governments, and always has been. This value was assessed according to the prevailing unit of account. Coins circulated at a value higher than their commodity value, otherwise they would simply have been melted down. In fact, this has happened throughout history when the commodity value of the coin has risen above its nominal value. The commodity value of the metal functions as a “floor” underneath the value of a coin–a level beneath which it will not fall, encouraging its use.

The reason we tend to think that precious metal is what gave the coins value is because coins are what have survived. They are what sit in museums and what are found by the thousands at archaeological sites. Meanwhile, the systems of credit clearing, taxation, and establishment of monetary value by state authorities have long since vanished. So we mistakenly assume that people were exchanging coins for their metal content, despite the fact coins have a dizzying array of metal quantities and standards throughout history, often even in the same time period and geographic location, as Alfred Mitchell-Innes writes:

…throughout the whole range of history, not only is there no evidence of the existence of a metallic standard of value to which the commercial monetary denomination, the “money of account” as it is usually called, corresponds, but there is overwhelming evidence that there never was a monetary unit which depended on the value of coin or on a weight of metal; that there never was, until quite modern days, any fixed relationship between the monetary unit and any metal; that, in fact, there never was such a thing as a metallic standard of value…

The earliest known coins of the western world are those of ancient Greece, the oldest of which, belonging to the settlements on the coast of Asia Minor, date from the sixth or seventh centuries B. C. Some are of gold, some of silver, others are of bronze, while the oldest of all are of an alloy of the gold and silver, known as electrum. So numerous are the variations in size and weight of these coins that hardly any two are alike, and none bear any indication of value. Many learned writers…have essayed to classify these coins so as to discover the standard of value of the different Greek States; but the system adopted by each is different; the weights given by them are merely the mean weight calculated from a number of coins, the weights of which more or less approximate to that mean; and there are many coins which cannot be made to fit into any of the systems, while the weights of the supposed fractional coins do not correspond to those of the units in the system to which they are held to belong.

As to the electrum coins, which are the oldest coins known to us, their composition varies in the most extraordinary way. While some contain more than 60 per cent of gold, others known to be of the same origin contain more than 60 per cent of silver, and between these extremes, there is every degree of alloy, so that they could not possibly have a fixed intrinsic value. All writers are agreed that the bronze coins of ancient Greece are tokens, the value of which does not depend on their weight. All that is definitely known is that, while the various Greek States used the same money denominations, stater, drachma, etc., the value of these units differed greatly in different States, and their relative value was not constant—in modern parlance the exchange between the different States varied at different periods. There is, in fact, no historical evidence in ancient Greece on which a theory of a metallic standard can be based…[15]

Coinage and Mercenaries

It is thought that minting coins eventually evolved into a way for the “state” (i.e. the  sovereign) to procure the resources it needed, and as a way to transfer private goods and services to itself as required.

One of the biggest requirements was paying for professional soldiers in place of the landholding citizen-soldier to facilitate external military conquest. These soldiers were transient, so a form of portable, anonymous wealth was needed. It furthermore appears that sex was one of the first services on offer using coins—women would work in brothels of Sardis to earn money for their dowry– with other services soon following in its wake (mercenaries and prostitutes may tie as the world’s oldest professions). The earliest “free” markets to spring up in coin appear to be for the slaves produced by such conquest.

The way it worked was this: The ruling class required mercenaries, and since they controlled the metal deposits, they issued lumps of metal stamped with the ruler’s insignia, signifying their “official” capacity. They then demanded these coins back from producers, and the only way to get their hands on them was to sell something to soldiers, allowing the soldiers buy the things they wanted and needed from the conquered population. Tim Johnson writes:

Around 4,000 years ago, people started making ornaments out of electrum (an alloy of gold and silver), copper and gold, metals found naturally (i.e. without processing) in nature. Metals have an almost unique, natural, physical property; they reflect light. The only other material that stone-age humans would have come across that reflected light would have been water, so to these people gold would appear to combine the essence of both water and the sun, the basis of life.

Imagine the awe that humans would have felt the first time they spotted a nugget of gold sparkling in a river bed, here was an object that seemed to captured and store life-giving sunlight, the ‘tears of the Sun’ as the Incas said. In the medieval period, European alchemists believed that metals were produced by some mechanism involving rays from different ‘planets’: gold from the Sun, silver from the Moon, mercury from Mercury, copper from Venus, iron from Mars, tin from Jupiter and lead from Saturn.

In ancient Babylon, Egypt and Greece, temples became associated with stores of metals, gold for the Greeks, silver for the Babylonians and copper for the Egyptians. It seems that these metals had developed a religious significance and become important as temple offerings. Consequently followers of the religion would look to acquire the metal, to enable them to make an offering, and so the metal became the commodity in the most universal demand. Athens treasury was in the Temple of Athena, and Jesus cast the money-lenders, exchanging worldly Roman money for divine shekels, out of the Temple.

The earliest tokens used as ‘money’ were not specific weights of a certain metal but roughly cut pieces of metal with an official stamp on them – monopoly money as it were. The emergence of money, in the sense of coins, in Greece coincides with the emergence of mercenary troops, the term ‘soldier’ is derived from the word for a Roman gold coin, solidus. A simple economic model developed, states paid soldiers in gold, who then spent it in the community. The government then recovered the gold by taxing the merchants and innkeepers that the soldiers had paid for food and lodgings.

This model would survive and drive colonialism until the modern age. A power, such as Alexander’s Greece, Imperial Rome, Napoleonic France or Industrial Britain, would take control of a region through force of arms. They would then demand tax from the conquered nation, which would have to be paid in currency specified by the coloniser. The conquered nation could only obtain the currency by exchanging their produce for the specified currency…

Why magic? ⇔ Why gold? (Magic, Maths and Money)

David Graeber describes this as a “military-coinage-slavery” complex, and sees this as a defining feature of the Axial Age. With coinage, slavery becomes a much greater factor in the economy of the Classical world than it ever was in the ancient Near East (inverting the “conventional” view of history as a contest between the “freedom” of the Classical World versus “Oriental Despotism”).

This strongly fits with the idea that supplanting the traditional relations of reciprocity, redistribution and householding with impersonal markets mediated by money was not a spontaneous development based on human instincts to “truck, barter and exchange,” but a top-down project facilitated by ruling elites. All of this is tied to the emergence of inequality and class-based society rather than freedom and egalitarianism. Markets did not emerge out of simple barter. Rather barter occurs after organic social relations have been dismantled and monetized, and the quantity of money becomes curtailed, such as by economic collapse.

The use of coinage was spread by Greek mercenaries throughout the Mediterranean world and beyond. Although coinage spread east to the Persian empire, it appears that older credit/debit systems and householding continued to prevail as the dominant economic paradigm. That changed with the conquest of the Persian Empire by Alexander the Great. Alexander melted down Persian gold and silver and used them to pay his troops. This spread both Hellenic culture and markets throughout the East. Greek silver and coins would find their way as far east as China:

Although silver, by becoming a medium of exchange, must have acquired a value higher than its intrinsic value as a not very useful commodity, the Babylonians did not invent anything like modern coinage, which has…a value in exchange even further above its intrinsic value as metal. Even after the people of Asia Minor had invented coins and they had been adopted by the Greek world, the Babylonians still preferred to measure silver by weight, under the illusion no doubt that that mattered! It was not until Alexander the Great conquered the region that coins were commonly used. It seems quite likely that in the area which was the heartland of the great Persian Empire, documentary credits were used in preference to physical silver.

Was the silver merely stored as a reserve, just as in the modern era gold has been accumulated in the Bank of England and in Fort Knox in the USA? Alexander certainly found vast hoards of gold and silver in the palaces and temples of Persia, and the Greeks thought it was odd it had just been stored…The Greeks probably did not realise that the Babylonians had found a convenient way of monetising precious metals, and had minimised the expensive and risky movement of precious metals by the use of an accounting system.

But with the conquest came no doubt the breakdown of the legal system, together with its religious backing, on which the documentary credits were founded. Alexander coined (monetised) the gold and silver he found, no doubt to pay his soldiers who would have had little use for documentary credits issued by foreign merchants or strange temples. It appears that trade increased dramatically between the nations in the eastern part of Alexander’s empire after the monetisation by coining of the precious metals he found. This and other experience suggests that coins which contain a high proportion of the precious metals did facilitate foreign trade, even though they are unnecessary in a more parochial society. Modern communication systems have made it possible to use documentary credits worldwide, and the case for coins made of precious metals hardly now exists.[16]

This is the “state theory” of money creation. Jack Goody argued that the state made war and war made the state. But we can update that to say that the state made money, and money made markets, and markets are what allowed for the bureaucratic state to form. The state, by issuing currency, could transfer “private” resources to itself via taxation. It could also hire expertise, at first in war, and later in technocratic management. Issuing currency money gave the state the power to transfer resources to itself and pay for armies. This paper describes the process in more detail:

A stylised story based upon the use of stamped metal might go as follows; a ruler might decide what she or he desired, for example, palaces, amphitheatres and an army of conquest. She or he could utilise their monopoly power over the monetary system to obtain what they desired.

They would first define the unit of account and then decide upon the money things acceptable in payment of debts denominated in this unit, say, stamped metal discs clearly marked with her or his head. The disc may contain precious metal. This precious metal content (if any) would be decided upon by the state (the mint standard). The use of precious metal may help prevent counterfeiting and raise the prestige of the issuer but the intrinsic value of the coins provided only a floor value for the currency. The nominal value would be higher and determined by decree.

She or he then imposed a tax on her or his subjects denominated in its chosen standard, payable by the surrender of the stamped discs. The ruler decided the nominal value of the coins and how many each person must pay to satisfy their tax bill. This process gave the coins value. They were tokens showing the holder had a credit on the state. They were really ‘tax credits’.

The ruler could now spend these tokens on whatever she or he wished as long as it was available in her or his own domain –or ‘monetary space.’ The private sector suppliers of goods accepted the tokens, not because they were made of precious metal but rather because the population needed them to pay taxes. The rulers then paid their soldiers with the stamped metal discs and the soldiers, in turn, were able to go to the villages and buy whatever they wished, provided of course it was available! The populace sold the soldiers real goods to obtain the discs to meet tax liabilities. Clearly, the empress or emperor had to spend before she or he could collect. A private agent minting discs with the ruler’s head on without her or his permission would soon be put to the sword. It may appear that the ruler needed to tax before spending but this is an illusion![17]

Money needs to be spent before it can be collected. It is not something “out there” that the government needs to procure from the “private” sector. Rather, it is a social technology which is issued by the government, and given value by collective confidence in the ruling body ,and its ability to make payments, redistribute, and collect taxes and fines. It is then transferred hand-to-hand, facilitating trading among unrelated strangers. How much of this was ‘planned’ and how much accidental is a matter of speculation.

The Emergence of Markets

As Greek society became increasingly monetized, traditional social obligations were transformed into money relationships. The public spaces of the Greek polis, where debate was conducted, started to double as the place where monetary exchanges took place: the market, such as the famous Agora in Athens. Over time, every Greek polis would come to possess its own market along with its own mint. David Graeber describes the transformation:

The world of the Homeric epics is one dominated by heroic warriors who are disdainful of trade. Money existed, but it was not used to buy anything; important men lived their lives in pursuit of honor, which took material form in followers and treasure. Treasures were given as gifts, awarded as prizes, carried off as loot.

All this was to change dramatically when commercial markets began to develop two hundred years later. Greek coinage seem to have been first used mainly to pay soldiers, as well as to pay fines and fees and payments made to and by the government, but by about 6oo BC, just about every Greek city-state was producing its own coins as a mark of civic independence. It did not take long, though, before coins were in common use in everyday transactions. By the fifth century, in Greek cities, the agora, the place of public debate and communal assembly, also doubled as a marketplace.[18]

As city-states minted money, the traditional social obligations of tribal society were now transformed into very different social obligations mediated by the new invention of money:

Everywhere, traditional social obligations were transformed into financial relationships. In Athens, traditional agricultural sharecroppers were converted into contractual tenants paying money rents. The so-called “liturgies”-the ancient, civic obligations of the thousand wealthiest inhabitants of the city to provide public services ranging from choruses for the theatre to ships for the navy-were now assessed in financial terms. By the last quarter of the fifth century BC, not only military stipends, public and private wages, rents and commodity prices, but also social payments such as dowries, regularly appear as sums of cash. The city states of classical Greece had become the first monetary societies. p. 62

Several characteristics of Greek society helped foster the development of money and markets.

As we’ve seen earlier, Greek diversified farming practices ensured that small farmers were relatively equal during the Dark Ages. The mainland of Greece is rocky and mountainous, preventing the large-scale plantations so common in later Roman Italy and North Africa. This is in contrast to the Near Eastern cultures where all land was owned by the gods/potentates, and administered by palaces and temple bureaucracies. Unrelated people had to deal with one another on more-or-less equal terms.

As we saw last time, in Greek culture, writing and numeracy were democratized. The alphabet, transmitted through the Phoenicians, allowed reading and writing to be easily learned and done by the average person, rather than an priesthood which kept such administrative skills to themselves and transmitted them only through esoteric channels. The departure from exclusively oral communication meant that myths gave way to recorded history, causing a questioning of old social forms.

The Greeks were geographically separated, yet there was a shared conception of what it meant to be Greek. The Greek peoples were scattered across hundreds of islands in the Aegean Sea, the Grecian mainland, the coast of Asia minor, and numerous colonies throughout the Mediterranean (“like frogs around a pond,” in Plato’s famous phrase). This alone would require trading. Greek culture was intimately tied with the ability to cultivate olives, and the ability to speak the Greek language (others’ tongues were just gibberish–“bar-bar-bar,” i.e. barbarians).

So we have decentralization, egalitarianism, individualism, and yet shared cultural notions and concepts. This created a need for trade, but without the necessity of mediation by a centralized governing bureaucracy as seen in Near Eastern redistributive economies. Several other distinct aspects of Greek culture and thought also contributed to the development of abstract, impersonal money and markets.

The first was the concept of a universal standard of value derived from the sacrificial feast, as Felix Martin describes:

…the idea of the equal worth of every member of the tribe was a social constant: a standard against which social value could be measured. At the heart of Greek society, in other words, was nothing other than a nascent concept of universal value and a standard against which to measure it, pret-a-porter.

Here was an answer to the question begged by the new perspective on society and the economy. Where the new understanding of physical reality had man, the observer of an objective universe, the new understanding of the social reality had the idea of the self, separate from society, an objective entity consisting of relationships measurable in a standard unit on the universal scale of economic value. It was a critical conceptual development-the missing link, on the intellectual level, in the invention of money. p. 59

Mesopotamia had for millennia possessed one of the three components of money-a system of accounting, based upon its discoveries of writing and numeracy. But the immense sophistiction of Mesopotamia’s bureaucratic, command economy had no need of any universal concept of economic value. It required and had perfected a variety of limited-purpose concepts of value, each with its respective standard. It therefore did not develop the first component of money: a unit of abstract, universally applicable, economic value.

Dark Age Greece, on the other hand, had a primitive concept of universal value and a standard by which to measure it. But the Greek Dark Ages knew neither literacy nor mimeracy, let alone a system of accounting. They had, in nascent form, the first component of money, but lacked the second. Neither civilisation had all the ingredients for money on its own.

But when the ultra-modem technologies of the East-literacy, numeracy, and accounting-were combined with the idea of a universal scale of value incubated in the barbaric West, the conceptual preconditions for money were at last in place…

This spread of money’s first two components-the idea of a universally applicable unit of value and the practice of keeping accounts in it-reinforced the development of the third: the principle of decentralised negotiability. The new idea of universal economic value made possible the offsetting of obligations without reference to a centralised authority. And the new idea of an objective economic space created the confidence that this possibility would exist indefinitely.

Markets require people to be able to negotiate a sale or agree a wage on their own, instead of feeding their preferences into a central authority in order to receive back a directive on how to act. But successful negotiation requires a common language-a shared idea of what words mean. For markets to function there needs to be a shared concept of value and standardised units in which to measure it. Not a shared idea of what particular goods or services are worth-that is where the haggling comes in-but a shared unit of economic value so that the haggling can take place at all. Without general agreement on what a dollar is, we could no more haggle in the marketplace over prices in dollars than we can talk to the birds and the bees. pp. 61-62

[19]

Other ideas that were unique to Greek society included the idea that the abstract was more important than the real, derived from philosophy, and the absolute isolation of the individual from one’s close kin, as seen in Greek tragedies such as Oedipus.

There is also evidence that the adoption of money was critical to the development Greek ideas about democratic political governance and scientific thought, as Tim Johnson explains in this excellent blog post (emphasis mine):

Greek culture that emerged around 600 BCE became known for being distinctive in its attitudes to politics and science. Greek science developed a non-mythical cosmology. The central idea emerged in Miletus, in Anatolia, and was apeiron (‘without limit’), something boundless, homogenous, eternal and abstract yet it held and motivated all things. Simultaneously, across the Aegean in Athens, Greek ideas of democracy were codified.

The standard explanations used to argue that the non-mythical cosmology originated in the polis where citizens were equal and ruled by an impersonal law: democracy generates science. This account did not acknowledge the temporal simultaneity of the origins of the ideas but there geographical separation. There needed to be something that preceded democracy and science common to both Athens and Miletus.

A more empirical explanation for origin of the distinctive nature of Greek politics and science lies in the Greek adoption of money in everyday use. Money can be seen as a prototype for the apeiron. Money is ‘fungible’, meaning one money-token is indistinguishable from any other, it is an empty signifier, like a word used in everyday language. The impersonality of money means that it is universal and makes no distinctions; it is used by rich and poor uniting opposites. There is a discrepancy between the value of money and its commodity value because money an abstract concept signified by a concrete token. Because it is abstracted, unlike any substance, money is unlimited. It has the power to transform objects, being able to turn wheat into wine in the market. Together, these properties enable money to perform multiple functions simultaneously. It is used to meet social obligations, such as tribute, legal compensation, and is the dominant means of conducting exchange; it stores value and is the unit of account. Money’s myriad uses means that it becomes a universal aim of all members of the community using it.

Money centralised social power in a single, abstract and impersonal entity. In monetised, Greek, economies personal power arose from the possession of impersonal and non-substantial money. The impersonality of Greek money nurtured the concept of equality, which is the foundation of democracy. The Greek word nomos, associated with ‘law’, is the root of the Greek word for money, nomisma. When combined with ‘auto’ – self – it gives autonomy, the idea that people can govern themselves and out of it, the concept of the individual emerges.

The foundations of Athenian democracy where laid by Solon (c. 638‒558) when he instituted several legal reforms. These sought to address instability created by conflicts in society caused by growing inequality created by the financialisation of society. Solon’s reforms solved the problems by substituting judicial violence with fines, something that was only possible because money was widely used. In the process, justice was depersonalised so that hostility between people was replaced by an impersonal quantification between an injury and its compensation. While money was disruptive of society it was also integral to Solon’s reforms that created a political system in which all citizens were equal.

Greek’s [sic] highlighted how their culture was distinctive from that of their neighbours, notably those in the civilised East…The essential difference was that Greek society was monetised and operated through inter-personal exchange where as that of the neighbouring societies were re-distributive.

In re-distributive societies, power originated in the gods. Priests (or a king, the distinction was often blurred) were the direct servants of the gods who mediated between the population and the divine. All that the community produced was owned, exclusively, by the gods and managed by a hierarchy of priests/kings. Produce was delivered to the temple (or palace) and the priests, from behind closed doors, would re-distribute the aggregate production per their own rules, taking a cut for their own use. In return, the priest/kings were expected to provide material and social security: food stores, walls, law and order. These societies maintained themselves so long as the priest/kings prevented famine and ensured peace and justice. It was passed through the priests/kings into the community through a clear hierarchy. The transference of power was often done through seals (amulets, talisman) that magically carried the power of the god.

Greek religious practice diverged from this standard model. The Greek gods lived on ambrosia and nectar, not on mortal food. When Homeric Greeks, in around 800 BCE, performed an animal sacrifice the smoke ‘honoured’ the gods, who were not located in their icons but ‘somewhere else’, alienated from the people. The sacrificial meat was then shared out amongst the community. The fairness of this sharing was fundamental to Greek culture, with both the Iliad and the Odyssey resting on problems resulting from unfair distribution. Consequently, the wealth of the Greek temples was owned and managed, inclusively, by the community in an egalitarian manner, in contrast to the wealth of temples in re-distributive societies.

There is a relationship between these Greek religious practices and the emergence of money in Greek society. The lowest value Greek coin was the obolos that took its name from the cooking spits (obelos) that were used to distribute sacrificial food and it is almost certain that the word drachma comes from obeliskon drachmai ‒ handfuls of spits.

A Financial Approach to the ‘Clash of Cultures’ (Magic, Maths and Money)

One deleterious result of the money economy was people falling into debt and relinquishing their freedom. This led to steep class divisions, as those who defaulted sold themselves into slavery (debt serfdom). Debt serfdom several times threatened the security of the polis, as debt serfs were unable to maintain military training to help defend the city-state (one reason why Sparta steadfastly refused to use coins). Rather than regular Clean Slates as in the Near East, periodic debt cancellations were legislated under rulers like Solon. The debt serfs would then be shipped off to found colonies across the Mediterranean. This dynamic drove Greek expansion and colonization, as David Graeber explains:

One of the first effects of the arrival of a commercial economy was a series of debt crises, of the sort long familiar from Mesopotamia and Israel. Revolutionary factions emerged, demanding amnesties, and most Greek cities were at least for a while taken over by populist strongmen swept into power partly by the demand for radical debt relief. The solution most cities ultimately found, however, was quite different than it had been in the Near East.

Rather than institutionalize periodic amnesties, Greek cities tended to adopt legislation limiting or abolishing debt peonage altogether, and then, to forestall future crises, they would turn to a policy of expansion, shipping off the children of the poor to found military colonies overseas.
Before long, the entire coast from Crimea to Marseille was dotted with Greek cities, which served, in turn, as conduits for a lively trade in slaves. The sudden abundance of chattel slaves, in turn, completely transformed the nature of Greek society.

First and most famously, it allowed even citizens of modest means to take part in the political and cultural life of the city and have a genuine sense of citizenship. But this, in turn, drove the old aristocratic classes to develop more and more elaborate means of setting themselves off from what they considered the tawdriness and moral corruption of the new democratic state…[20]

The decentralization of economic life and establishment of self-rule had dramatic effects. According to Josiah Ober, at the bottom point of Iron Age circa 1000 B.C., the Greek world was sparsely populated and living near the subsistence level. Almost 700 years later, in the age of Aristotle, the population of the Greek world had increased twentyfold and per capita consumption had doubled, achieving growth rates comparable to those of England or Holland in Early Modern Europe. Ober attributes this growth to low levels of inequality (which Davis-Hanson attributes to farming practices), which led to investments in human capital, economic and political stability, non-authoritarian political structures, and high levels of social trust:

In the 12th century BCE, the palace-centered civilization of Bronze Age Greece collapsed, utterly destroying political and social hierarchies. Surviving Greeks lived in tiny communities, where no one was rich or very powerful.

As Greece slowly recovered, some communities rejected attempts by local elites to install themselves as rulers. Instead, ordinary men established fair rules (fair, that is, for themselves) and governed themselves collectively, as political equals. Women and slaves were, of course, a very different story. But because these emerging citizen-centered states often out-competed elite-dominated rivals, militarily and economically, citizenship proved to be adaptive. Because participatory citizenship was not scalable, Greek states stayed small as they became increasingly democratic. Under conditions of increasingly fair rules, individuals and states rationally invested in human capital, leading to increased specialization and exchange.

The spread of fair rules and a shared culture across an expanding Greek world of independent city-states drove down transaction costs. Meanwhile competition encouraged continuous institutional and technological innovation. The result was 700+ years of world-class efflorescence, marked by exceptional demographic and per capita growth, and by immensely influential ideas, literature, art, and science. But, unlike the more familiar story of ancient empires, no one was in running the show: Greece remained a decentralized ecology of small states. [21]

Greek colonization spreads ideas of democracy, science, religion, money, markets, slavery and debt to other cultures, including the militarized cultures of the Italian peninsula. Eventually, these ideas gave rise to two great powers who fought over control of the Mediterranean: the Latin empire centered in Rome, and the Phoenician-derived colony of Carthage. With the victory of Rome, the entire Mediterranean becomes a giant free-trade zone, and the coinage-mercenary-slave complex expands to an unprecedented degree. We’ll take a brief look at that next time.

[1] Ernest Cline; 1177 B.C.: The Year Civilization Collapsed

[2] http://michael-hudson.com/2015/04/sovereignty-in-the-ancient-near-east/

[3]Felix Martin; Money: THe Unauthorized Biograhy, p. 38

[4] Semenova and Wray; The Rise of Money and Class Society: The Contributions of John F. Henry. Levy Economics Institute Working papaer no. 832

[5] David Graeber; Debt: The First 5000 Years.

[6] Kent Flannery and Joyce Marcus; The Creation of Inequality, pp. 193-195

[7] Radical Anthropology; Interview with Richard Seaford: http://radicalanthropologygroup.org/sites/default/files/journal/ra_journal_nov_2013_1-5.pdf

[8] Semenova and Wray; The Rise of Money and Class Society: The Contributions of John F. Henry. Levy Economics Institute Working papaer no. 832

[9] Not Used

[10] https://en.wikipedia.org/wiki/Obol_(coin)

[11] Tim Di Muzio, Richard H. Robbins; An Anthropology of Money: A Critical Introduction, p. 48

[12] Wray et. al.; The Credit and State Theories of Money, pp. 96-97

[13] Radical Anthropology; Interview with Richard Seaford: http://radicalanthropologygroup.org/sites/default/files/journal/ra_journal_nov_2013_1-5.pdf

[14] Semenova and Wray; The Rise of Money and Class Society: The Contributions of John F. Henry. Levy Economics Institute Working papaer no. 832

[15] Wray et. al.; The Credit and State Theories of Money, pp. 96-97

[16] hWray et. al.; The Credit and State Theories of Money, p. 138,

[17] Phil Armstrong; Heterodox Views of Money and Modern Monetary Theory (MMT)

[18] David Graeber; Debt: The First 5000 Years.

[19] Felix Martin; Money: The Unauthorized Biography, p. 60

[20] David Graeber; Debt: The First 5000 Years.

[21] http://blog.press.princeton.edu/2015/05/13/an-interview-with-josiah-ober-author-of-the-rise-and-fall-of-classical-greece/

The Origin of Money – 4

2. The First IT Revolution

In order for something like the general-purpose universally-applicable money that we know to form, two critical innovations were needed: numeracy/literacy and standardized measurement.

In order to manage the redistributive economy of ancient Mesopotamia, increasingly sophisticated “information-processing” technologies were invented. We might call this the “First IT Revolution,” and it eventually ushered in writing and mathematics. It is now known that these originally developed in the service of keeping track of goods and labor for this economy– accounting, in other words:

This prehistoric communication revolution began some 9000 Years ago among the early agricultural communities of northern Mesopotamia and Syria. Like the invention of the computer, it involved the creation of an ingenious device which served both to transmit information and to record it for future reference.

In Neolithic Mesopotamia this new device served also to identify property and to ensure its security, and in that sense to signal to us not only that society was becoming more differentiated (that is, that there were those with goods to protect or secure) but that man could no longer trust his fellow man…

…the earliest stage of recording numeracy utilized the geometric token, followed by the use of the complex token and bulla, and still later, with an increasing complexity of communication needs, the cylinder seal was used for securing and identifying property; and finally, the seminal tool of bureaucratic administration, the inscribed tablet.

A theoretical account of this process was developed by Denise Schmandt-Besserat beginning in the 1970’s. She realized that the earliest shapes in cuneiform writing were based on the shapes of tokens found on archaeological sites. This led her to formulating the following sequence describing the development of writing:

1. Small clay tokens about 1-3 centimeters in length shaped into simple geometric forms are found scattered throughout Mesopotamian archaeological sites after about 9000 BC. The tokens represented various primary commodities –grain, jars of olive oil, sheep, beer, etc. They came in a variety of sizes and shapes–cones cylinders, spheres, ovoids, disks and tetrahedrons (three dimensional triangles), often covered with various dots and markings.

Simple tokens represented basic items such as grain and cattle, whereas more incised and perforated tokens represented services and manufactured items. One might think of game pieces (which at one point they were believed to be), or animal crackers. This allowed for a much greater control over varied items than just simple notches on tally sticks. The tokens could be matched one-to-one with the various standardized goods and services.

Number was represented by a phenomenon called correspondence (one-to-one) counting. Five ovoids meant five jars of olive oil, three tokens meant three jars, and so on; there was no abstract notion of “fiveness” apart from the thing being counted. The tokens were “non-lingual,” that is, no matter what language you spoke, both parties could understand that that five ovoid tokens meant five jars of olive oil:

The direct antecedent of the Mesopotamian script was a recording device consisting of clay tokens of multiple shapes. The artifacts, mostly of geometric forms such as cones, spheres, disks, cylinders and ovoids, are recovered in archaeological sites dating 8000–3000 BC.

The tokens, used as counters to keep track of goods, were the earliest code—a system of signs for transmitting information. Each token shape was semantic, referring to a particular unit of merchandise. For example, a cone and a sphere stood respectively for a small and a large measure of grain, and ovoids represented jars of oil.

The repertory of some three hundred types of counters made it feasible to manipulate and store information on multiple categories of goods…The token system showed the number of units of merchandize [sic] in one-to-one correspondence, in other words, the number of tokens matched the number of units counted: x jars of oil were represented by x ovoids. Repeating ‘jar of oil’ x times in order to express plurality is unlike spoken language. [1]

2. The economy expanded and became more complex as urbanization proceeded. The clay tokens also began to get more numerous and more elaborate, tracking the various “secondary commodities” of the Mesopotamian economy –wool, clothing, metals, honey, bread, oil, beer, textiles, garments, rope, mats, carpets, furniture, jewelry, tools, hides, perfume, and so on.

The tokens represented the various items stored in the “holy storehouse” of the temple. Standardized tokens could be used for keeping track of inventory, or recording tax payments, and even for establishing future transactions–essentially forming the first economic contracts. Tokens could represent anticipated tax payments, deferred payments, or a provide a record of previous payments. They could also provide for secure transmission of goods between stewards.

In order for this to work, some method needed to be developed to keep the transaction secure, that is, safe from tampering after the fact. Two methods were devised to do this. One was using tokens with perforations in them and stringing them together with a cord like a bracelet or necklace, and binding the ends of the cord with a lump of clay called a bulla. This prevented tokens from being added or removed to the string without breaking the clay “seal.”

The other involved sealing them inside a hollow clay “envelope” about 3-5 cm in diameter also called a bulla. The tokens were placed inside and the opening was pinched shut, and then the envelope was then fired. After it was fired, tokens could not be added or removed without breaking open the bulla.

Officials marked the bullae with clay seals testifying to the authenticity of the transaction. There were two types of seals-stamp seals and cylinder seals, which made impressions by being rolled across the wet clay. The seals were unique to the steward and usually depicted some type of religious imagery. The outer surface of the clay envelopes were often covered with seals, probably to make sure that a hole could not be made to add or remove items from the bulla without an official knowing. If any dispute arose about the contents of the bulla, both parties to the contract could break open the clay envelope and verify what was inside.

For some unknown reason, plain tokens were secured by envelopes, while more complex ones were secured with a cord. Both the seals and the tokens are found in burials, indicating that certain designated individuals were in charge of managing the surplus—a sure sign of burgeoning class inequality. Seals found buried with children indicate the transmission of intergenerational status.

http://it.stlawu.edu/~dmelvill/mesomath/tokens.html

3. Because it was unknown exactly what was inside the clay envelopes once they were fired, scribes made impressions in the outer surface of the wet clay to indicate what was inside. These markings are the first definite signs of writing in the sense of using abstract shapes impressed in clay to represent specific items and quantities. Number was still indicated by correspondence counting rather than abstract numerals.

After four millennia, the token system led to writing. The transition from counters to script took place simultaneously in Sumer and Elam, present-day western Iran when, around 3500 BC, Elam was under Sumerian domination. It occurred when tokens, probably representing a debt, were stored in envelopes until payment. These envelopes made of clay in the shape of a hollow ball had the disadvantage of hiding the tokens held inside. Some accountants, therefore, impressed the tokens on the surface of the envelope before enclosing them inside, so that the shape and number of counters held inside could be verified at all times. These markings were the first signs of writing. [1]

4. By the middle of the fourth millennium, instead of just being recorded on the bullae, impressions of tokens are recorded on flat clay tablets and fired. By 3200 BC, puffy clay tablet “receipts” are found recording various disbursements and transactions in temple archives. The tablets simply list numbers of quantities of items without purpose or context. The level of detail recorded by the tablets varied according to administrative level—more detail was recorded by scribes at higher administrative levels.

About 3200 BC, once the system of impressed signs was understood, clay tablets—solid cushion-shaped clay artifacts bearing the impressions of tokens—replaced the envelopes filled with tokens. The impression of a cone and a sphere token, representing measures of grain, resulted respectively in a wedge and a circular marking which bore the same meaning as the tokens they signified. They were ideograms—signs representing one concept. The impressed tablets continued to be used exclusively to record quantities of goods received or disbursed. They still expressed plurality in one-to-one correspondence. [1]

Eventually the clay tablets alone served to record transactions, taking the place of bullae. The tablets become the primary means of recording past and future transactions, even though both “technologies” continued to be used side-by-side for millennia. For unknown reasons, the clay tablet method was extensively adopted in southern Mesopotamia, whereas tokens continued to be the main method used in northern Mesopotamia. Clay tablet records were stored in temple archives, managing payments, contracts, receipts, loans, debts, and so on.

5. Eventually, when the quantities under consideration become too big for correspondence counting to work, symbols were established to separate quantity from the thing being counted – a symbol for “five” and “sheep” are combined together instead of repeating “sheep” five times. These numerals impressed in clay were derived from the shape of the token itself.

Early numerals were not abstract, but derived their value from association with the items they counted. The Sumerians used 60 different number signs grouped in a dozen or so metrological systems. For example, one system counted discrete objects like sheep, while other systems measured areas or volumes.

At the same time, the clay markings evolved into abstract symbols (pictographs) made with a wedge-shaped stylus rather than impressions of tokens. The wedge-shaped pictographs derived from the object they described:

Pictographs—signs representing tokens traced with a stylus rather than impressed—appeared about 3100 BC. These pictographs referring to goods mark an important step in the evolution of writing because they were never repeated in one-to-one correspondence to express numerosity.

Besides them, numerals—signs representing plurality—indicated the quantity of units recorded. For example, ‘33 jars of oil’ were shown by the incised pictographic sign ‘jar of oil’, preceded by three impressed circles and three wedges, the numerals standing respectively for ‘10’ and ‘1’.

The symbols for numerals were not new. They were the impressions of cones and spheres formerly representing measures of grain, which then had acquired a second, abstract, numerical meaning. The invention of numerals meant a considerable economy of signs since 33 jars of oil could be written with 7 rather then [sic] 33 markings. [1]

Sometime around the end of the third millennium BC during the Ur III period, a sexigecimal (base 60) place value notation system was devised. Each place represents a multiple of sixty (just as in our system, each place represents a multiple of ten. Sixty is the first number that 1,2,3,4,5, and 6 all factor into. It’s thought that counting was done by marking the phalanges of outstretched fingers in each hand with the thumb (three phalanges times four outstretched fingers). This could be repeated five times, using the fingers of the other hand to keep track (5 x 12 = 60). Base-60 actually has quite a few advantages. 60 is highly composite and easily divisible by 12 numbers simplifying fractional/decimal notation.

…the origin of the base 12 and of the related base 60 is an often-recurring question, even to non-mathematicians. The usual arithmetic (based on the divisors of 12) and or astronomical explanations (based on the number of moon-months) both are a posterior…

….a counting technique that considers parts of the fingers to represent the numbers from 1 to 12, is still in use in Egypt, Syria, Turkey, Iraq, Iran and Afghanistan, Pakistan, Indochina, India. The thumb of a hand counts the bones in the fingers of the same hand. Four fingers, with each three little bones, evidently yield 12 as a counting unit. The thumb itself is the counting tool, and its bones are not considered. Also, each dozen is counted by the fingers of the other hand, including the thumb, and the multiple 5 x 12 = 60 provides an additional indication of the often simultaneous occurrence of the duodecimal and sexagesimal base…

This physiological explanation for the duodecimal base is only a hypothesis, but number words as present day tribes in Africa use them, provide further evidence. N. W. Thomas [Tho] reported on such number words in his study of the West-African tribes in the region of the actual Nigeria. Between the rivers Benue and Gurara, which flow into the river Niger more westwards, live the Yasgua, the Koro and the Ham.

This explanation is not posterior like the arithmetical or the astronomical ones. This duodecimal base was indeed a practical one for what these early civilisations wanted to count or to represent. In the matriarchal societies, they could associate the number 1 to the woman, the number 3 to the man, and 4 to the union of woman and man. Or, in after some rather general evolution, they designated the male genitals by the number 3, and the genital symbol of women by 4, making 7 the symbol of their union. The number 4 seems to have been the most widespread of the mystical numbers. It was established by associations with colours, with social organisation, and with various customs among numerous tribes. The use of six as a mystical or sacred number was less extensively distributed through history and throughout the world than the four-cult, but sometimes a mythology past from quarters cult to a six cult. For example, the four cardinal points (such as North, South, East, West) are simply augmented by the addition of two other points (such as the zenith, above and nadir, below). On the other hand, the counting skills they obtained in this way, allowed them to note that there are 13 (moon)-months in one (solar) year, and not 12. [2]

The Babylonian cuneiform was not a true sexagesimal system as in there were not 60 different symbols. They basically represented numbers in a hybrid base-60 of a base-10. For example, thirty was made by repeating the symbol for 10 three times, forty was 10 repeated four times, and so on. Base sixty was likely chosen for ease of time/value calculations based on the length of the Mesopotamian year (a 360-day ‘fiscal year” with 5-and-change days set aside for festivals and debt forgiveness). Our divisions of a circle (degrees) and hours/minutes are also derived from this Mesopotamian base sixty, and are still in use.

…the sexagecimal number system of Mesopotamia in the historical period must have arisen from a fusion of a decimal system and a duodecimal system, and possible of a third element based on twenty. The widespread evidence for the very early duodecimal system, especially in the diffusion of the practice of dividing into twelve parts the wide band of fixed stars through which the sun passes its annual revolution (the zodiac), and the association of this feature with painted pottery gardening would indicate that the duodecimal system was characteristic of the Highland Zone Neolithic peasant cultures. The decimal usage probably came from the Semite peoples within the Fertile Crescent. If a vigecimal system also entered the mixture, it might have come from the south or southeast, for there seem to be, in the substrata of Mesopotamian culture, elements of tropical forest origin from this direction. [3]

We continue to use this counting method for time, which may make it somewhat clearer. Think of the value holders like this: (Hours) : (Minutes) : (seconds).

01:00 = 60
01:01 = 61
02:00 = 120
It takes the 60th count to turn the next value holder 1. So,
01:19=79
11:09=669

Interestingly, there is some evidence that the markings on the Ishango bone are based on a base-12 number system.

A good account of this process is given in this BBC article: How the world’s first accountants counted on cuneiform

6. Eventually, the need for recording proper names in contracts gave rise to the establishment of phonetic alphabets where symbols represented not words, but spoken sounds, typically syllables. This was done by using the word attached to a symbol to represent sounds.

For example, when Coca-Cola first arrived in China, shopkeepers needed a way to represent this new product. There was no pre-existing ideogram for “Coca Cola” in Chinese. They used a combination of Chinese characters which phonetically spelled out the sounds “Ko-ka-ko-la.” Many of these signs used the character pronounced “la” meaning “wax.” This led to all sorts of nonsensical phrases when it was read out loud, such as “female horse fastened with wax,” “wax-flattened mare,” and, most famously, “bite the wax tadpole” (eventually the company provided an ‘official’ transcription meaning, roughly, “to allow the mouth to be able to rejoice”). Nonetheless, clearly phonetic sounds were separated from what the ideograms represented. In such a way one could begin to separate the sound of the word from the pictographic image of what it represented.

In a similar fashion, when the system became adopted by the Akkadian culture, and Akkadian became the lingua franca of commerce during the Bronze Age, the need to transcribe proper names in written contracts led to ideograms being used to represent sounds rather than concepts. Transactions could be described in writing rather than just items and numbers, making them more meaningful:

With state formation, new regulations required that the names of the individuals who generated or received registered merchandise were entered on the tablets.

The personal names were transcribed by the mean of logograms—signs representing a word in a particular tongue. Logograms were easily drawn pictures of words with a sound close to that desired (for example in English the name Neil could be written with a sign showing bent knees ‘kneel’).

Because Sumerian was mostly a monosyllabic language, the logograms had a syllabic value. A syllable is a unit of spoken language consisting of one or more vowel sounds, alone, or with one or more consonants. When a name required several phonetic units, they were assembled in a rebus fashion. A typical Sumerian name ‘An Gives Life’ combined a star, the logogram for An, god of heaven, and an arrow, because the words for ‘arrow’ and ‘life’ were homonyms. The verb was not transcribed, but inferred, which was easy because the name was common. Phonetic signs allowed writing to break away from accounting…

After 2600–2500 BC, the Sumerian script became a complex system of ideograms mixed more and more frequently with phonetic signs. The resulting syllabary—system of phonetic signs expressing syllables—further modeled writing on to spoken language. With a repertory of about 400 signs, the script could express any topic of human endeavor. Some of the earliest syllabic texts were royal inscriptions, and religious, magic and literary texts. [1]

Far away in Egypt, totemic symbols were adapted to represent these sounds, resulting in the creation of hieroglyphic script. Proper names were recorded, and eventually the sounds of Egyptian speech were written down to transcribe the entire spoken language. Hieroglyphs are found on buildings such as tombs and temples. Early transactions were recorded on pottery shards. Later, the invention of papyrus from sedges growing along the Nile lead to the first written paper scripts.

Phonetic signs to transcribe personal names…created an avenue for writing to spread outside of Mesopotamia…The first Egyptian inscriptions…consisted of ivory labels and ceremonial artifacts such as maces and palettes bearing personal names, written phonetically as a rebus, visibly imitating Sumer…This explains why the Egyptian script was instantaneously phonetic. It also explains why the Egyptians never borrowed Sumerian signs. Their repertory consisted of hieroglyphs representing items familiar in the Egyptian culture that evoked sounds in their own tongue.

The phonetic transcription of personal names also played an important role in the dissemination of writing to the Indus Valley where, during a period of increased contact with Mesopotamia, c. 2500 BC, writing appears on seals featuring individuals’ names and titles. In turn, the Sumerian cuneiform syllabic script was adopted by many Near Eastern cultures who adapted it to their different linguistic families and in particular, Semitic (Akkadians and Eblaites); Indo-European (Mitanni, Hittites, and Persians); Caucasian (Hurriansand Urartians); and finally, Elamite and Kassite. It is likely that Linear A and B, the phonetic scripts of Crete and mainland Greece, c. 1400–1200 BC, were also influenced by the Near East. [1]

7. This system transformed from syllables to the letters as we know them today and spread via the activities of Semitic merchants and traders operating in the eastern Mediterranean. These traders would been familiar with the accounting techniques of the Near East, and their business was conducted with strangers. Since these were strangers, you needed contracts, and so you needed ways to write names and forms of speech. This allowed writing and numbers to grow beyond their original roots in managing centralized economies.

Semitic traders simplified the system into easily written “scratches” to represent distinct consonant sounds. A small repeating number of these “letters” could represent any language the Phoenician traders encountered.

Most vowels were not written in this system, a tradition which persists to this day in the Semitic alphabets of Hebrew and Arabic (although vowel marks are sometimes added). This may seem odd, but it works: I bt y cn rd ths sntnc evn wtht vwls.

The invention of the alphabet about 1500 BC ushered in the third phase in the evolution of writing in the ancient Near East. The first, so-called Proto-Sinaitic or Proto-Canaanite alphabet, which originated in the region of present-day Lebanon, took advantage of the fact that the sounds of any language are few. It consisted of a set of 22 letters, each standing for a single sound of voice, which, combined in countless ways, allowed for an unprecedented flexibility for transcribing speech.

This earliest alphabet was a complete departure from the previous syllabaries. First, the system was based on acrophony—signs to represent the first letter of the word they stood for—for example an ox head (alpu) was ‘a,’ a house (betu) was b. Second, it was consonantal—it dealt only with speech sounds characterized by constriction or closure at one or more points in the breath channel, like b, d, l, m, n, p, etc. Third, it streamlined the system to 22 signs, instead of several hundred. [1]

In the decentralized world after the Bronze Age collapse, this new system took the place of the Linear A and B recording systems of the earlier palace economies.

Alphabets appear to have arisen in only a few places and diffused from there, as this Reddit comment points out:

The cuneiform alphabets of the Middle East were ledgers first, then evolved into words. Egyptian hieroglyphs were totemic first, then evolved numbers and words. Chinese Han characters started as divination marks on turtle shells and ox bones. The Mayans started recording calendar days, and that evolved into a syllabic alphabet. My guess is that recording abstract information is a natural product of structured civilisation, which grows around cereal-based agriculture. That’s the common theme between all of them. Simple writing systems and totemic pictographs are a common theme all round the world. Where they really come into their own is in a trade-based central civilisation.

The “democratization” of script was to have a profound influence on Greek culture. Rather than just remaining in the hands of temple scribes and priests, many more people could use letters and numbers up and down the social ladder. They were not under the exclusive control of one particular social class. Due to the democratization of words and numbers, economic planning passed out of the hands of temple scribes and priests and engendered a radically decentralized approach to economic life. This eventually lead to markets and metallic coinage similar to our own system, as we’ll see.

2. Systems of Measurement

The other crucial innovation of accounting was metrology: partitioning items into discrete units that are divisible by one another. Although we take such measurement for granted today, the creation of standardized weights and measures continued until well into the nineteenth century with the establishment of the system international (SI) units of meter (distance), second (time), kilogram (mass), kelvin (temperature), pascal (pressure), and others. Standard weights and measures are as critical to bureaucracy as are writing and numerals.

Standardization is a fundamental aspect of state formation that is often overlooked. In this review of James C. Scott’s book, Seeing Like a State, Scott Alexander quotes Scott describing the difficulties faced by regional tax collectors in medieval Europe:

A hypothetical case of customary land tenure practices may help demonstrate how difficult it is to assimilate such practices to the barebones scheme of a modern cadastral map [land survey suitable for tax assessment][…]

Let us imagine a community in which families have usufruct rights to parcels of cropland during the main growing season. Only certain crops, however, may be planted, and every seven years the usufruct land is distributed among resident families according to each family’s size and its number of able-bodied adults. After the harvest of the main-season crop, all cropland reverts to common land where any family may glean, graze their fowl and livestock, and even plant quickly maturing, dry-season crops. Rights to graze fowl and livestock on pasture-land held in common by the village is extended to all local families, but the number of animals that can be grazed is restricted according to family size, especially in dry years when forage is scarce. Families not using their grazing rights can give them to other villagers but not to outsiders. Everyone has the right to gather firewood for normal family needs, and the village blacksmith and baker are given larger allotments. No commercial sale from village woodlands is permitted.

Trees that have been planted and any fruit they may bear are the property of the family who planted them, no matter where they are now growing. Fruit fallen from such tree, however, is the property of anyone who gathers it. When a family fells one of its trees or a tree is felled by a storm, the trunk belongs to the family, the branches to the immediate neighbors, and the “tops” (leaves and twigs) to any poorer villager who carries them off. Land is set aside for use or leasing out by widows with children and dependents of conscripted males. Usufruct rights to land and trees may be let to anyone in the village; the only time they may be let to someone outside the village is if no one in the community wishes to claim them. After a crop failure leading to a food shortage, many of these arrangements are readjusted.

Book Review: Seeing Like a State (Slate Star Codex)

Scott’s book reminds us just how much measurement and taxation are the harbingers of the coming of the state, even though these early states were not the impersonal professional bureaucracies that we associate with states today (China appears to have been the first to develop this). The creation of money and markets is what allowed for the state’s ability to channel resources to itself  to pay for soldiers and bureaucratic expertise, as we’ll see.

By the Babylonian period, complex time and material calculations were undertaken in the temples by officials in order to allow for mass production on a much larger scale than cottage industries. These activities, centered in the temples, were the first intentional surplus-generating activities to be undertaken by society. Such activities are not commonplace in traditional societies: production is mainly undertaken for subsistence and hoarding is explicitly discouraged.

Some tablets from the later Old Sumerian period detail bread baking, where a specific amount of bread is listed against the specification of its cereal ingredients, depending on quality as reflected in a production rate for a given type of bread. Other tablets included entries for bread and beer rations and the ingredients required to make them.

These tablets began by listing the names of individuals with the largest rations followed by those with smaller rations. At the end of the tablet, the amounts of bread and beer are totalled by type and the grand total for the flour and barley used was also recorded. The tablets were dated daily, and the scribes showed how the amount of flour corresponded exactly to the amount actually used in baking the bread, and the same applied to barley and beer…

…this checking of actual against theoretical amounts was “Perhaps the most important accounting operation introduced during the third millennium B.C.”…Deficits in one year, arising from shortage of actual amounts compared to theoretical amounts, were carried forward to the following year and were liable to later reimbursement…

…the entries record labour performance, along with theoretical credits and duties. The balancing of expected and actual labour performance was recorded at regular intervals for the foremen of the state-controlled labour force, using an accounting period of a 12-month-year, with each month being 30 days long, a time conception that corresponds exactly to that of ancient Egypt. Balances were carried forward to next periods; most frequently the balances were deficits (overdrawn) as the expected performances seem to have been “fixed as the maximum of what a foreman could reasonably demand of his workers”. Such balancing periodic entries were underpinned by some measure of standardisation of performance and a value equivalence system…[4]

In fact, the entire concept of leadership in these ancient societies appears to have been centered around concepts of fair and accurate standards of measurement, as Michael Hudson describes:

With writing and account-keeping came weights, measures, and standardizarion…Politically, the ideology of Mesopotamian cities was to create an evenly measured and “straight” cosmology of economic and social relations. Sumerian and Babylonian iconography represents rulers characteristically holding the measuring stick and coiled measuring rope to layout temple precincts. This defining royal task is illustrated on Gudea’s statues F and B in Lagash at the end of the third millennium. Such orientation aimed at grounding cities and their rule symbolically in the eternal regularities of natural order, as reflected in the celestial movements of the heavens.[5]

This “natural order” extended to the levies which were collected by the temples. This likely grew out of their role in coordinating the labor required to maintain the canal system which agriculture depended on. Their ability to accurately measure and plan future activities was a logical extension of their ability to scan the heavens and predict future floods and eclipses. From astronomy came the rest of their abilities.

These institutions were not dependent upon “taxpayer funds” unlike governments today; rather they were self-supporting enterprises, with prebends and dependent staff who were paid stipends (salaries) for their work. Because of their pro-social nature (they regularly aided widows and orphans), religious justification, and role in expanding the economy (they regularly produced goods for export), they were allowed to undertake activities such as charging rent and interest–the first written examples of this behavior. We might consider them to be the first antecedents of the modern business corporation (see future chapter).

What gave the ancient Sumerians the idea of charging one another interest? Linguistic evidence provides a clue. In the Sumerian language, the word for interest, mash, was also the term for calves. In ancient Greek, the word for interest, tokos, also refers to the offspring of cattle. The Latin term tecus, or flock, is the root of our word “pecuniary.” The Egyptian word for interest, like the Sumerian word, is ms, and means “to give birth.” All these terms point to the derivation of interest rates from the natural multiplication of livestock. If you lend someone a herd of thirty cattle for one year, you expect to be repaid with more than thirty cattle. The herd multiplies-the herder’s wealth has a natural rate of increase equal to the rate of reproduction of the livestock. If cattle were the standard currency, then loans in all comparable commodities would be expected to “give birth” as well. The idea of interest seems to be a natural one for an agricultural or pastoral society, but not so for hunter-gatherers. [6]

Just as with the scribes and viziers of ancient Egypt, a method had to be devised to standardize various tax, tithe, tribute, fines, and other payments owed to the central institutions from various entities. They also needed a way to evaluate how much was needed for time and material calculations. The way they accomplished this was to create a measurement unit, and to then use that unit to standardize the various goods and services produced by the diversifying Sumerian economy. In other words, a “unit of account.”

The earliest unit of account appears to have been a standard weight of a basket of barley, barley being the staple crop of the Sumerian economy. However, a more stable method was developed based on various weights of silver. This seems to have been related to silver’s role as a sacred substance whose storage and trade was controlled and manipulated by centralized institutions, that is, the temples and their high priests (what anthologists might call ‘prestige goods’):

…At about the same time as cities began to appear people started making ornaments out of electrum (an alloy of gold and silver), copper and gold, metals found naturally in nature. Metals have an almost unique, natural, physical property; they reflect light. The only other material that stone-age humans would have come across that reflected light would have been water, which along with sunlight is the basis of life. The first time a human spotted a nugget of gold sparkling in a river bed they must have experienced a sense of awe, here was an object that seemed to capture life-giving sunlight and water.

Religiously significant metals became important as temple offerings and temples began accumulate large reserves. Followers of the religion would look to acquire the metal, to enable them to make an offering to the gods, and so the metal became the commodity in the most demand.

The Ancient Egyptians, who had easy access to gold, used Cypriot copper for their religious offerings while the Cypriots used Egyptian gold. In Mesopotamia, the metal of choice was silver. When ‘Currency Cranks’ or ‘Bullionists’ argue that the economy would be improved by reverting to a Gold Standard because gold has an ‘inherent value’ they need to explain where is the value in gold, apart from its inherent symbolic, representative, value.

We don’t know much about economics in the ancient cities apart from for Mesopotamia, which has left hordes of clay tablets describing financial transactions. The economy was dominated by the temples who received rents and tribute, provided religious services and loans. The cuneiform tablets recorded the debits and credits associated with these activities. The transactions were denominated in shekels, crude bars of silver. Coins, metal tokens, rarely, if ever, actually changed hands.

Lady Credit (Magic, Maths and Money)

Another theory behind the use of silver bullion is derived from the fact that Mesopotamian city-states were not self-sufficient and needed to trade with each other on a regular basis. Silver was a universal standard of value, since the same religious ideas predominated across the Tigris/Euphrates valley, and this is what allowed is what allowed inter-city trading to take place. The value of silver percolated down through the rest of the society in “private” economic transactions by osmosis from temple activities (debt collection, tithes, trade, etc.)

In either case, money is a creation of the state through writing and measurement; it is not a spontaneous development arising out of countless market transactions. Silver derived from its ability to be accepted as payment to centralized institutions, and not from any intrinsic value. Impersonal economic transactions, to the extent that they existed, used this standard of value long before the emergence of coins or markets. As G.F. Knapp put it, “Within a state the validity of the kinds of money is not a trade phenomenon but rests on authority.”

Michael Hudson summarizes the creation of money in ancient Mesopotamia:

The kind of general-purpose money our civilisation has come to use commercially was developed by the temples and palaces of Sumer (southern Mesopotamia) in the third millennium BC…Their large scale and specialisation of economic functions required an integrated system of weights, measures and price equivalencies to track the crops, wool and other raw materials distributed to their dependent labour force, and to schedule and calculate the flow of rents, debts and interest owed to them. The most important such debts were those owed for consigning handicrafts to merchants for long-distance trade, and land, workshops, ale houses and professional tools of trade to ‘entrepreneurs’ acting as subcontractors.

Accounting prices were assigned to the resources of these large institutions, expressed in silver weight-equivalency, as were public fees and obligations. Setting the value of a unit of silver as equal to the monthly barley ration and land-unit crop yield enabled it to become the standard measure of value and means of payment…Under normal conditions these official proportions were reflected in transactions with the rest of the economy.

…The use of silver in their transactions was economized by the system functioning largely on the basis of debts mounting up as unpaid balances due. For small retail sales…the common practice for consumers was not to pay on the spot but to ‘run up a tab,’ much as is done in bars today[114]…such balances typically were cleared at harvest time, the New Year, the seasonal return of commercial voyages or similar periodic occasions. The most important debts were owed to the chiefs in tribal communities or to the public institutions in redistributive economies…[102]… and their official ‘collectors.’ …it also was through the commercial role of these institutions in long-distance trade that the monetary metals were imported and put into circulation.

The major way most families obtained silver evidently was to sell surplus crops produced on their own land or land leased from these institutions on a sharecropping basis. The palace also may have distributed silver to fighters after military victories, or perhaps on the occasion of the New Year or royal coronation…[115]

Silver’s use in exchange derived from its role as a unit of account. This is what gave it a general character beyond that of just another commodity… these public institutions were the ultimate guarantors of the value of silver, by accepting it in payment of obligations owed to them…

The units of measurement–the shekel in Babylonia and the deben in Egypt, and their various partitions– were the standard by which value was measured in these ancient societies. Yet all the evidence indicates that these standardized units were established and used thousands of years before “free” markets and profits played any significant role in daily economic life. While individual transactions in silver are recorded, it appears that most “commercial” transactions were written contracts – credit/debit relations. There were no coins. Daily transactions were likely undertaken through the traditional methods of redistribution, reciprocity and householding, as well as credit. As Henry summarizes in the case of Egypt:

…goods were…valued in terms of the deben (and labour services in the pyramid cities determined by the deben value of consumption goods), but no debens ever changed hands…In other words, money does not originate as a medium of exchange but as a unit of account (and something of a store of value with regard to the king’s treasury), where the measure of value is arbitrarily specified by decree, and goods and services of various qualities and quantities can then be assigned a monetary value to allow a reasonable form of bookkeeping to keep track of tax obligations and payments and to maintain the separate accounts of the king. It should also be noted that the deben did not serve as means of payment (as with modern money), but did function as the means (or measure) through which payment was made.

He quotes Alfred Mitchell-Innes, who came to the same conclusion from his survey of economic history in his pathbreaking article for the Banking Law Journal:

The theory of an abstract standard is not so extraordinary as it at first appears…All our measures are the same. No one has ever seen an ounce or a foot or an hour .. . We divide, as it were, infinite distance or space into arbitrary parts, and devise more or less accurate implements for measuring such parts when applied to things having a corporeal existence …

Credit and debt are abstract ideas, and we could not, if we would, measure them by the standard of any tangible thing. We divide, as it were, infinite credit and debt into arbitrary parts called a dollar or a pound, and long habit makes us think of these measures as something fixed and accurate; whereas, as a matter of fact, they are peculiarly liable to fluctuations (Innes, 1914, p. 155).

Essentially, the privileging of the “medium of exchange” aspect of money is not rooted in historical fact, but is based on economists’ desire to set up “free markets” and “private enterprise” as primordial and all state activity as an unnecessary and parasitical appendage. They need this in order to make their philosophical assumptions valid. In other words, this ahistorical view stems from the libertarian bias of modern economic “science” and not from true historical reality.

It is important to note that in Egypt (and this would accord with Mesopotamia and other areas) money was developed in a non-market, non-exchange economy. While some economic historians and anthropologists of a neoclassical persuasion diligently speculate that the Egyptian economy must have paralleled that with which we are now familiar, there is no evidence for exchange in the Old Kingdom. The Egyptians had no vocabulary for buying, selling, or even money; there was no conception of trading at a profit. It is very clear that there was no market in grains. A market economy (of a sort) and the monetization of the economy, including the production of coins, had to wait until Greek domination…

When these concepts become imported into Greek culture by Middle-Eastern traders after the Bronze Age collapse, they will become transmogrified into something closer to the kind of money and markets we know of today. This is the next crucial step in the evolution of money. We’ll consider that history next time.

[1] http://sites.utexas.edu/dsb/files/2014/01/evolution_writing.pdf

[2] Vladimir Pletser: Does the Ishango Bone Indicate Knowledge of the base 12? An Interpretation of a Prehistoric Discovery.

[3] Carroll Quigley: The Evolution of Civilizations, pp. 213-214

[4] Carmona and Ezzamel: Accounting and Forms of Accountability in Ancient Civilizations: Mesopotamia and Ancient Egypt. IE Working Paper WP05-21

[5] Urbanization and land ownership summary review

[6] William Goetzmann: Money Changes Everything: How Finance Made Civilization Possible.

[7] Wray, et. al.: Credit and State Theories of Money: The Contributions of Alfred Mitchell-Innes

The Origin of Money 3 – Two Paths to Money

1. Class and Religion

As the very first proto-states began to form in the great alluvial river valleys of the world some time around 8000 years ago, social relations were profoundly transformed. The switch from shifting cultivation to permanent holdings must have called for some sort of land distribution method. The resulting increase in population density created the need for some sort of authority which could allocate resources which were now becoming scarce—things like land and water. New and specialized tasks were called for, from creating bricks, timber and plaster for now-permanent dwellings, to creating storage vessels for grain (granaries, pottery), to digging drainage ditches, irrigation channels and water wells for cereal cultivation (as well as the need to manage all these activities).

Evidence indicates that at this time, class stratification emerged. Increasingly elaborate burials signify that some individuals had gained a measure of control over surplus resources. It is this development which is key to the development of money, not market transactions.

Egyptologist John Henry argues that the origin of money is intrinsically bound up with the transformation from egalitarian tribal societies to class-based societies. It is the ability of one class to impose non-reciprocal obligations on another, he argues, that is the basis of money, not voluntary self-interested transactions among equals. In other words, “…the rise of class society and inequality took place alongside the emergence of money, whereby money played a key role in establishing, maintaining and exacerbating inequality and class division in societies” [1]

Henry points out that traditional societies are egalitarian and have no need for money. They practice the “rule of hospitality” such that everyone is assured access to basic subsistence. Critical resources are owned and managed collectively. Everyone must contribute to the survival of the collective, but such obligations are reciprocal and not top-down. As the tribes made political decisions on a consensus basis, there was no way for one group to impose its will on the majority and gain control over all the surplus resources.

He argues that the uneven nature of creditor-debtor relationships would have precluded money from emerging under such conditions, since money presupposes a credit/debt relationship, and debtors are under one-way obligations to creditors (although this is not entirely correct–as we have seen, feasting is often used to create such unequal arrangements, albeit without formalized “money”).

In this society, there could be no debt. For every debtor there must be a creditor, and such a relationship is one of inequality with creditors having economic power over debtors. Such an arrangement runs counter to the rule of hospitality, violating the right of some – debtors – to subsistence. True, tribal members were placed under various obligations – they must contribute to production, provide for the well-being of their members, etc. – and debt is an obligation. But, such obligations were internal to the collective itself and of a reciprocal nature: all had obligations to all. There was no arrangement in which some would owe obligations to others in a non-egalitarian relationship [2]

Evidence indicates increasing cultural unification among villages along the Nile during the Naqada (pre-dynastic) period. Cereal farming practices spread southward from the delta during Naqada IA-IIB, and southern pottery depicts images of paddled boats which likely unified north and south. During Naqada IIC-D, we see a “cultural unification of Egypt” as funerary practices spread as well. More elaborate burial goods and segregated cemeteries indicate the presence of hierarchy at this time. During Naqada IIIA-B, it is thought that rule by hereditary kings was established (Dynasty 0), and by Naqada IIIC the first dynasty was founded, ushering in “official” Egyptian history. As Henry sums up: “Up to about 4400 BC, the evidence is that Egyptian populations lived in egalitarian, tribal arrangements. By the period 3200-3000, tribal society had been transformed into class society, and over the next 500 years the class structures became solidified around a semi-divine kingship.”

As class stratification emerged, reciprocal tribal obligations would have gradually been transformed into non-reciprocal obligations levied on the majority by a minority–a managerial class who controlled and managed surplus economic production. But how could a small subgroup gain control over the resources produced by the whole tribe? Such a transformation would not have been simply acquiesced to by the majority. As Henry states, “A segment of an egalitarian society cannot (and would not) simply set itself up as a separate and unequal class de novathe practice of inequality…would have to develop as a consequence of historical accident rather than conscious plan…

Henry’s hypothesizes that taxes began when reciprocal tribal levies became concentrated in the hands of administrator elites operating out of the Pharaoh’s household who were tasked with creation and maintenance of the hydraulic system. Through their role as managers of the Nile river, the hydraulic engineers would come to play an increasingly important role in the expansion of the Egyptian economy.

The need for material support for their efforts gave rise to levies to support these activities. While all members of society would benefit from such efforts, the hydraulic engineers would benefit more. Even a small degree of wealth differential would add up over time. At the same time, the engineers would have also garnered control over the trade in the goods moving up and down the Nile. Henry writes:

Given the traditional arrangements of tribal society, it is probable that members of a particular clan (or kinship group) were designated as hydraulic engineers. Such a group would organize the labour which was rotated out of other clans to construct the dykes, levees, and canals. They would also be in charge of the distribution of food, clothing, tools, etc. produced in the tribal villages and regularly sent to wherever the hydraulic system was being worked. And, they would gradually organize the increasingly regularized trade relations that the expansion of the hydraulic system required as the engineers would have the requisite knowledge of those requirements. This would also place them in the position of organizing the goods that served as exportables. In other words, these full-time engineers learned administrative skills beyond those required in the small communities of which tribal society consisted.

…As full-time specialists, they would develop skills and, in particular, knowledge that was not shared by all members of the community. And, as these populations became increasingly dependent on agriculture, they also become increasingly dependent on the specialized knowledge of the engineers…They were now full-time specialists who controlled a significant flow of goods and labour and upon whom the majority of the population were dependent. The old collective rights and obligations of tribal society were being abridged and one group – the majority – was increasingly obligated to another. Inequality was growing and now becoming marked…

As this process unfolded, the appearance of tribal society remained intact, while the substance was transformed.This prevented rival institutions from forming.

Egyptian society was traditionally organized on the basis of phyles. It is thought that these originated in prehistoric times as “totemic clans.” Members of various clans would rotate in and out of service in the king’s household. Increasingly, the king’s administrators usurped the roles formerly played by clan leaders:

The temple staff was organized into groups for which the conventional modern term is phyle (a Greek term meaning company, tribe). This was the common form of temple organization, with five phyles in the Old Kingdom, each one subdivided into two divisions, which apparently worked at different times. Each subdivision, of around twenty men, served for only one month in ten.

Presumably for the extended leave periods they reverted to agricultural or other work in their villages, so that the undoubted benefits of temple service—payments as well as prestige—were widely spread. Whatever ancient reasoning lay behind the system, the practical consequence was a sharing out of jobs by the state. The number of employees required was multiplied by many times, hugely increasing the numbers of people receiving partial support from the state.

Thus, it was a transformation of existing structures, rather than the creation of new ones, that ushered in class society. The same process took place roughly at the same time in Mesopotamia, where the household model remained intact while becoming “institutionalized:”

Johannes Renger (1995) succinctly states: “The records, both written and archaeological, indicate that large institutional households decisively determined the social and economic reality in southern Mesopotamia, i.e., Babylonia, at least since the latter part of the fourth and the beginning of the third millennium.” Kinship was neither marginalized nor replaced by a meritocracy of individualism, rather, an increasing managerial bureaucracy emerged that was controlled by kin-related individuals. Written records and archaeology provide evidence for the existence of large institutional households (oikoi) by the end of the fourth millennium. These institutional households were self-sustaining and autarchic economic units. The household (oikos) constituted the center of the productive economic activities we now handle through the market…[4]

The interdependence of villages up and down the river (and across the canal system in Mesopotamia) would have called for the engineers to apply their skills in a broader context than that of a single village. They would have formed a supra-regional authority to manage the entire watershed, since the agricultural activities one village affected all the others downstream. This would have expanded their reach beyond that of a single village, and far beyond that of the simple territorial clan leaders:

During years of low inundation, one village taking too much of the available water would endanger the production process of villages downstream. During periods of high inundation, failure to attend to needed repairs to the levees in one region would obviously affect not only that area but the whole valley beyond the breach. We also know that in this period, there was a significant shift in the ecology of this region resulting in greater aridity, thus a reduced water flow. Such a development would promote the need for control superseding any particular tribe’s needs or abilities.

Thus, the engineer-administrators, originally based in one tribal organization and practising egalitarian relations with other members of their tribe, would now be called upon to use their knowledge and skills to administer an extended physical area that would include any number of tribes. That is, the engineers increasingly saw themselves as independent of any particular tribe and were now responsible for the well-being of a large population, independent of tribal status…

To keep resources flowing in their direction, the old reciprocal back-and-forth tribal obligations had to be transformed into one-way, non-reciprocal ones. Henry speculates that this was accomplished by religious ideology. The hydraulic engineers became a full-time priesthood. “The older tribal obligations to provide the resources to construct and maintain the hydraulic system were now converted – in part – to maintain a privileged section of the population that no longer functioned, except in a ceremonial fashion, as specialized labour in the production process.”

Tribal societies practice totemic magic; where communication with long-deceased ancestors by the living is used to gain control over the invisible world underlying complex natural phenomena, such as the change of seasons and movements of stars, which were not understood by pre-scientific populations.

Totemism became supplanted by a specialized priesthood practicing “magic” which could intercede with the gods on behalf of humanity. The old tribal totems were converted to a pantheon of animal-headed gods(Horus, Thoth, Anubis, et.al.). The pharaoh became a divine entity who could intercede with the gods on behalf of humanity. An elaborate funerary architecture and death cult was established to justify these practices. Cosmological symbolism, reaching back to the herding origin of Egyptian culture, was appropriated to create a rich and complex mythology centered around the afterlife. The temples played an increasing role in both the spiritual and also the material management of Egyptian culture. But then again, magic has always really been about manipulating people’s psychology rather than any so-called invisible forces:

“The king had been chosen and approved by the gods and after his death he retired into their company. Contact with the gods, achieved through ritual, was his prerogative, although for practical purposes the more mundane elements were delegated to priests. For the people of Egypt, their king was a guarantor of the continued orderly running of their world: the regular change of seasons, the return of the annual inundation of the Nile, and the predictable movements of the heavenly bodies, but also safety from the threatening forces of nature as well as enemies outside Egypt’s borders.”

[…]

Essentially, the spirit world was converted to one of gods, and the control of nature, previously seen as a generally sympathetic force, was now in the hands of the priests. Nature itself became hostile and its forces, controlled by gods, required pacification through offerings. The king -the ‘one true priest’ – and the priests placed themselves as the central unifying force around which continued economic success depended. In so doing, they could maintain the flow of resources that provided their enormously high levels of conspicuous consumption and wasteful expenditures that certified their status as envoys to the natural world.

This encoding of celestial movements in the very earliest monoliths indicates that studying the movements of the stars, planets, sun and moon was associated with management of mass labor and religious concepts from the start. This association can be seen encoded in the form of the earliest cities. Every major priesthood in both the Old world and the New was obsessed with observing the heavens. The bones found with calendrical markings indicate that this probably dated back to the Ice Age with certain “sky chiefs” or shamans.

This ability to mark time and track the movements of the heavens was probably just as responsible for the establishment of the priesthood as was hydraulic engineering, as Carroll Quigley  observes:

…we might infer that, at some remote date, some unsung genius or, better, some observant family, saw a connection between the advent of the flood and the movements of the sun–two events that had not previously seemed connected. This individual or family noted that the rising sun appeared at a slightly different point on the horizon each morning, finally reaching a limit where it hesitated for a few days before it began to return…Thus was born a rudimentary idea of the solar year, the full duration of the sun’s movement back to its starting point. With this information the observer was able to estimate roughly the day on which the flood would arrive each year. This calculation the discoverers kept secret, for their own profit, using the knowledge to work on the fears and superstitions of their neighbors, trying to convince others that they possessed magical powers enabling them to foretell the arrival of the flood, or even the power to make it arrive.

The original discoverers of this information could hardly have told the arrival of the flood within a span of time much less than ten days. However, the fear engendered by the flood was so great, increased by the realization that the crops would fail if it did not arrive, that some, at least, accepted the discoverers’ claims and yielded to their demands for tribute. The discoverers probably offered to reveal the time of the flood in advance to those who would contribute a share of their crops, or perhaps they even threatened to bring the flood or to keep it away if they failed to obtain promises of tithes from the crops of their neighbors. However skeptical these neighbors might be of such claims the first year, no more than one lucky forecast was needed for most of them to become willing givers…The ignorance of the majority made it easy for the possessors of this specialized knowledge to use it as proof that they had supernatural powers.

Moreover, it was not necessary to convince a majority or even many of their neighbors. If any small number contributed, a surplus would accumulate which could be used, in the form of flood protection embankments or irrigation ditches, to provide very concrete evidence that it was worthwhile to belong to the new organization. Thus came into existence the central institution of ancient Mesopotamia–the Sumerian priesthood.

This priesthood became a closed group, able to control enormous wealth and incomes, and concentrated very largely within the study of solar and astronomical periodicities on which their influence was originally based. With the surplus thus created, the priesthood was able to command human labor in large amounts and to direct this labor from the simple tillage of the peasant peoples to the diversified and specialized activities that constitute civilized living. Above all, this centralized direction provided the system of flood control and irrigation on which all subsequent progress was founded. Similarly, these priest-controlled surpluses provided the capital for the many inventions of the age of expansion of Mesopotamian civilization. [5]

Mass labor was channeled to building the elaborate funerary architecture and temples of the Egyptian state religion. In the days before mass media, the prevailing cultural ideology had to be encoded and reinforced by brick and stone. This labor was also organized by phyle. The priestly caste, rather than the tribal leaders, were now perforce the ruling class:

Under the new social organization, tribal obligations were converted into levies (or taxes, if one views this term broadly enough). The economic unit taxed was not the individual but the village. As well, the king and priests did not arbitrarily assign a tax level on the village, but tax assessors and collectors (scribes) met with the village chief who would assemble the village council to negotiate the tax. This appears to have been done on a biennial basis known as ‘counting of cattle’, a census that also served as the dating for the various reigns of the king. Should a village renege on its obligation (default), the chief responsible for the collection of taxes could be flogged by the scribes.

Note that such a punishment makes the chief responsible to the priests rather than to the clan, further eroding the substance of tribal relations. Supervising all the local or regional scribes, and assuring both competence and honesty in this process, was a vizier who exercised central authority in the name of the king.

The central authority used their control over society’s resources to establish a redistributive economy, run through pharaoh’s household. The redistributive economy reinforced the need for levies-cum-taxes from the general population, which were channeled through the Pharaoh’s household and back through all strata of the Egyptian economy:

Tribal reciprocity, though not totally abrogated, was no longer the universal standard among the Egyptian populations, and was replaced by an economy of limited redistribution...while the substance of tribal society was increasingly gutted, the emerging class had to maintain the forms of that organization. This was necessary in order to present the veneer that nothing fundamental had changed when, in fact, everything of substance had been altered…

The economic surplus collected in the form of taxes was directed toward the priests who then redistributed some portion through the various levels of the bureaucracy, the temple artisans, and the workers who laboured on the various religious and hydraulic projects. Hence, Egyptian society (along with others of this type) can be labelled an economy based on ‘redistribution’.

However, it is important not to misunderstand the nature of this term. Such economies did not engage in full redistribution as it would defeat the whole purpose of such an economy if all production were to be first directed to the centre, then flow back through all segments of society in some elaborate redistribution system. Not only would such a system be markedly inefficient, but what would be the point?

Rather, only a portion of the economic surplus, produced by the majority of the population, would flow to the centre, and this share of output would then be apportioned among the minority segments of society as stated above. The priests, of course, would claim the lion’s share.

Simple redistribution would not be enough to secure coercive power, however. In that case, you would be just an intermediary, collecting everything and giving it away. Instead, many of the resources thus collected would be channeled into image building activities: construction projects, hiring specialized craftsmen, acquiring a retinue of retainers and advisors, engaging in overseas trading missions, infrastructure improvements, military campaigns, religious rituals, and other such activities. It is through these activities that redistributive economies, made possible through taxation, became centralized institutions of power cemented in the hands of a hereditary elite.

As long as a chief merely returns everything he has been handed, he gains nothing in wealth or power. Only when he begins to keep a large part of it, sharing it with his retainers and supporters but not beyond that, does power begin to augment…the power of a chief to appropriate and retain food does not flow automatically from his right to collect and redistribute it. Villagers freely allow a chief to equalize each family’s share of meat or crops through redistribution because they benefit from it. But they will not willingly suffer the same chief to keep the lion’s share of food for himself. Before doing this, he must acquire additional power, and that power must come from another source.

The word “redistribution” is often used very loosely. Whenever the word is applied in describing the activity of a chief we should ask two questions (1) “What percentage of the food or goods taken in by the chief is actually redistributed?” (2) “To what percentage of the population are they redistributed?” For chiefly disbursement to be genuine redistribution, both percentages should be high. If the percentages are small, what we have is not real redistribution at all, but something more akin to taxation. And it is in taxation that the sinews of government really lie. When a chief can compel the population to turn food and goods over to him, which he can then apply at will, he is at last manifesting power.

By the selective distribution of food, goods, booty, women and the like the chief rewards those who have rendered him service. Thus he builds up a core of officials, warriors, henchmen, retainers, and the like who will be personally loyal to him and through whom he can issue orders and be obeyed. In short, it is through shrewd and self-interested disbursement of taxes that the administrative machinery of the chiefdom (and the state) is built up. However, the chief who does this is no longer a redistributor, he is an appropriator and a concentrator… Summarizing his findings for chiefdoms generally, Steponaitis noted: “What formally appears to be a redistribution in complex chiefdoms is functionally more akin to the collection of tribute than the institutionalized sharing of surplus.” [6]

This process probably came about through military conquest.

By the fourth millennium BC, three proto-states emerged along the Nile River: This, Naqada, and Heirakonopolis, each centered on a capital city. These shared a common culture, but competed politically. These polities came to be dominated by Heirakonoplis (Nekhen), which went on to unify Upper (southern) Egypt. Upper Egypt conquered the chiefdoms of Lower Egypt (the Nile Delta), creating the Egyptian state and the first dynasty, as depicted on the Narmer Palette. Depictions of martial conquest remained in royal iconography through Egyptian history.

A military needs supplies–food, weapons, and so forth, to wage war. In cases of attack by outsiders, everyone is expected to contribute to common defense. Military operations would also have required levies from the general population. Armies need to be provisioned and fed, and this can only be done with forward planning and large storehouses. But it’s not fair to just requisition supplies from producers who make things directly related to military use. It would have violated egalitarian norms of shared sacrifice in wartime. The answer for this situation was to raise a general levy across the population to support military efforts, even from who produced items not directly related to military use like coppersmiths and chariot-makers.

These contributions would have been paid to those who could organize the surplus in collective defense of the territory, mobilize labor in the form of troops, and engage in successful territorial expansion. The resources of the conquered territories would then flow into the same bureaucratic structure. This process continued apace, as the villages along the Nile became assimilated into a single culture under the reign of a single ruler.

No state is known to have arisen directly from the fusion of autonomous villages. all seem to have been formed through the coalescing of groups already aggregated into supravillage units. Such units were, by my definition, chiefdoms. Moreover, because the aggregation of villages occurs only through war, or the threat of it, any theory of the origin of chiefdoms that foregoes this mechanism is severely handicapped…Once chiefdoms begin to form in a region, the process proceeds rapidly. The military advantage that size alone confers on a society means that even a minimal chiefdom will have a significant edge over its neighbors if they are still independent villages. as a result, it will not be long before autonomous villages as such will cease to exist. Either they will be defeated by and incorporated into one of the existing chiefdoms or they will join forces with other such villages in a defensive alliance, which will itself tend to become a chiefdom. [7]

Eventually, foreigners would become subjugated as well. When populations were overrun, they became subject populations where wealth was regularly extracted from them in the form of tribute. Tribute is essentially an extortion payment from a militarily weak population to a stronger one in order to leave them alone. To collect this tribute, a top-down political apparatus was established which funneled resources from the periphery to a core.

In addition to the portion of the surplus collected now as taxes, the king also collected royal gifts as a form of tribute from foreign populations. As the goods that formed this income could be in the same form as the income that flowed from the internal population, but was the property of the king proper, it had to be kept apart from the internally generated income…

The later Haxamanishya-Akhaemenid-dynasty Persian emperors of 550 to 330 BC, who ended up controlling much of the Near East, perfected this technique. Rather than killing or enslaving defeated populations, they kept them alive and allowed them to live in peace under the rule and laws of the imperial power. In exchange, they set up a tax system which funneled a portion of their economic output into the imperial treasuries. They became, in essence, farmers who kept peasants instead of livestock. This goes to prove Stanley Diamond’s observation that “Civilization originates in conquest abroad and repression at home.” [8]

The necessity of managing these diverse resource flows called for the creation of a bureaucratic structure. Taxes and tribute were assessed in a unit of account, usually a reference to a certain set measure of weight. It was this standard, that is the origin of money, not some sort of intermediate good chosen to reduce barter costs. On this point, the evidence is unambiguous:

At some early point in the Old Kingdom, the growing complexities of the new economic arrangements required the introduction of a unit of account in which taxes and their payment could be reckoned and the various accounts in the treasury could be kept separate and maintained. This unit was the deben (and its fractional denomination, the shdt- 1/12 of a deben)…The fact that the deben bore no relation to any specific object, but referred to an arbitrary unit of weight only, is a certain indication that Egyptian money was decidedly not based on some ‘intrinsic value.’…In other words, money does not originate as a medium of exchange but as a unit of account (and something of a store of value with regard to the king’s treasury), where the measure of value is arbitrarily specified by decree, and goods and services of various qualities and quantities can then be assigned a monetary value to allow a reasonable form of bookkeeping to keep track of tax obligations and payments and to maintain the separate accounts of the king.

It should also be noted that the deben did not serve as means of payment (as with modern money), but did function as the means (or measure) through which payment was made….money as simply a non-tangible abstract unit in which obligations are created and discharged, while it may appear obtuse to a modern economist, should not be all that difficult to comprehend….

2. Tribal obligations and Weregild

A second route to money stems from ancient penal systems set up by tribal societies.

In tribal societies, when a crime is committed, the transgressor is required to make restitution payments to the victim and/or the victim’s family/clan/tribe. The transgressor is considered to be “indebted” or “liable” to the victim(s) until such payment is made. In many languages, the word for “debt” is analogous to the words designating “sin” or “transgression.” Also, the verb “to pay” has its roots in words meaning “to pacify, “to appease” or “to satisfy.” This indebtedness continues until such time as restitution is paid to the victim and balance is restored.

Many Indo-European cultures practice the notion of “blood-wealth,” or Weregild. The term derives from wair meaning man, and gildan meaning “to pay” or “to render.” These were fines assessed by tribal councils and public assemblies and paid directly to the victims or their families in order to prevent blood feuds from escalating out of control. “A long list fines for each possible transgression was developed, and a designated “rememberer” would be responsible for passing it down to the next generation. Note that each fine was levied in terms of a particular good that was both useful to the victim and more-or-less easily obtained by the perpetrator.”

Often, violations were associated with a specific fine based on the severity of the offense. The Code of Hammurabi and the Salic law both specified very specific compensation payments for various offenses (such as gouging out an eye, or cutting off a nose, or manslaughter—must have been fun times back then!). In tribal societies, these could be assessed in terms of cattle, grain, goats, chickens, and even (in ancient Ireland, for example) slave girls!

These payments were originally assessed on a case-by-case basis rather than a regular unit of account. However, over time the idea of weregild gave rise to the idea of general monetary debts owed to authorities, including fees, tithes, taxes, and tribute. “The key innovation, then, lay in the transformation of what had been the transgressor’s debt to the victim to a universal “debt” or tax obligation imposed by and payable to the authority.”

It is almost certain that weregild fines were gradually converted to payments made to an authority. This could not occur in an egalitarian tribal society, but had to await the rise of some sort of ruling class. As Henry argues for the case of Egypt, the earliest ruling classes were probably religious officials, who demanded tithes (ostensibly, to keep the gods happy). Alternatively, conquerors require payments of tribute by a subject population. Tithes and tribute thus came to replace weregild fines, and fines for “transgressions against society”, paid to the rightful ruler, could be levied for almost any conceivable activity. Eventually, taxes would replace most fees, fines and tribute.

Once debts are paid to a central authority, it is unwieldy to juggle all the various types of objects that can be paid. “When all payments are made to the single authority…this wergild sort of system becomes cumbersome. Unless well-developed markets exist, those with liabilities denominated in specific goods or services could find it difficult to make such payments. Or, the authority could find itself blessed with an overabundance of one type of good while short of others.” [9]

For example, tribal payments in ancient Ireland were made in slave girls called kumals. But over time, this became cumbersome, and kumals became simply an abstract unit of account:

Probably the second century a.d. saw the kumal transformed into an abstract unit of account. The laws under King Fegus, king of Uldah, required a blood money payment of “seven kumals of silver” and “seven kumals of land” for the murder of anyone under the king’s protection. These laws clearly show that land and silver were mediums of exchange, and kumals were only a unit of account. These laws were set forth in two legal texts, the Senchus Mor and the Book of Aicill, both of which contained a table legally sanctioning the kumal standard. According to this table:

8 wheat-grains = 1 pinginn of silver
3 pinginns = 1 screpall
3 screpalls = 1 sheep
4 sheep = 1 heifer
6 heifers = 1 cow
3 cows = 1 kumal

The example of slave-girl money in Ireland brings to the forefront four separate functions of money. Money serves as a medium of exchange, a store of wealth, a unit of account or measure of value, and a standard of deferred payment. The slave-girl money evolved into a unit of account only, while the other roles of money were filled by various commodities, land, and precious metals.

Slave Currency of Ancient Ireland (Encyclopedia of Money)

Once again, money arises out of the ability to extinguish a debt, in this case one’s “debt to society”:

According to this view, money is essentially an instrument that denominates and extinguishes social debt obligation. It first quantifies debt obligation between individuals. For example, Joshua has conducted wrongdoing to Henry; hence the public authority determines that Joshua owes to Henry one cattle. In this case, that cattle is the “money” that effectively extinguishes Joshua’s liability/debt to Henry. …Money of account might be a cattle between Joshua and Henry, and then ten watermelons between Helen and Linda, etc.

However, when there emerges the need to denominate debt obligation between individuals and the “society”/central authority in various forms (such as fines, fees, taxes, etc.), a standard unit of account for money was needed to serve as the standard measure of value. By choosing a unit of account as the only means for individuals to extinguish his/her liabilities to themselves, the central authorities “write the dictionary” (Keynes, 1930). Hence, the power of the central authority (state, temple, tribe, etc.) to impose a debt liability (fines, fees, taxes, etc.) on its population gives the former the unique right to choose a particular unit of account as the only means of payment to the central authority.

3. Conclusion

Although these paths to money differ, they are fundamentally similar and provide a historically supported and logically consistent account of the transformation from primitive money to more modern forms.

In both of these scenarios, payments are made to some sort of institutional authority tasked with social maintenance, whether adjudication of disputes, execution of justice, military operations, communal redistribution and welfare, or maintenance of critical infrastructure. As Wray states, “The unit of account is the numeraire in which credits and debts are measured.” Only when this “unit of account” is established can markets form. Thus, both money and markets are creations of the state and are rooted in social hierarchy and inequality.

Two further critical inventions are required to create such a numeraire: accounting and measurement. We’ll discuss how those innovations came about next time.

[1] Semenova and Wray. The Rise of Money and Class Society: The Contributions of John F. Henry (WP 832)
http://www.levyinstitute.org/pubs/wp_832.pdf (2)

[2] John Henry: The Social Origins of Money: The Case of Egypt. In Credit and State Theories of Money: The Contributions of Alfred Mitchell-Innes. Randall Wray and Edward Elgar, editors. Subsequent passages from Henry are also taken from this work unless noted otherwise.

[3] Barry Kemp: Egypt: Anatomy of a Civilization, pp. 166-168

[4] C.C. Lamberg-Karlovsky: Households, Land tenure, and Communication Systems in the 6th-4th Millennia of Greater Mesopotamia. In Urbanization and Land Ownership in the Ancient Near East. Michael Hudson and Baruch Levine, editors.

[5] Carroll Quigley: The Evolution of Civilizations, pp. 211-213

[6] The Transition to Statehood in the New World. edited by Grant D. Jones, Robert R. Kautz, Cambridge University Press

[7] ibid.

[8] Stanley Diamond: In Search of the Primitive: A Critique of Civilization

[9] L. Randall Wray: The Credit Money and State Money Approaches (Working Paper 32)