The Origin of Paper Money 8

US one dollar bill, obverse, series 2009.jpgThis is sort an afterward or corollary to our story of paper money. This describes how we here in the United States ended up with the “Almighty Dollar.” Believe it or not, this was not present after the Revolution, but took a very long time to materialize.

The history of central banking in the U.S. is too much to get into here, but this post from the Minneapolis Fed sums it up probably better than I could: A History of Central Banking in the United States. It’s actually a good summary and a quick read. The WEA Pedagogy blog cited earlier has come out with a second post on the development of central banking in Europe in the nineteenth century: Central Bank History (2/5) 1814-1914 Hundred Years Peace

Believe it or not, at this time, aside from minted coins, there was no national paper currency in the United States. Not only that, but state governments were actually prohibited from issuing their own currency! Instead, as in other Western nations, the government permitted people to use whatever they wanted as currency. Only private banks issued banknotes:

Before the Civil War, the United States was on a bimetallic system with both gold and silver serving as the basis for money. Practically, however, gold was the de facto standard since very little silver coin was in circulation. American currency consisted of bank notes and coin, with the bank notes convertible on demand into specie: paper money was thus “backed” by gold.

The federal government issued no paper currency of its own and there were no federally chartered banks; state banks issued thier own bank notes. Thus in the 1850s the domestic monetary system was comprised of may hundreds of different state banks, each issuing its own paper currency.

This was problematic since the value of a bank note (as opposed to its face value) depended on the financial status of the issuing bank, and, with so many different banks, it was hard to know what money was worth.

Furthermore, there were no deposit insurance programs and no central bank. In contrast to the state banking system, the international gold standard served the United States well since its biggest trading partner and creditor, Great Britain, was also on the gold standard.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

In this era, banking was regulated by the states. Despite their importance to the financial system, pretty much anyone could start a bank and issue their own banknotes; all they needed was sufficient startup capital. This was called “free” banking by its proponents, but it acquired another less complimentary nickname: wildcat banking

By action of the state legislatures a bank was held to be not a corporation, which then and for many more years required a charter from the state, but a voluntary association of individuals and thus, like blacksmithing or rope-making, open to anyone. There were rules, most notably as to the hard-money reserves to be held against notes and deposits…But frequently failure to abide by regulations was discovered only after the failure of the bank made the question academic… (Galbraith, p. 88)

Although banks were required to held enough gold reserves to be able to redeem their banknotes in specie on demand, often that could be circumvented just by moving a set amount of gold around the state ahead of the regulators, as in Michigan:

…[I]n Michigan…commissioners were put in circulation to inspect the banks and enforce the requirement [of 30 per cent reserve of gold and silver against note circulation]…Also put in circulation just in advance of the commissioners, was the gold and silver that served as the reserve. This was moved in boxes from bank to bank; when required, the amount was extended by putting a ballast of lead, broken glass and (appropriately) ten-penny nails in the box under a thinner covering of gold coins. p. 88

The results, as one might expect, were not good:

by the time of the Civil War, the American monetary system was, without rival, the most confusing in the long history of commerce and associated cupidity. The coins coming to the Amsterdam bourse were simplicity itself by comparison.

An estimated 7000 different banks notes were, in greater or lesser degree of circulation, the issue of some 1600 different or defunct state banks.

Also, since paper and printing were cheap and the right of note issue was defended as a human right, individuals had gone into the business on their own behalf. An estimated 5000 counterfeit issues were currently in circulation.

No one could do any considerable business without an up-to-date guide that distinguished the wholesome notes from the less good, the orphaned and the bad. A Bank Note Reporter or Counterfeit Detector was essential literature in any significant business enterprise. (Galbraith, p. 90)

It was not a recipe for financial stability, to put it mildly. NPR’s Planet Money describes the situation on the ground during the pre-war era of wildcat banking:

So I’m looking at the Howard Banking Company’s $5 bank note. It’s…a Santa Claus note…You get a picture, I think, of the bank president up in the left-hand corner. And then right in the middle, you get a picture of Santa Claus on a sleigh.

So what basically this note will do is that if you have this note, Santa Claus and all, you’ll go to the Howard Banking Company. And they are obligated to pay you $5 in gold and silver coins if you demand it at their bank.

If you demand it at their bank, but nobody else outside that bank is required to give you gold or silver for the note or, for that matter, even to accept it at all. Sometimes people might choose to take the bill at full face value. Sometimes they might not want it. Sometimes they’ll say, yeah, I’ll accept it but it’s a $5 bill. I’ll give you $4 for it. A dollar bill was not always worth a dollar in this world.

Now, you could argue – and some people do – that this universe of 8,000 different kinds of currency is the free market at work and that this market for bank notes helped keep banks honest. But this world, it did create huge problems for people…

The Birth Of The Dollar Bill (NPR)

What kind of problems did it create?

What if you run a store? What if you run that bar in New York and some guy walks in and gives you some bill that you’ve never seen before? What do you do? Well, that’s when you take out your trusty bank note reporter, this huge book the size of a phone book. This thing, it tells you what bills are in circulation, what they’re supposed to look like and how much they might be worth.

You would take out this big…encyclopedia-looking thing…You’d look in this. You’d find the Howard Banking Company list. It would then tell you where the bank was. And then it would tell you at what discount the note was to be accepted at.

So, for instance, if this was a particularly good bank, $5 note would trade at $5. You, as a bartender, would accept it at that. If it was trading at a discount, it would also say that. If the bank had defaulted, you’d know that. And you’d know that it’s worthless and not to accept it.

And these books, new ones come out every month to keep up with the news. And you have a different book for every city. This is because a bill from, say, a Boston bank might be worth $5 in Boston but only $4 in New York. Usually, the further you get from a bank, the less its money is worth. People’s money loses value just because they’re traveling.

The Birth Of The Dollar Bill (NPR)

In fact, it could be argued that entire monetary history of the United States after the 1830’s was one long clusterfuck. Although the United States would accidentally create, for the first time, a true national paper currency due to the financing needs of the Civil War, it would undermine those innovations after the war by trying to go back on the gold standard. The use of a bimetallic (gold & silver) standard was a sort of compromise  position between gold and fiat. But back then endless debates about the true nature of money (much like today) had no clear resolution:

In the accepted, and it must be added, far from the inspired view of the monetary history of the United States, the years after 1832 were deplorable. Free banking, the resulting bank failures, then greenbacks, agitation for more greenbacks and the pressure, partly successful, for the coinage of cheap silver combined with the recurrent panics to make the financial system of the United States, as Andrew Carnegie held, ‘the worst in the civilized world.’ (Galbraith p. 85)

Greenbacks and National Banks

What brought this madness to an end was, once again, war–this time the United States Civil War. The northern and southern United States split into two separate nations who immediately went to war with each other for control of the North American continent, especially its western expansion.

The industrialized Union needed to raise funds to prosecute its war against the predominantly agrarian Confederacy. because the Confederacy was the source of nearly all the cotton for a massive sector of England’s economy, the South believed that England would intervene on their behalf to put an end to the “cotton famine.” England did not, instead finding other sources of cotton in Egypt and India.

The escalating cost of the war forced the Union government to go off of the international gold standard and–much like in the Revolutionary war—issue fiat money. And the ultimate in fiat money were the greenbacks. They were called this because they were printed in green ink (as is U.S. money today, which is often informally referred to as ‘greenbacks’, but this is something different). The U.S. government issued slips of paper and used them to pay its contractors and suppliers. It declared them to be good for payment of all domestic debts, by law (fiat). And, crucially for MMT concepts, they could be used to settle all debts with the federal government—i.e. taxes, fees and fines. Greenbacks were not good for international debts, customs duties and interest payments on the national debt. Greenbacks were not convertible into gold, and no one claimed that they were. But they were the first true national paper currency, and were useful all across the country (outside of Dixie), unlike the state bank notes. Thus, they began to circulate more broadly throughout the economy.

With the outbreak of the [Civil War], the U.S. economy was severely disrupted, and U.S. government revenues plunged as Union military expenditures soared. The fiscal crisis of the Northern state meant that it could not pay its suppliers and contractors. Moreover, speculators hoarded gold and there was a general liquidity crisis.

By the end of 1861, Northern banks had to suspend convertibility and cease to exchange specie for their bank notes. Thus, the United States went off the gold standard.

The daunting problem facing Salmon Chase, then secretary of the treasury, was a daunting one: how to fund public spending with a huge deficit and an inconvertible currency?

The first step toward a solution began in early 1862 when the government issued greenbacks, inconvertible paper money that by law was legal tender…The government also raised new taxes (including tariffs and an income tax) and borrowed to cover the deficit…By the end of the war, issuance of $450 million of greenbacks had been authorized, and the total currency more than doubled between 1861 and 1866…

Greenbacks were never thought to be a permanent solution, much less a new type of currency for the United States; rather, they were seen as a stopgap measure. It was thought that after the war, they would be replaced by “real” money, that is, money backed by gold:

…this was basically the first dollar bill issued by the U.S. government, though during the war, these dollars, they were not always worth a dollar in gold…So this was not a plan to establish a single national currency. It was a plan to fund war…

[T]he greenbacks…were seen as an emergency thing, something a government would only do in time of war. The underlying belief was that these greenbacks were temporary in the sense that we would issue them, the war would end and that…within 10 years, they’d be gone. The problem was that the consumers kind of liked them. Would you rather use a bill issued by a bank you’re not sure exists or would you want to use a bill that everyone recognizes?

Despite increased taxes and the issuance of greenbacks, the government’s costs continued to soar as the war raged on:

Thus, federal revenues grew thirteenfold…but…the national debt grew from $65 million to 2.7 billion…

To cover this national debt, the government needed to borrow. How would it do that? The usual way for governments to borrow was to sell war bonds. But the Union came up with an ingenious idea to encourage loans to the government: If one bought U.S. government bonds (which is loaning money to the government, remember), then they could use those bonds as backing to open a national bank, as opposed to a state bank. Thus, a system of national banks was created for the first time.

The national banks were different from the state banks in several crucial ways. Most notably, if you had bonds held by the U.S. government, you could issue “official” U.S. government banknotes against them. What was backing these banknotes was, of course, the government’s debt (i.e. the loans to the government). Thus, once gain we see that paper money represents the government’s liabilities. The more government debt, the more money that could be issued. This is basically the MMT conclusion: the government’s debt represents the savings surplus of the private sector.

To encourage loans to the government, a new system of nationally chartered banks replaced the old one of state-chartered banks … national banks … are regulated not by states but by the federal government. These banks are created during the Civil War and they also help raise money for the Union because in order to be a national bank, you had to buy government bonds. In other words, you had to lend money to the government.

The Birth Of The Dollar Bill (NPR)

The National Banking Act of 1863 mandated the creation of national banks whose notes were backed by government bonds. Upon deposit of federal bonds with the comptroller of the currency, investors could establish a private bank and issue national bank notes up to 90% of the value of the bonds….this made it profitable to organize national banks and thus to loan money to the government by purchasing its bonds.

The government also placed a tax on the state bank notes:

Though predictably the state banks opposed the National Bank Act, initially they did not suffer. The suspension of specie payments in 1861 relieved them of the always unwelcome need to redeem their notes in hard cash. The greenbacks … were made legal tender and served instead.

But on 3 March 1865, a mere month before Appomattox, the financial power again asserted itself. Congress was persuaded to pass additional legislation sweeping all state notes away.

A tax of 10 per cent per annum was levied on all state bank issues with effect from 1 July 1866. It was perhaps the most directly impressive evidence in the nation’s history that the power to tax is, indeed, the power to destroy.

Bank failures continued after the banning of the notes and on some years were epidemic – 140 suspensions in 1878; 496 in 1893; 155 in 1908. Most of the casualties were small state banks. For another sixty-five years these continued to be created. and the resulting loans and deposits continued to put or sustain marginal but aspiring farmers and deserving and undeserving entrepreneurs in business. (Galbraith, pp. 91-92)

Between the failures of state banks and the increasing desire to use national banks, the dollars issued by the national banks gradually took over–another manifestation of Gresham’s Law. This proves another point – that the credit that is most favored is that of the sovereign rather than that of other individuals.

Of course, you could say the the government put their thumb on the scale by taxing the state banknotes.This is often depicted by the usual suspects as a diabolical statist plan by the “evil” government to take over the money supply and crush “freedom”. While I couldn’t find the rationale for doing this, one could make the point that since the state banks were not providing funds for the war effort, the tax was an entirely justifiable way to force them to contribute to the war effort in another way.

The net effect was a decline in state banks and an increase in the importance of the national banks:

From 1860 to 1870 the number of state banks declined from 1,579 to 261, while the number of national banks went from zero to 1,612. National bank notes were legal tender in the same way that greenbacks were: payable for all public and private debts, except for import duties and the interest on the national debt. The new national banking system also helped standardize the currency, although that was not its primary intent.

For all its problems, the national banking system fulfilled its original purpose of selling government bonds and funding the war. In addition to would-be bankers, government bonds were sold directly to the public, an innovation promoted by the financier Jay Cooke. By enlisting a large sales force, advertising in the newspapers, and appealing to patriotism, Cooke was able to sell hundreds of millions of dollars worth of bonds.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

The United States had established—totally by accident—a consistent national currency for the first time after the Civil War:

So after the Civil War, the only paper money that’s circulating is the greenbacks and the bank notes issued by the national banks. And those bank notes issued by the national banks, they all start to look alike. So in the post-war years, there’s this convergence. Bills are looking more and more uniform. And for the first time, they’re all worth what they say they’re worth…So the United States at this point has kind of accidentally stumbled on an economic innovation – a $10 bill that is worth $10 in New York and in Connecticut and in New Jersey. You can take it all the way to Wyoming and it is still worth $10. And now, finally, if you’re a bartender – life is much easier…

So this really is how we got from a world of 8,000 kinds of money and of monthly guides that tell you if a $5 bill is actually worth $4 to the world basically that we know today, where if somebody gives you a $5 bill, you know it’s worth $5. This makes travel and trade much, much more efficient.

After the war, the debate was, once again, whether or not to go back on the gold standard. But there was a problem: thanks to the war, there was simply too much money floating around. Some way had to be found of reducing the amount of greenbacks in circulation. One enthusiastic goldbug even advocated a weekly bonfire of greenbacks! The problem was that such a policy would be deflationary at at time when farmers and small businessmen were hurting:

Wartime inflation had depreciated greenbacks in relation to gold, and so, for example, the value in gold of $100 of greenbacks averaged $97.00 during February 1862 but was down to $35.00 by January 1864. (I have rounded these numbers to the dollar-CH)

If greenbacks were convertible to gold, enterprising persons could buy them cheaply on the market and “sell” them at face value to the Treasury and thus make a profit. Hundreds of millions of dollars of greenbacks were in circulation, and had the government declared these paper notes convertible into specie, the Treasury would soon have exhausted its entire gold supply.

And so, if there was any hope of making money convertible into gold once again, the first step would have to be a drastic reduction of the amount of greenbacks in circulation. The government attempted to retire the greenbacks, but their timing was terrible as the nation was slipping into another recession. The contraction of the money supply especially hit debtors like small farmers. As a result of popular pressure, the power to retire greenbacks by the treasury Secretary was rescinded; only about $48 million were retired.

Resistance to…hard money policy raised the larger question or whether a return to gold was desirable and whether resumption was a suitable goal for monetary policy. Related to this was the issue of how to repay the national debt, for although the law required that interest be paid in coin (and not in greenbacks), it was unclear whether the principal also had to be repaid in coin.

To do so seemed particularly unfair to some since in the darkest days of the war the government sold its bonds for greenbacks. As a result, speculators could buy, for example, $100 in greenbacks on the market with only $35.00 in gold, and with those greenbacks purchase $100 in government bonds, hoping that both the interest and principal would be repaid in gold.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

But why retire the greenbacks at all? As Benjamin Franklin had pointed out long ago, an increase in the money supply increases economic activity. And constraining money creation with something like the gold standard severely limited the amount of money that could be issued by government, much as the hated British had done to the colonies back before the Revolution.

The debate over the gold standard shaped up along economic lines:

Farmers and other agrarian groups were heavily reliant on credit and so were hurt when money became tight. Thus, the ideas of the greenbackers found a receptive audience in American farmers who would later support the Populist movement. Greenbackism also enjoyed a brief popularity among mercantile traders, insurance brokers, capitalists of the Pennsylvania steel industry, and certain sectors of the labor movement.

Bullionism, on the other had, found support among bankers, financiers, bondholders and importers, all of whom stood to lose from inflation and gain from an appreciation of the currency.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

In the 1870’s, the “hard money” position won out and the United States went back on the gold standard. The result was a general deflation and a series of painful crashes and depressions, including the “Long Depression” (which was called the “Great Depression” prior to 1929). Between the end of the Civil War and the Panic of 1907, there were a large number of financial panics, crises, depressions, etc. You can go visit Crisis Chronicles on the Liberty Street (NY Fed) blog to read about them in more detail. In brief, here are some of the major ones:

– Panic of 1873, a US recession with bank failures, followed by a four-year depression
– Panic of 1884
– Panic of 1890
– Panic of 1893, a US recession with bank failures
– Panic of 1896
– Panic of 1901, a U.S. economic recession that started a fight for financial control of the Northern Pacific Railway
– Panic of 1907, a U.S. economic recession with bank failures.

List of economic crises (Wikipedia)

The banking panic of 1907 eventually led to the creation of the Federal Reserve System, but that’s a story for another time.

The Greenback Legacy

By allowing the government to increase the money supply without worrying about convertibility to gold or increasing debt, the economy improved. After the war, many believed that the government should continue to do this: they even formed a Greenback Party to advocate for this.

Even today, some have made an argument for such a policy to be revived. Ellen Brown has written about this on her Web of Debt blog:

Helicopter money is a new and rather pejorative term for an old and venerable solution. The American colonies asserted their independence from the Motherland by issuing their own money; and Abraham Lincoln, our first Republican president, boldly revived that system during the Civil War. To avoid locking the government into debt with exorbitant interest rates, he instructed the Treasury to print $450 million in US Notes or “greenbacks.” In 2016 dollars, that sum would be equivalent to about $10 billion, yet runaway inflation did not result. Lincoln’s greenbacks were the key to funding not only the North’s victory in the war but an array of pivotal infrastructure projects, including a transcontinental railway system; and GDP reached heights never before seen, jumping from $1 billion in 1830 to about $10 billion in 1865.

Indeed, this “radical” solution is what the Founding Fathers evidently intended for their new government. The Constitution provides, “Congress shall have the power to coin money [and] regulate the value thereof.” The Constitution was written at a time when coins were the only recognized legal tender; so the Constitutional Congress effectively gave Congress the power to create the national money supply, taking that role over from the colonies (now the states).

Outside the Civil War period, however, Congress failed to exercise its dominion over paper money, and private banks stepped in to fill the breach. First the banks printed their own banknotes, multiplied on the “fractional reserve” system. When those notes were heavily taxed, they resorted to creating money simply by writing it into deposit accounts. As the Bank of England acknowledged in its spring 2014 quarterly report, banks create deposits whenever they make loans; and this is the source of 97% of the UK money supply today. Contrary to popular belief, money is not a commodity like gold that is in fixed supply and must be borrowed before it can be lent. Money is being created and destroyed all day every day by banks across the country. By reclaiming the power to issue money, the federal government would simply be returning to the publicly-issued money of our forebears, a system they fought the British to preserve.

Trump’s $1 Trillion Infrastructure Plan: Lincoln Had a Bolder Solution (Web of Debt)

And just like back in the late 1800’s, such ideas are opposed by a radical conservative movement that wishes to go back to free (wildcat) banking, abolish the central bank altogethet (just like Andrew Jackson), and go back on the gold standard. One prominent example is Gary North:

Ellen Brown is the latest in a long line of pro-fiat money, anti-gold currency, monetary statists who have infiltrated the conservative movement. They have accomplished this for over 50 years by the tactic of wrapping themselves in a flag of opposition to the Federal Reserve System. I call them false-flag infiltrators.

False-flag infiltrators are remnants of a left-wing American political movement of the late 19th century: the Greenbackers, named after the green currency issued by the North during the Civil War. These paper bills were unbacked by gold. Consumer prices rose by 75%, 1861-65.

The Greenbackers were opposed to the gold standard because it kept prices low. They wanted the government to inflate the currency, so that debtors could pay off their debts with cheap money. They had a small political party for almost two decades, the Greenback Party. It 1878, it merged with a labor Party to become the Greenback Labor Party. It went out of existence after 1888. Its main leader, James Weaver, co-founded the Populist (People’s) Party in 1891. It was a farm-bloc party that promoted fiat money in order to let farmers pay their debts with cheap money and also because they thought inflation would raise farm products’ prices more than the prices of other goods.

There was never any question of the Greenbackers’ politics. They were leftists, and openly sided with government controls on the economy…

https://www.garynorth.com/public/department141.cfm

Of course, today paper isn’t used very much anymore, and neither are coins. I’m sure most of us have used plastic debit cards and credit cards (hopefully paying it off immediately) to buy things. Money is now primarily electronic transfers between computer spreadsheets maintained by banks. Virtual money.

Conclusions

So what (if anything) have we learned about paper money?

Well, the first lesson, to me, is that paper money was inevitable. There was simply no amount of gold and silver anywhere in the entire world to run the kind of economy we were entering after 1700, much less today. All of the gold ever mined in human history would fit into a cube 20 meters on a side. Such a cube could easily fit on one of those giant supertankers bringing our goods over from China many times over.

When gold and silver was not enough, the quest was on for another thing to back paper money. Land was the first idea, as we’ve seen. Eventually paper money money became backed by the sovereign’s debt. Paper money became circulating government liabilities. It still is today.

Paper money was invented independently in many places, indicating to me that it must have been an inevitability. The Chinese were the first to do it, and used it on and off for about 500 years (c. 950 to 1455). Ironically, they stopped using it just at the time when the New World was being colonized by Europeans, which sent massive amounts of silver their way. But soon it was invented independently in the North Atlantic trading economies, which went on to dominate the rest of the world.

Long before “official” paper money was issued by central governments, there were things like bills of exchange, municipal bonds and annuities, and shares in joint-stock corporations. That is, much of the value transfer in the European economy was already done via paper instruments and ledgers long before paper money came on the scene, and so it’s inevitable that people made the leap. They just had to get over the cultural baggage of “money” being simply a substitute for precious metals—baggage that even today many people hold on to. Money creation was done by private banks via the stroke of a pen long before governments began issuing it. Even today, banks create most of the money in the world via keystrokes.

The first paper money were simply IOUs. Such IOU’s were issued by private individuals before governments. Eventually the government took over and issued their own IOUs, which soon changed hands as money. This is because the government’s credit is usually the most reliable. This feeds into ideas that there is a “pyramid” of what constitutes money, with the government’s money as the ultimate means of settlement at the apex.

The faith in paper money is based on the stability of the government issuing it. Just like the credit of an individual determines how much faith people have in an IOU, so too with governments. The IOUs of Zimbabwe or Venezuela are very different than those of Japan or Switzerland. Throughout history, problems with money are almost always related to political crises, and not simply to “debasement”. Debasement of currency is usually more of a signal of decline than a cause.

Another point is one I’ve made repeatedly: every major financial innovation has been created in order help states fund wars. That is, financial innovations were ways for states to aggregate and control the resources necessary to wage war. They were then later pressed into the service of trade and technological development. Paper money is a prime example of this. No country in history has decided to simply lose a war or surrender to a foreign power in order to limit their money supply or adhere faithfully to a precious metal standard.

Paper money was an instrument of revolution. How much has the modern world been affected by its creation? Would there even be a modern world without it? Without the ability to issue money in excess of the gold and silver floating around, neither the American nor French Revolutions would have succeeded. These paved the way for everything that came after—both socially and politically.

Is there a danger of uncontrollable inflation with paper money? Sure. But incomprehensibly more damage is done to the average citizen by locking your financial system into artificial handcuffs. Such systems are designed exclusively for the benefit of international merchants (who wish to have the money they make in one country’s market have the same value in their home country), while at the same time causing terrible harm to domestic populations who suffer from the resulting depressions.

As Tim Harford puts it, “While we may not always be able to trust central bankers to print just the right amount of new money, it probably makes more sense than trusting miners to dig up just the right amount of new gold.” He adds, “mainstream economists generally now believe that pegging the money supply to gold is a terrible idea. Most regard low and predictable inflation as no problem at all – perhaps even a useful lubricant to economic activity.”

In fact, it is a lack of inflation which makes debts harder to pay off. Hard-money policy has always been advocated by bankers and other big creditors, and yet the reactionary Right has somehow made this into a populist cause. Incredible!

This Reddit comment succinctly sums up the problems with tying money to gold, or anything else (I have combined two comments here):

1. Gold is scarce, and not enough of it is being found to match the increasing GDP of the world. Therefore it’s deflationary, and tends to entice people to hoard it, because simply owning the wealth makes you even wealthier as demand for it increases dramatically over supply. This chokes your economy as the poor fight over scraps and the rich do nothing. Leads to severe deflationary recessions every 5-10 years.

2. Finding a large cache of gold can royally fuck up an economy as wealth plummets overnight. There is literally nothing but luck controlling this. There’s an instance in history, of an African warlord who made a great trek to the middle east, giving out vast supplies of his wealth … during the trip, because he had so much of it, it was useless to him. He ended up crashing nearly every economy he passed through. (Mansa Musa)

3. Gold is actually very abundant on earth, but not easily accessible. There’s trillions of tons in our core, for example. And billions of tons dissolved in our oceans. Right now, gold isn’t worth the effort to extract it; but make it the driver of the worlds largest economy and people will start working on technology to get the gold out of the ocean. Pretty soon the economy will crash again.

4. In the distant future, all materials will be able to be produced in fusion furnaces. All elements were created from fusion of hydrogen during supernovas, and once fusion technology gets to the right place, we’ll be able to make any stable element we want. Gold, at that point, will become infinite. It is for this reason that we’d better figure out how to perfect fiat currencies, because we’re at the precipice of a demand-less society. One could make the argument that energy then becomes the chief currency of the world (as if it already isn’t!), but our sun provides more than enough for our civilization a billion times over.

Bottom line; basing currency on physical items is dumb and constrains us too much. It leads to crashes and gives us absolutely no ability to prevent them from happening. It’s dumb.

People … forget the single most obvious answer, which also happens to be a major reason we ditched it in the first place: it would allow any other country of sufficient size (read: China, Japan, Britain, the EU, and possibly Russia, Saudi Arabia, Australia due to their hard asset base(s)) to manipulate our currency by flooding/hoarding gold on the open markets.

Does anyone, who seriously understands international finance, think that if we handed the keys to our economy to China, that they wouldn’t use it to their ends? People that are pro-gold are a special breed of stupid.

It’s also worth noting that persistently high inflation is almost always due to other boneheaded things that governments do above and beyond simply “money printing.” In the Unites States in the sixties and seventies, we decided to ramp up a war on the other side of the world because of the “domino effect.” And we didn’t raise taxes to pay for it. We also built our entire economy around a substance whose supply ended up being controlled by countries who hated us (i.e. oil). Boneheaded!

All of this goes to say that given the history of paper money, the description of how our money system works by MMT seems basically correct. And, as MMT advocates point out, it is descriptive more than prescriptive. However, a proper understanding of what money is and how it works in modern industrial economies does lead to some policy recommendations. Perhaps the simplest one is this: any politician who claims that “we can’t afford it” should be voted out of office immediately. Another is that the low-information voters who claim to be “socially liberal but economically conservative” are just middle-of-the-road dimwits who haven’t a clue about how money and government finance work and should have their voting rights revoked.

Sources

I’ve mentioned some of the sources I’ve used throughout this series of posts, but I thought I’d list them here for convenience.

The major sources were Money: Whence it Came, Where it Went by John Kenneth Galbraith, originally published in 1975, with a revised version released in 1995 which is the the one I used. The other is The History of Money by Jack Weatherford, which came out in 1998. This one is a bit outdated, and ignores the insights of more in-depth and recent works in monetary theory.

One particularly notable one is this one: Money: 5,000 years of Debt and Power by Michel Aglietta. This is from Verso and was originally published in French.

Another major source is this article from The New Yorker: The Invention of Money

Crisis Chronicles is a series of posts by the New York Federal Reserve on its blog Liberty Street Economics: https://libertystreeteconomics.newyorkfed.org/crisis-chronicles/

There is a good summary of the various chapters of Glyn Davies’ History of Money on this site: http://projects.exeter.ac.uk/RDavies/arian/llyfr.html

The WEA Pedagogy Blog is doing a 5-part series on the history of central banking (also accessible on the Real World Economic Review blog). Part one is available here: https://weapedagogy.wordpress.com/2019/03/31/origins-of-central-banking/

The Minneapolis Fed has good history of central banking in the United States as noted above, and is available here: A History of Central Banking in the United States.

I’ve also used the following PDFs: Benjamin Franklin and the Birth of a Paper Money Economy by Owen F. Humpage

Paper Money and Inflation in Colonial America by Owen F. Humpage

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America by Bruce G. Carruthers and Sarah Babb

Land Bank Proposals 1650-1705 by Charlie Landale

If podcast are your preferred medium, these two are good. The first is Tim Harford’s recounting of the birth of paper money in China in his podcast 50 things that made the modern economy: https://www.bbc.co.uk/programmes/p059c7g1

And NPR’s Planet Money podcast did a podcast on the birth of the dollar bill after the Civil War: Episode 421: The Birth Of The Dollar Bill

The Origin of Paper Money 7

It’s here that we finally get to what’s really the heart of this entire series of posts, which is this: in the West, paper money has been an instrument of revolution.

Both the American and French Revolutions were funded via paper money, and it’s very likely they could not have succeeded without it. It allowed new and fledgling regimes to command necessary resources and fund their armies, which allowed them to take on established states. While such states have mints, a tax base, ownership of natural resources, the ability to write laws, etc.; a rebellion against an established order has none of these things. So, to raise funds, the ability to issue IOUs as payment makes being able to start a revolution far more likely. As we’ve already seen, just about every financial innovation throughout history came about due to the costs of waging wars. Paper money was no exception.

One might even go so far as to say that the American, French and Russian Revolutions would never have been able to happen at all without the invention of paper money!

Washington Crossing the Delaware by Emanuel Leutze, MMA-NYC, 1851.jpg

1. The United States

Earlier we looked at the financial innovations that the colonies undertook to deal with the lack of precious metals in circulation. Wherever paper money and banks had been created, commerce and prosperity increased.

Then it all came to a screeching halt.

The British government passed laws which forbade the issuing and circulation of paper money in the colonies. The monetary experiments came to an end. As you might expect, the domestic economy shrank, and commerce was severely constricted. Of course, the colonists became quite angry at this turn of events.

British authorities initially viewed colonial paper currency favorably because it supported trade with England, but following New England’s “great inflation” in the 1740s, this view changed. Parliament passed the Currency Act of 1751 to strictly limit the quantity of paper currency that could be issued in New England and to strengthen its fiscal backing.

The Act required the colonies to retire all existing bills of credit on schedule. In the future, the colonies could, at most, issue fiat currencies equal to one year’s worth of government expenditures provided that they retired the bills within two years. During wars, colonies could issue larger amounts, provided that they backed all such issuances with taxes and compensated note holders for any losses in the real value of the notes, presumably by paying interest on them.

As a further important constraint on the colonies’ monetary policies, Parliament prohibited New England from making any fiat currency legal tender for private transactions. In 1764, Parliament extended the Currency Act to all of the American colonies.

Paper Money and Inflation in Colonial America (Owen F. Humpage, Economic Commentary, May 13, 2015)

To get around the prohibition on governments issuing paper notes as IOUs, banking may have filled the void. But that option was also cut off by the British government. Last time we saw that the South Sea Bubble, along with a panoply of related schemes, had nearly taken down the entire British economy (as it had done in France). In response, Parliament passed the Bubble Act, which forbade any chartered corporations except those expressly authorized by a Royal Charter. This effectively put the kibosh on banking as an alternative source of paper money in the American colonies.

Given their instinct for experiment in monetary matters, it would have been surprising if the colonists had not discovered or invented banks. They did, and their enthusiasm for this innovation would have been great had it not also been systematically curbed.

In the first half of the eighteenth century the New England colonies, along with Virginia and South Carolina, authorized banking institutions. The most famous, as also the most controversial of these, was the magnificently named Land Bank Manufactory Scheme of Massachusetts which, very possibly, owed something to the ideas of John Law.

The Manufactory authorized the issue of bank notes at nominal interest to subscribers to its capital stock – the notes to be secured, more or less, by the real property of the stockholders. The same notes could be used to pay back the loan that their issue had incurred. This debt could also be repaid in manufactured goods or produce, including that brought into existence by the credit so granted.

The Manufactory precipitated a bitter dispute in the colony. The General Court was favorable, a predisposition that was unquestionably enhanced by the award of stock to numerous of the legislators. Merchants were opposed. In the end, the dispute was carried to London.

In 1741, the Bubble Acts – the British response, as noted, to the South Sea Company and associated promotions and which outlawed joint-stock companies not specifically authorized by law – were declared to apply to the colonies. It was an outrageous exercise in post-facto legestlation, one that helped inspire the Constitutional prohibition against such laws. However, it effectively ended the colonial banks. (Galbraith, pp. 56-57)

Benjamin Franklin, as we have seen, was a longstanding advocate of paper money. He wrote treatises on the subject, and even printed some of it on behalf of the government of Pennsylvania. It was this paper money, he argued, that was the cause of the colonies’ general prosperity in contrast to the widespread poverty and discontent he witnessed everywhere in England:

Before the war, the colonies sent Benjamin Franklin to England to represent their interests. Franklin was greatly surprised by the amount of poverty and high unemployment. It just didn’t make sense, England was the richest country in the world but the working class was impoverished, he wrote “The streets are covered with beggars and tramps.”

It is said that he asked his friends in England how this could be so, they replied that they had too many workers. Many believed, along with Malthus, that wars and plague were necessary to rid the country from man-power surpluses.

“We have no poor houses in the Colonies; and if we had some, there would be nobody to put in them, since there is, in the Colonies, not a single unemployed person, neither beggars nor tramps.” – Benjamin Franklin

He was asked why the working class in the colonies were so prosperous.

“That is simple. In the Colonies, we issue our own paper money. It is called ‘Colonial Scrip.’ We issue it in proper proportion to make the goods and pass easily from the producers to the consumers. In this manner, creating ourselves our own paper money, we control its purchasing power and we have no interest to pay to no one.” – Benjamin Franklin

Soon afterward, the English bankers demanded that the King and Parliament pass a law that prohibited the colonies from using their scrip money. Only gold and silver could be used which would be provided by the English bankers. This began the plague of debt based money in the colonies that had cursed the English working class.

The first law was passed in 1751, and then a harsher law was passed in 1763. Franklin claimed that within one year, the colonies were filled with unemployment and beggars, just like in England, because there was not enough money to pay for the goods and work. The money supply had been cut in half.

Hidden History: According to Benjamin Franklin, the real reason for the Revolutionary War has been hid from you (Peak Prosperity)

A good comment to the above article notes other factors which were also at work:

The timing of the shift in British policy toward colonial scrip (1763) also encompasses…the end of the Seven Years’ War, better known in the United States as the French and Indian War.

William Pitt’s prosecution of the war was conducted by running up government debt, and the settlement of this debt after the war’s conclusion required the raising of taxes by Parliament. Since, from Britain’s view, the war had been fought in order to protect its colonies, it felt that it was only fair that the colonies bore some of the financial burden. Colonial scrip was useless to Parliament in this regard, as was barter. The repayment of British lenders to the Crown could only be done in specie.

The colonies, as you correctly pointed out, did not have this in any significant quantity, although in the view of British authorities this was the colonies’ problem and not theirs. This policy also came on the heels of the approach of benign neglect conducted by Robert Walpole as Prime Minister, under which the colonies were allowed to do pretty much as they pleased so long as their activities generally benefited the British Crown. It should also be noted here that demands of payment of taxes in hard currency is a common tactic for colonial powers to undermine local economies and customs. It played that role in fomenting the American Revolution as well as the Whiskey Rebellion of the new Constitutional republic, not to mention how it was used in South Africa to compel natives participating in a traditional economy to abandon their lands and take up work as laborers in the gold mines.

Hidden History: According to Benjamin Franklin, the real reason for the Revolutionary War has been hid from you (Peak Prosperity)

Now, it would be unreasonable to say that this was THE cause of the American Revolution. In school, we’re taught that that taxes were the main cause: “No taxation without representation” went the slogan (and precipitated the Boston Tea Party). We’re also told that the colonists were much aggrieved by high customs duties, such as those of the unpopular Stamp Act.

But the suppression of paper money and local currency issuance by the British government appears to have been just as much of a cause, although it is probably unknown by the vast majority of Americans. The reason for this strange omission is unexplained. Galbraith thinks that that more conservative attitudes towards money creation in modern times have caused even American historians to argue that the British authorities were largely correct in their actions!

English historian, John Twells, wrote about the money of the colonies, the colonial Scrip:

“It was the monetary system under which America’s Colonies flourished to such an extent that Edmund Burke was able to write about them: ‘Nothing in the history of the world resembles their progress. It was a sound and beneficial system, and its effects led to the happiness of the people.

In a bad hour, the British Parliament took away from America its representative money, forbade any further issue of bills of credit, these bills ceasing to be legal tender, and ordered that all taxes should be paid in coins. Consider now the consequences: this restriction of the medium of exchange paralyzed all the industrial energies of the people. Ruin took place in these once flourishing Colonies; most rigorous distress visited every family and every business, discontent became desperation, and reached a point, to use the words of Dr. Johnson, when human nature rises up and assets its rights.”

Peter Cooper, industrialist and statesman wrote:

“After Franklin gave explanations on the true cause of the prosperity of the Colonies, the Parliament exacted laws forbidding the use of this money in the payment of taxes. This decision brought so many drawbacks and so much poverty to the people that it was the main cause of the Revolution. The suppression of the Colonial money was a much more important reason for the general uprising than the Tea and Stamp Act.”

Our Founding Fathers knew that without financial independence and sovereignty there could be no other lasting freedoms. Our freedoms and national sovereignty are being lost because most people do not understand our money system…

Hidden History: According to Benjamin Franklin, the real reason for the Revolutionary War has been hid from you (Peak Prosperity)

If paper money was the cause of the American Revolution, it was also the solution. The Continental Congress issued IOUs to pay for the war – called ‘Continental notes’ or ‘Continental scrip’:

With independence the ban by Parliament on paper money became, in a notable modern phrase, inoperative. And however the colonies might have been moving towards more reliable money, there was now no alternative to government paper…

Before the first Continental Congress assembled, some of the colonies (including Massachusetts) had authorized note issues to pay for military operations. The Congress was without direct powers of taxation; one of its first acts was to authorize a note issue. More states now authorized more notes.

It was by these notes that the American Revolution was financed….

Robert Morris, to whom the historians have awarded the less than impeccable title of ‘Financier of the Revolution’, obtained some six-and-a-half million dollars in loans from France, a few hundred thousand from Spain, and later, after victory was in prospect, a little over a million from the Dutch. These amounts, too, were more symbolic than real. Overwhelmingly the Revolution was paid for with paper money.

Since the issues, Continental and state, were far in excess of any corresponding increase in trade, prices rose – at first slowly and that, after 1777, at a rapidly accelerating rate…Eventually, in the common saying, ‘a wagon-load of money would scarcely purchase a wagon-load of provisions’. Shoes in Virginia were $5000 a pair in the local notes, a full outfit of clothing upwards of a million. Creditors sheltered from their debtors like hunted things lest they be paid off in worthless notes. The phrase ‘not worth a Continental’ won its enduring place in American language. (Galbraith, pp. 58-59)

Despite this painful bout of hyperinflation, as Galbraith notes, there was simply no other viable alternative to fund the Revolutionary War at the time:

Thus the United States came into existence on a full tide not of inflation but of hyperinflation – the kind of inflation that ends only in the money becoming worthless. What is certain, however, is the absence of any alternative.

Taxes, had they been authorized by willing legislators on willing people, would have been had, perhaps impossible to collect in a country of scattered population, no central government, not the slightest experience in fiscal matters, no tax-collection machinery and with its coasts and numerous of its ports and customs houses under enemy control.

And people were far from willing. Taxes were disliked for their own sake and also identified with foreign oppression. A rigorous pay-as-you-go policy on the part of the Continental Congress and the states might well have caused the summer patriots (like the monetary conservatives) to have second thoughts about the advantages of independence.

Nor was borrowing an alternative. Men of property, then the only domestic source, had no reason to think the country a good risk. The loans from France and Spain were motivated not by hope of return but by malice towards an ancient enemy.

So only the notes remained. By any rational calculation, it was the paper money that saved the day. Beside the Liberty Bell there might well be a tasteful replica of a Continental note. (Galbraith, p. 60)

While this is often used as yet another cautionary tale of “government money printing” by libertarians and goldbugs, a couple of things need to be noted. The first, and most obvious is the fact that: without government money printing there would be no United States. That seems like an important point to me.

The second is a take from Ben Franklin himself. He argued that inflation is really just a sort of tax by another name. And, as opposed to “conventional” government taxation, the inflationary tax falls more broadly across the population, meaning that it was actually a more even-handed and fair method of taxation!

And you can kind of see his point. With legislative taxes, government always has to decide who and what to tax—and how much. This inevitably means that the government picks winners and losers by necessity. Sometimes this can be done wisely, but in practice it often is not. But an inflationary tax cannot be easily controlled by government legislation to favor privileged insiders, unlike more conventional methods of direct taxation, where the rich and well-connected are often spared much of the burden thanks to undue influence over legislators:

From 1776 to 1785 Franklin serves as the U.S. representative to the French court. He has the occasion to write on one important monetary topic in this period, namely, the massive depreciation of Congress’ paper money — the Continental dollar — during the revolution. In a letter to Joseph Quincy in 1783, Franklin claims that he predicted this outcome and had proposed a better paper money plan, but that Congress had rejected it.

In addition, around 1781 Franklin writes a tract called “Of the Paper Money of America.” In it he argues that the depreciation of the Continental dollar operated as an inflation tax or a tax on money itself. As such, this tax fell more equally across the citizenry than most other taxes. In effect, every man paid his share of the tax according to how long he retained a Continental dollar between the time he received it in payment and when he spent it again, the intervening depreciation of the money (inflation in prices) being the tax paid.

Benjamin Franklin and the Birth of a Paper Money Economy (PDF; Philidelphia Fed)

I’m not sure that many people would agree with that sentiment today, but it is an interesting take on the matter.

Once the war was won, and with the Continental notes inflating to zero, the new fledgling government could now issue money for real. The first government building constructed by the new government was the mint. The power to tax was authorized by Congress.

Although the war ended in 1783, the finances of the United States remained somewhat chaotic through the 1780s. In 1781, successful merchant Robert Morris was appointed superintendent of finance and personally issued “Morris notes”—commonly called Short and Long Bobs based on their tenure or time to maturity—and thus began the long process to reestablish the government’s credit.

In 1785, the dollar became the official monetary unit of the United States, the first American mint was established in Philadelphia in 1786, and the Continental Congress was finally given the power of taxation to pay off the debt in 1787, thus bringing together a more united fiscal, currency, and monetary policy.

Crisis Chronicles: Not Worth a Continental—The Currency Crisis of 1779 and Today’s European Debt Crisis (Liberty Street)
One of the more common silver coins used all over the world at this time was the Maria Theresa thaler (or taler), issued by the Holy Roman Empire from its silver mines in Joachimsthal, hence the name (today the town of Joachimsthal is known as Jáchymov and is located in the Czech Republic).

“Taler” became a common name for currency because so many German states and municipalities picked it up. During the sixteenth century, approximately 1,500 different types of taler were issued in the German-speaking countries, and numismatic scholars have estimated that between the minting of the first talers in Jáchymov and the year 1900, about 10,000 different talers were issued for daily use and to commemorate special occasions.

The most famous and widely circulated of all talers became known as the Maria Theresa taler, struck in honor of the Austrian empress at the Gunzberg mint in 1773…The coin…became so popular, particularly in North Africa and the Middle East that, even after she died, the government continued to mint it with the date 1780, the year of her death.

The coin not only survived its namesake but outlived the empire that had created it. In 1805 when Napoleon abolished the Holy Roman Empire, the mine at Gunzberg closed, but the mint in Vienna continued to produce the coins exactly as they had been with the same date, 1780, and even with the mintmark of the closed mint. The Austro-Hungarian government continued to mint the taler throughout the nineteenth century until that empire collapsed at the end of World War I.

Other countries began copying the design of the Maria Theresa taler shortly after it went into circulation. They minted coins of a similar size and put on them a bust of a middle-aged woman who resembled Maria Theresa. Of they did not have a queen of their own who fit the description, they used an allegorical female such as the bust of Liberty that appeared on many U.S. coins of the nineteenth century.

The name dollar penetrated the English language via Scotland. Between 1567 and 1571, King James VI issued a thirty-shilling piece that the Scots called the sword dollar because of the design on the back of it. A two-mark coin followed in 1578 and was called the thistle dollar.

The Scots used the name dollar to distinguish their currency, and thereby their country and themselves, more clearly from their domineering English neighbors to the south. Thus, from very early usage, the word dollar carried with it a certain anti-English or antiauthoritarian bias that many Scottish settlers took with them to their new homes in the Americas and other British colonies. The emigration of Scots accounts for much of the subsequent popularity of the word dollar in British colonies around the world… (Weatherford, History of Money, pp. 115-116)

In 1782, Thomas Jefferson wrote in his Notes on a Money Unit of the U.S. that “The unit or dolar is a known coin and most familiar of all to the mind of the people. It is already adopted from south to north.”

The American colonists became so accustomed to using the dollar as their primary monetary unit that, after independence, they adopted it as their official currency. On July 6, 1785, the Congress declared that “the money unit of the United States of America be one dollar.” Not until April 2, 1792, however, did Congress pass a law to create an American mint, and only in 1794 did the United States begin minting silver dollars. The mint building, which was started soon after passage of the law and well before the Capitol or White House, became the first public building constructed by the new government of the United States. (Weatherford, History of Money, p. 118)

In the nineteenth century, there were strong arguments around the establishment of a central bank in the United States. One was, in fact, chartered, and then its charter was later revoked. We’ll talk a little about this in the final entry of this series next time, but for now, it is beyond the scope of this post.

Scene from the French Revolution

2. France

In the late eighteenth century, France’s financial circumstances were still very dire. It constantly needed to raise money for its perennial wars with England who, as we saw earlier, successfully funded its own wars with paper money and state borrowing via the Bank of England an—option not available to France in the wake of the Mississippi Bubble’s collapse and the failure of John Law’s Banque Royale. France’s generous loan to the United States’ revolutionaries may have been well appreciated by us Americans, but in retrospect, it was probably not the best move considering France’s fiscal situation (plus the fact that Revolution would soon engulf it; something the French aristocracy obviously had no way of knowing at the time).

In the aftermath of the Revolution, the National Assembly repudiated the King’s debts. It also suspended taxation. But it still badly needed money, especially since many of the countries surrounding France (e.g. Austria, Prussia, Great Britain, Spain and several other monarchies) declared war on it soon after the King met the guillotine. The answer they came up with was, once again, monetizing land. In this case, it was the land seized from the Catholic Church by the Revolutionary government. “[T]he National Assembly agreed that newly nationalised properties in the form of old church land could be purchased through the use of high-denomination assignats, akin to interest-bearing government bonds, mortgaged (assignée) on the property.”

The Estates-General had been summoned in consequence of the terrible fiscal straits of the realm. No more could be borrowed. There was no central bank which could be commanded to take up loans. All still depended on the existence of willing lenders or those who could be apprehended and impressed with their duty.

The Third Estate could scarcely be expected to vote new or heavier levies when its members were principally concerned with the regressive harshness of those then being collected. In fact, on 17 June 1789 the National Assembly declared all taxes illegal, a breathtaking step softened by the provision that they might be collected on a temporary basis.

Meanwhile memories of John Law kept Frenchmen acutely suspicious of ordinary paper money; during 1788, a proposal for an interest-bearing note issue provoked so much opposition that it had to be withdrawn. But a note issue that could be redeemed in actual land was something different. The clerical lands were an endowment by Heaven of the Revolution.

The decisive step was taken on 19 December 1789. An issue of 400 million livres was authorized; it would, it was promised, ‘pay off the public debt, animate agriculture and industry and have the lands better administered’. These notes, the assignats, were to be redeemed within five years from the sale of an equivalent value of the lands of the Church and the Crown.

The first assignats bore interest at 5 per cent; anyone with an appropriate amount could use them directly in exchange for land. In the following summer when a new large issue was authorized, the interest was eliminated. Later still, small denominations were issued.

There were misgivings. The memory of Law continued to be invoked. An anonymous American intervened with Advice on the Assignats by a Citizen of the United States. He warned the Assembly against the assignats out of the rich recent experience of his own country with the Continental notes. However, the initial response to the land-based currency was generally favourable.

Had it been possible to stop with the original issue or with that of 1790, the assignats would be celebrated as a remarkably interesting innovation. Here was not a gold, silver or tobacco standard but one based solidly and logically on the good soil of France.

Purchasing power in the first years had stood up well. There was admiring talk of how the assignats had put land into circulation. And business had improved, employment had increased and sales of the Church and other public lands had been facilitated. On occasion, sales had been too good. In relation to annual income, the prices set were comparatively modest; speculators clutching large packages of the assignats had arrived to take advantage of the bargains.

However, in France, as earlier in America, the demands of revolution were insistent. Although the land was limited, the claims upon it could be increased.

The large issue of 1790 was followed by others – especially after war broke out in 1792. Prices denominated in assignats now rose; their rate of exchange for gold and silver, dealing in which had been authorized by the Assembly, declined sharply. In 1793 and 1794, under the Convention and the management of Cambon, there was a period of stability. Prices were fixed with some success. What could have been more important, the supply of assignats was curtailed by the righteous device of repudiating those that had been issued under the king. In those years they retained a value of around 50 per cent of their face amount when exchanged for gold and silver.

Soon, however, need again asserted itself. More and more were printed. In an innovative step in economic warfare, Pitt, after 1793, allowed the royalist emigres to manufacture assignats for export to France. This, it was hoped, would hasten the decay.

In the end, the French presses were printing one day to supply the needs of the next. Soon the Directory halted the exchange of good real estate for the now nearly worthless paper – France went off the land standard. Creditors were also protected from having their debts paid in assignats. This saved them from the ignominy of having (as earlier in America) to hide out from their debtors. (Galbraith, pp. 64-66)

The lands of aristocrats who had fled France was confiscated as well and used to back further issuances of paper currency. Despite this, as with the Continentals, the value of the assignats soon inflated away to very little. France then issued a new paper money, the mandats territoriaux, also carrying an entitlement to land, in an attempt to stabilize the currency. But distrust in the paper currency (and in the government) was so endemic that the mandats began to depreciate even before they were issued:

With the sale of the confiscated property, a great debtor class emerged, which was interested in further depreciation to make it cheaper to pay back debts. Faith in the new currency faded by mid-year 1792. Wealth was hidden abroad and specie flowed to surrounding countries with the British Royal Mint heavily purchasing gold, particularly in 1793 and 1794.

But deficits persisted and the French government still needed to raise money, so in 1792, it seized the land of emigrants and those who had fled France, adding another 2 billion livres or more to French assets. War with Belgium that year was largely self-funded as France extracted some rents, but not so for the war with England in 1793. Assignats no longer circulated as a medium of payment, but were an object of speculation. Specie was scarce, but sufficient, and farmers refused to accept assignats, which were practically demonetized. In February 1793, citizens of Paris looted shops for bread they could no longer afford, if they could find it at all.

In order to maintain its circulation, France turned to stiff penalties and the Reign of Terror extended into monetary affairs. During the course of 1793, the Assembly prohibited buying gold or silver at a premium, imposed a forced loan on a portion of the population, made it an offense to sell coin or differentiate the price between assignats and coin, and under the Law of the Maximum fixed prices on some commodities and mandated that produce be sold, with the death penalty imposed for infractions.

France realized that to restore order, the volume of paper money in circulation must decrease. In December 1794, it repealed the Law of the Maximum. In January 1795, the government permitted the export of specie in exchange for imports of staple goods. Prices fluctuated wildly and the resulting hyperinflation became a windfall for those who purchased national land with little money down. Inflation peaked in October 1795. In February 1796, in front of a large crowd, the assignat printing plates were destroyed.

By 1796, assignats gave way to specie and by February 1796, the experiment ended. The French tried to replace the assignat with the mandat, which was backed by gold, but so deep was the mistrust of paper money that the mandat began to depreciate before it was even issued and lasted only until February 1797…

Crisis Chronicles: The Collapse of the French Assignat and Its Link to Virtual Currencies Today (Liberty Street)

…In February 1797 (16 Pluvoise year V), the Directory returned to gold and silver. But by then the Revolution was an accomplished fact. It had been financed, and this the assignats had accomplished. They have at least as good a claim on memory as the guillotine. (Galbraith, p. 66)

FRA-A73-République Française-400 livres (1792) 2.jpgEventually, France’s money system stabilized once its political situation more-or-less stabilized, but entire books have been written about that subject. The military dictatorship of Napoleon Bonaparte sold off the French lands in North America to the United States to raise money for its wars of conquest on the European continent. Napoleon also finally established a central bank in France based on the British model.

In 1800, the lingering suspicion of the French of such institutions had yielded to the financial needs of Napoleon. There had emerged the Banque de France which, in the ensuing century, developed in rough parallel with the Bank of England. In 1875, the former Bank of Prussia became the Reichsbank. Other countries had acquired similar institutions or soon did…(Galbraith, p. 41)

It might to be going too far to say that without paper money, neither the American or French revolutions would have ever happened. But nor is entirely absurd to say that this may well be the case. It’s certainly doubtful that they would have succeeded. It’s difficult to imagine how much history would be different today had it not been for paper money and its role in revolution.

Paper money would continue to play that role throughout the Age of Revolutions well into the Twentieth Century, as Galbraith notes:

Paper was similarly to serve the Soviets in and after the Russian Revolution. By 1920, around 85 per cent of the state budget was being met by the manufacture of paper money…

In the aftermath of the Revolution the Soviet Union, like the other Communist states, became a stern defender of stable prices and hard money. But the Russians, no less than the Americans or the French, owe their revolution to paper.

Not that the use of paper money is a guarantee of revolutionary success. In 1913, in the old Spanish town of Chihuahua City, Pancho Villa was carrying out his engaging combination of banditry and social reform. Soldiers were cleaning the streets, land was being given to the peons, children were being put in schools and Villa was printing paper money by the square yard.

This money could not be exchanged for any better asset. It promised nothing. It was sustained by no residue of prestige or esteem. It was abundant. Its only claim to worth was Pancho Villa’s signature. He gave this money to whosoever seemed to be in need or anyone else who struck his fancy. It did not bring him success, although he did, without question, enjoy a measure of popularity while it lasted. But the United States army pursued him; more orderly men intervened to persuade him to retire to a hacienda in Durango. There, a decade later, when he was suspected by some to be contemplating another foray into banditry, social reform, and monetary policy, he was assassinated. (Galbraith, pp. 66-67)

3. Conclusions

Given that both the Continentals and the assignats both suffered from hyperinflation towards the end, they have been often held up as a cautionary tale: governments are inherently profligate and can not be trusted with money creation; only by strictly pegging paper money issuance to a cache of gold stashed away in vault somewhere can hyperinflation be avoided.

As Galbraith notes, this is highly selective. Sure, if you look just for instances of paper money overissuance and inflation you will find them. But this is also deliberately ignoring instances–often lasting for decades if not for centuries–that paper money functioned exactly as intended all across the globe; from ancient China, to colonial America, to modern times. It emphasizes the inflationary scare stories, but intentionally ignores the very real stimulus to commercial activity that paper money has provided, as opposed to the extreme constraints of a precious metal standard. It also totally ignores any extenuating circumstances in hyperinflations, such as Germany’s repayment of war debt in the twentieth century, or persistent economic warfare in the case of Venezuela today.

So the attitude that “government simply can’t be trusted” is more of a political opinion than something based on historical facts.

…in the minds of some conservatives…there must have been a lingering sense of the singular service that paper money had, in the recent past, rendered to revolution. Not only was the American Revolution so financed. So also was the socially far more therapeutic eruption in France. If the French citizens had been required to act within the canons of conventional finance, they could not, any more than the Americans, acted at all. (Galbraith, pp. 61-62)

The desire for a gold standard comes from a desire to anchor the value of money in something outside of the control of governments. But, of course, pegging the value of currency to a certain arbitrary amount of gold is a political choice. Nor does it guarantee price stability–the value of gold fluctuates. A gold standard is more of a guarantee of the stability of the price of gold than the stability of the value of money. Also, in almost every case of war and economic depression in modern history, the gold standard is immediately chucked into the trashbin.

The other thing worth noting is that the worth of paper money is related to both issues of supply AND demand. Often, it’s not just that there is too much supply of currency. It’s that people refuse to accept the currency, leading just as assuredly to a loss in value.

And the lack of acceptance is usually driven by a lack of faith in the issuing government. You can see why this might be the case for assignats and Continentals. Both were revolutionary governments whose very stability and legitimacy was in question, particularly in France. If the government issuing the currency (which are IOU’s, remember) may not be around a year from now, then how willing are you to accept that currency? James Madison pointed out that the value of any currency was mostly determined by faith in the credit of the government issuing the currency. That’s why he and other Founding Fathers worked so hard to reestablish the credit of the United States following the Continental note debacle.

As Rebecca Spang—the author of “Stuff and Money in the Time of the French Revolution”—notes, many people in revolutionary France were vigorously opposed to the seizing of Church property. Thus, they would not accept the validity of notes based on their value. This led to a lack of acceptance which contributed just as much to hypernflation as did any profligacy on the part of the government:

Revolutionary France became a paradigm case for the quantity theory of money, the view that prices are directly and proportionately correlated with the amount of money in circulation, and for the deleterious consequences of letting the latter run out of control.

Yet Spang shows that such neat economic interpretations are inadequate. At times, for example, prices rose first and politicians boosted the money supply in response.

Spang reiterates that the first assignats were neither a revolutionary policy nor a form of paper money. But as her stylishly crafted narrative makes clear, this soon changed. Politicians made the cardinal error of thinking that the state could be stabilised by in effect destabilising its money.

Popular distrust of the “real” worth of assignats prompted a contagion of fraud, suspicion and uncertainty. How could one tell a fake assignat, when technology couldn’t replicate them precisely? How could they even be used, when there was no compulsion beyond patriotic duty for sellers to accept them as payment? Small wonder that so many artists made trompe l’oeil images out of them — what looked solid and real was anything but…

‘Stuff and Money in the Time of the French Revolution’, by Rebecca Spang (Financial Times)

Note that the situation of a stable government is totally different. Britain’s government was eminently stable compared to the United States and France at that time, hence its money retained most of its value, even when convertibility was temporarily suspended. This also underlies the value of Switzerland’s currency today, since they have a legendarily stable, neutral government (and really not that much in the way of actual  resources).

So those who argue that America’s “fiat” money is no good would somehow have to make the case that the United States government is somehow more illegitimate or more unstable than the governments of other wealthy, industrialized nations. To my mind, this is tangential to treason. Yet no one ever calls them out on this point. From that standpoint, the biggest threat to the money supply comes not from overissuance (hyperinflation is nowhere to be seen), but from undermining the faith in, and credit of, the United States government. That’s been done exclusively by Republicans in recent years by grandstanding over the debt ceiling—an artificial borrowing constraint imposed during the United States’ entry into World War One. Really, this should be considered an unpatriotic and treasonous act. It almost certainly would have been perceived as such by the Founding Fathers.

I always have the same response to libertarians who sneer at the “worthlessness” of government fiat money. My response is this: if you truly believe it is worthless, then I will gladly take it off your hands for you. Please hand over all the paper money you have in your wallet right now at this very moment, as well as all the paper money you may have lying around your house. If you want, you can even take out some “worthless” paper money from the nearest ATM and hand it over to me too; I’ll gladly take that off your hands as well. You can give me as much as you like.

To date, I have yet to have a libertarian take me up on that offer. I wonder why?

Next: The Civil War finally establishes a national paper currency for the U.S.

The Origin of Paper Money 6

1. France

France ended up conducting its own monetary experiment with paper money at around the same time as the American colonies in the early 1700s. Unlike the American experiment, it was not successful. It would be initiated by an immigrant Scotsman fleeing a murder charge (and gambling addict) by the name of John Law. (Jean Lass in French).

At this time—the early 1700’s—France was having much the same conversation around the money supply as in the Anglo-Saxon world. There, the problem was not so much a shortage of  coins, but an excess of sovereign debt due to the wild spending sprees of France’s rulers on foreign wars and luxury lifestyles.

Despite being probably the most wealthy and powerful nation in Western Europe, France’s debts (really, the King’s debts) exceeded its assets by quite a bit, at least on paper. The country struggled to raise enough funds via its antiquated and inefficient feudal tax system to pay the interest on its bonds; France’s debt traded in secondary markets as what we might today call junk bonds (i.e. low odds of repayment).

Louis XIV, having lived too long, had died the year before Law’s arrival. The financial condition of the kingdom was appalling: expenditures were twice receipts, the treasury was chronically empty, the farmers-general of the taxes and their horde of subordinate maltôtiers were competent principally in the service of their own rapacity.

The Duc de Saint-Simon, though not always the most reliable counsel, had recently suggested that the straightforward solution was to declare national bankruptcy – repudiate all debt and start again. Philippe, Duc d’Orleans, the Regent for the seven-year-old Louis XV, was largely incapable of thought or action.

Then came Law. Some years earlier, it is said, he had met Philippe in a gambling den. The latter ‘had been impressed with the Scotsman’s financial genius.’ Under a royal edict of 2 May 1716, law, with his brother, was given the right to establish a bank with capital of 6 million livres, about 250,000 English pounds…
(Galbraith, pp. 21-22)

…The creation of the bank proceeded in clear imitation of the already successful Bank of England. Under special license from the French monarch, it was to be a private bank that would help raise and manage money for the public debt. In keeping with his theories on the benefits of paper money, Law immediately began issuing paper notes representing the supposedly guaranteed holdings of the bank in gold coins.

Law’s…bank that took in gold and silver from the public and lent it back out in the form of paper money. The bank also took deposits in the form of government debt, cleverly allowing people to claim the full value of debts that were trading at heavy discounts: if you had a piece of paper saying the king owed you a thousand livres, you could get only, say, four hundred livres in the open market for it, but Law’s bank would credit you with the full thousand livres in paper money. This meant that the bank’s paper assets far outstripped the actual gold it had in store, making it a precursor of the “fractional-reserve banking” that’s normal today. Law’s bank had, by one estimate, about four times as much paper money in circulation as its gold and silver reserves…

The new paper money had an attractive feature: it was guaranteed to trade for a specific weight of silver, and, unlike coins, could not be melted down or devalued. Before long, the banknotes were trading at more than their value in silver, and Law was made Controller General of Finances, in charge of the entire French economy.

The Invention of Money (The New Yorker)

It’s also worth noting that banknotes were denominated in the unit of account, unlike coins which typically were not. Coins’ value usually fluctuated against the unit of account (what prices were expressed in), sometimes by the day. What a silver sovereign or gold Louis d’Or was worth on one day might be different that the next, especially since the monarchs liked to devalue the currency in order to decrease the amount of their debts. However, if you brought, say, 10 livres, 18 sous worth of coins to Law’s bank, the paper banknote would be written up for the equivalent amount the coins were worth at that time: 10 livres, 18 sous.

By buying back the government’s debt, Law was able to “retire” it. Thus, the money circulating was ultimately backed by government debt (bonds), just like our money today. Law’s promise to redeem the notes for specie gave users the confidence to use them. Later on, the government will decree the notes of the Banque Generale as the “official” money to be used in payment of taxes and settlement of all debts, legitimizing their value by fiat. Law later attempted to sever the link to gold and silver by demonetizing the latter. He was not successful; paper money was far too novel at the time for people to trust its value in the absence of anything tangible backing it.

Not much of what transpired was that unusual for today, but it was pretty radical for the early 1700s. Had Law stopped at this point, it’s likely that all of this would have been successful, as Galbraith points out:

In these first months, there can be no doubt, John Law had done a useful thing. The financial position of the government was eased. The bank notes loaned to the government and paid out by it for its needs, as well as those loaned to private entrepreneurs, raised prices….[and] the rising prices…brought a substantial business revival.

Law opened branches of his bank in Lyons, La Rochelle, Tours, Amiens and Orleans; presently, in the approximate modern language, he went public. His bank became a publicly chartered company, the Banque Royale.

Had Law stopped at this point, he would be remembered for a modest contribution to the history of banking. The capital in hard cash subscribed by the stockholders would have sufficed to satisfy any holders of notes who sought to have them redeemed. Redemption being assured, not many would have sought it.

It is possible that no man, having made such a promising start, could have stopped…
(Galbraith, pp. 22-23)

Trading government debt for paper money helped lower the government’s debts, but on paper, France’s liabilities still exceeded its assets. But it had one asset that had not yet been monetized—millions of acres of land on the North American continent. So Law set out to monetize that land by turning it into shares in a joint-stock company called the Mississippi Company (Compagnie d’Occident). The Mississippi Company had a monopoly on all trading with the Americas. Buying a share in the company meant a cut of the profits (i.e. equity) of trading with North America.

The first loans and the resulting note issue having been visibly beneficial – and also a source of much personal relief – the Regent proposed and additional issue. If something does good, more must do better. Law acquiesced.

Sensing the need, he also devised a way of replenishing the reserves with which the Banque Royale backed up its growing volume of notes. Here he showed that he had not forgotten his original idea of a land bank.

His idea was to create the Mississippi Company to exploit and bring to France the very large gold deposits which Louisiana was thought to have as subsoil. To the metal so obtained were also to be added the gains of trade. Early in 1719, the Mississippi Company (Compagnie d’Occident), later the Company of the Indies, was gives exclusive trading privileges in India, China and the South Seas. Soon thereafter, as further sources of revenue, it received the tobacco monopoly, the right to coin money and the tax farm. (Galbraith, p. 23)

Law—or the Duc d’Arkansas as he was now known—talked up the corporation so well that the value of the shares skyrocketed—probably the world’s very first stock bubble (but hardly the last). Gambling fever was widespread and contagious, as the desire to get rich by doing nothing is a human universal. The term “millionaire” was coined. Law took advantage of the inflated share price to buy back more of the government’s debt. And the money to buy the shares at the inflated prices was printed by the bank itself. Knowing that there was far more paper than gold and silver to back it in the kingdom, Law then tried to break the link between paper money and specie by demonetizing gold and silver; at one point making it illegal to even hold precious metals.

He was unsuccessful. Paper money was still too new, and people were unwilling to trust it without the backing of previous metal, causing a loss of faith in the currency. Later suspensions of convertibility were done after generations of paper money use. Law’s entire scheme (from origin to collapse) took place over the course of less than a year.

[Law] funded the [Mississippi] company the same way he had funded the bank, with deposits from the public swapped for shares. He then used the value of those shares, which rocketed from five hundred livres to ten thousand livres, to buy up the debts of the French King. The French economy, based on all those rents and annuities and wages, was swept away and replaced by what Law called his “new System of Finance.”

The use of gold and silver was banned. Paper money was now “fiat” currency, underpinned by the authority of the bank and nothing else. At its peak, the company was priced at twice the entire productive capacity of France…that is the highest valuation any company has ever achieved anywhere in the world.

Galbraith and Weatherford summarize the shell game that Law’s “system” ended up becoming:

To simplify slightly, Law was lending notes of the Banque Royale to the government (or to private borrowers) which then passed them on to people in payment of government debts or expenses. These notes were then used by the recipients to buy stock in the Mississippi Company, the proceeds from which went to the government to to pay expenses and pay off creditors who then used the notes to buy more stock, the proceeds from which were used to meet more government expenditures and pay off more public creditors. And so it continued, each cycle being larger than the one before. (Galbraith, p. 24)

The Banque Royale printed paper money, which investors could borrow in order to buy stock in the Mississippi company; the company then used the new notes to pay out its bogus profits. Together the Mississippi Company and the Banque Royale were producing paper profits on each other’s accounts. They bank had soon issued twice as much paper money as there was specie in the whole country; obviously it could no longer guarantee that each paper note would be redeemed in gold. (Weatherford, p. 131)

Such a scheme couldn’t last, of course. Essentially the entire French economy—its central bank, its money supply, its tax system, and the monopoly on land in North America—were in the hands of one single, giant conglomerate run by one man. That meant that when one part of the system failed, all the rest went down like ascending mountain climbers roped together.

Because the central bank owned the Mississippi company, it had an incentive to loan out excess money to drive the share price up—in other words, to inflate a stock bubble based on credit. This is always a bad idea. Finally, Law’s exaggeration of the returns on investments in the Mississippi Company inflated expectations far beyond what was realistic.

The popping of the Mississippi stock bubble, followed by a run on the bank, was enough to bring the whole thing crashing down.

People started to wonder whether these suddenly lucrative investments were worth what they were supposed to be worth; then they started to worry, then to panic, then to demand their money back, then to riot when they couldn’t get it.

Gold and silver were reinstated as money, the company was dissolved, and Law was fired, after a hundred and forty-five days in office. In 1720, he fled the country, ruined. He moved from Brussels to Copenhagen to Venice to London and back to Venice, where he died, broke, in 1729.

The Invention of Money (The New Yorker)

As Law must have known, if you gamble big, sometimes you lose big.

Some of the death of the Bank was murder, not suicide. As part of his System, one of Law’s initiatives was to simplify and modernize the inefficient and antiquated French tax system. Taxes were collected by tax farmers (much as in ancient Rome), and Law threatened to overturn their apple cart. He also attempted to end the sale of government offices to the highest bidder. This made him a lot of enemies among the moneyed classes, who thrived on graft and corruption. Such influential people (notably the financiers the Paris brothers), were instrumental in the run on the bank and the subsequent loss of confidence in the money system:

[Law] set about streamlining a tax system riddled with corruption and unnecessary complexity. As one English visitor to France in the late seventeenth century observed. “The people being generally so oppressed with taxes, which increase every day, their estates are worth very little more than what they pay to the King; so that they are, as it were, tenants to the Crown, and at such a rack rent that they find great difficulty to get their own bread.” The mass of offices sold to raise money had caused one of Louis XIV’s ministers to comment, “When it pleases Your Majesty to create an office, God creates a fool to purchase it.” There were officials for inspecting the measuring of cloth and candles; hay trussers; examiners of meat, fish and fowl. There was even an inspector of pigs’ tongues.

This did nothing for efficiency, Law deemed, and served only to make necessities more expensive and to encourage the holders of the offices “to live in idleness and deprive the state of the service they might have done it in some useful profession, had they been obliged to work.” In place of the hundreds of old levies he swept away (over forty in one edict alone), Law introduced a new national taxation system called the denier royal, based on income. The move caused an outcry among the holders of offices, many of whom were wealthy financiers and members of the Parliament, but delight among the public. “The people went dancing and jumping about the streets,” wrote Defoe. “They now pay not one farthing tax for wood, coal, hay, oats, oil, wine, beer, bread, cards, soap, cattle, fish.” (Janet Gleeson, Millionaire; pp. 155-156

Michel Aglietta, in his magisterial work on money, notes that Law…

…wanted to introduce the logic of capitalism in France, based on providing credit through money creation. Money creation had to be based on expected future wealth, and no longer on the past wealth accumulated in precious metals. (Aglietta, p. 206, emphasis in original)

The danger is, if this wealth fails to materialize; or if people lose the belief that it will materialize, confidence in the system is lost, and failure soon follows.

Although John Law has come down in history as a grifter, and his ideas as fundamentally unsound, many of his ideas eventually became fundamental tenets of modern global finance:

The great irony of Law’s life is that his ideas were, from the modern perspective, largely correct. The ships that went abroad on behalf of his great company began to turn a profit. The auditor who went through the company’s books concluded that it was entirely solvent—which isn’t surprising, when you consider that the lands it owned in America now produce trillions of dollars in economic value.

Today, we live in a version of John Law’s system. Every state in the developed world has a central bank that issues paper money, manipulates the supply of credit in the interest of commerce, uses fractional-reserve banking, and features joint-stock companies that pay dividends. All of these were brought to France, pretty much simultaneously, by John Law.

The Invention of Money (The New Yorker)

Law’s efforts left a lingering suspicion of paper money in France. Unfortunately, the revenues problem was not definitively solved. Going back on a specie standard delivered a huge blow to commerce. While England’s paper money system flourished, France stagnated economically. Eventually, the revenues situation of the government became so dire that the King had no choice but to call an Estates General—the extremely rare parliamentary session that kicked off the French Revolution—in 1789.

Once the Mississippi bubble burst, a lot of the capital in France needed some new outlet to invest in. Much of that capital fled across the channel to England, which at the time was inflating a stock bubble of its own:

France’s ruin was England’s gain. Numerous bruised Mississippi shareholders chose to reinvest in English South Sea shares.
The previous month, with a weather eye to developments in France, the South Sea Company managed to beat its rival the Bank of England and secure a second lucrative deal with the government whereby it took over a further $48 million of national debt and launched a new issue of shares. A multitude of English and foreign investors were now descending on London as they had flocked less than a year earlier to Paris “with as much as they can carry and subscribing for or buying shares.”

In Exchange Alley–London’s rue Quincampoix–the sudden surce of new money also bubbled a plethora of alternative companies launched to capitalize on the new fashion for financial fluttering… (Gleeson, p, 200)

2. England

Britain chose a different tack – sovereign debt would be monetized and circulate as money. It too utilized the joint-stock company model that had been invented in the previous centuries to enable the Europeans to raise the funds to exploit and colonize the rest of the world. A bank was founded as a chartered company to take in money through subscribed shares and loan out that money to the King. That debt—and not land—would securitize the notes issued by the bank. The notes would then circulate as money, albeit alongside precious metal coins and several other forms of payment. As with the original invention of sovereign debt in northern Italy, it was used to raise the necessary funds for war:

The modern system for dealing with [the] problem [of funding wars] arose in England during the reign of King William, the Protestant Dutch royal who had been imported to the throne of England in 1689, to replace the unacceptably Catholic King James II.

William was a competent ruler, but he had serious baggage—a long-running dispute with King Louis XIV of France. Before long, England and France were involved in a new phase of this dispute, which now seems part of a centuries-long conflict between the two countries, but at the time was variously called the Nine-Years’ War or King William’s War. This war presented the usual problem: how could the nations afford it?

King William’s administration came up with a novel answer: borrow a huge sum of money, and use taxes to pay back the interest over time. In 1694, the English government borrowed 1.2 million pounds at a rate of eight per cent, paid for by taxes on ships’ cargoes, beer, and spirits. In return, the lenders were allowed to incorporate themselves as a new company, the Bank of England. The bank had the right to take in deposits of gold from the public and—a second big innovation—to print “Bank notes” as receipts for the deposits. These new deposits were then lent to the King. The banknotes, being guaranteed by the deposits, were as good as gold money, and rapidly became a generally accepted new currency.

The Invention of Money (The New Yorker)

From this point forward, money would be circulating government debt. Plus, it’s value would be based on future revenues, as Aglietta noted above, and not just on the amount of gold and silver coins floating around.

The originality of the Bank of England was that it was not a deposit bank. Unlike for the Bank of Amsterdam, the coverage for the notes issued was very low (3 percent in the beginning). These notes, the counterparty to its loans to the state, replaced bills of exchange and became national and international means of payment for the bank’s customers.

They were not legal tender until 1833. But the securities issued by the bank, bringing interest on the public debt, became legal tender for all payments to the government from 1697 onwards. (Aglietta, pp. 136-137)

Why did the King of England have to borrow at all? Well, for a couple reasons. The power to raise taxes had been taken away from the King and given to Parliament as a consequence of the English Revolution. That revolutionary era also witnessed the inauguration goldsmith banking (such as that undertaken by John Law’s own family of goldsmiths). These goldsmith receipts were the forerunners of the banknote:

The English Civil War…broke out because parliament disputed the king’s right to levy taxes without its consent. The use of goldsmith’s safes as secure places for people’s jewels, bullion and coins increased after the seizure of the mint by Charles I in 1640 and increased again with the outbreak of the Civil War. Consequently some goldsmiths became bankers and development of this aspect of their business continued after the Civil War was over.

Within a few years of the victory by the parliamentary forces, written instructions to goldsmiths to pay money to another customer had developed into the cheque (or check in American spelling). Goldsmiths’ receipts were used not only for withdrawing deposits but also as evidence of ability to pay and by about 1660 these had developed into the banknote.

Warfare and Financial History (Glyn Davies, History of Money online)

By this time, control over money had passed into the hands of a rising mercantile class, who—thanks to the staggering wealth produced by globalized trade—possessed more wealth than mere princes and kings, but lacked the ability to write laws or to print money, which they strongly coveted. It was these merchants and “moneyed men” (often members of the Whig party in Parliament) who backed the Dutch staadtholder William of Orange’s claim to the English throne in 1688.

The banknotes began to circulate widely, displacing coins and bills of exchange. And it didn’t stop there: more money was quickly needed, and the Bank acquired more influence. Part of this was due to England being a naval—rather than an army—power. Warships require huge expenditures of capital to build. They also require a vast panoply of resources, such as wood, nails, iron, cloth, stocked provisions, and so forth; whereas land-based armies just require paying soldiers and provisions (which can be commandeered). Thus, financial means to mobilize these resources were much more likely in naval powers such as Holland and England than in continental powers like France, Austria and Spain.

This important post from the WEA Pedagogy blog uses excerpts from Ellen Brown’s Web of Debt to lay out the creation of the Bank of England, and, consequently, central banking in general (and is well-worth reading in full):

William was soon at war with Louis XIV of France. To finance his war, he borrowed 1.2 million pounds in gold from a group of moneylenders, whose names were to be kept secret. The money was raised by a novel device that is still used by governments today: the lenders would issue a permanent loan on which interest would be paid but the principal portion of the loan would not be repaid.

The loan also came with other strings attached. They included:

– The lenders were to be granted a charter to establish a Bank of England, which would issue banknotes that would circulate as the national paper currency.

– The Bank would create banknotes out of nothing, with only a fraction of them backed by coin. Banknotes created and lent to the government would be backed mainly by government I.O.U.s, which would serve as the “reserves” for creating additional loans to private parties.

– Interest of 8 percent would be paid by the government on its loans, marking the birth of the national debt.

The lenders would be allowed to secure payment on the national debt by direct taxation of the people. Taxes were immediately imposed on a whole range of goods to pay the interest owed to the Bank.

The Bank of England has been called “the Mother of Central Banks.” It was chartered in 1694 to William Paterson, a Scotsman who had previously lived in Amsterdam. A circular distributed to attract subscribers to the Bank’s initial stock offering said, “The Bank hath benefit of interest on all moneys which it, the Bank, creates out of nothing.” The negotiation of additional loans caused England’s national debt to go from 1.2 million pounds in 1694 to 16 million pounds in 1698. By 1815, the debt was up to 885 million pounds, largely due to the compounding of interest. The lenders not only reaped huge profits, but the indebtedness gave them substantial political leverage.

The Bank’s charter gave the force of law to the “fractional reserve” banking scheme that put control of the country’s money in a privately owned company. The Bank of England had the legal right to create paper money out of nothing and lend it to the government at interest. It did this by trading its own paper notes for paper bonds representing the government’s promise to pay principal and interest back to the Bank — the same device used by the U.S. Federal Reserve and other central banks today.

Note that the interest on the loan is paid, but never the loan itself. That meant that tax revenues were increasingly funneled to a small creditor class to whom the government was indebted. Today, we call such people bond holders, and they exercise their leverage over governments through the bond markets. For all intents and purposes, this system ended government sovereignty and tied the hands of even elected governments being able to spend tax money on the domestic needs of their own people. Control over the state’s money was lost forever.

An interesting couple of notes: William Paterson was, like John Law, a Scotsman—giving credence to the claim that it was the Scots who “invented Capitalism” (Adam Smith and James Watt were also Scots). It also raises the idea (to me, anyway) that the modern financial system was started by instinctive hustlers and gamblers. We’ve already referred to John Law’s expertise at the gambling tables of Europe and ability to inspire confidence in his schemes. Patterson, upon returning to Scotland, began raising funds via stock for an ambitious scheme to develop a society in Central America. This scheme ended up being on of the worst disasters in history. Not only that, but the Darien scheme collapsed so badly that Scotland’s entire financial health was devastated, and is considered to be a factor in Scotland signing the Acts of Union, politically joining with England to the south.

For an overview of the Darien scheme, see this: Scotland’s lessons from Darien debacle (BBC)

The WEA Pedagogy blog than adds some additional details:

Some more detail of interest is that the creation of Bank of England was tremendously beneficial for England. The King, no longer constrained, was able to build up his navy to counter the French. The massive (deficit) spending required for this purpose led to substantial progress in industrialization.

Quoting Wikipedia on this: “As a side effect, the huge industrial effort needed, including establishing ironworks to make more nails and advances in agriculture feeding the quadrupled strength of the navy, started to transform the economy. This helped the new Kingdom of Great Britain – England and Scotland were formally united in 1707 – to become powerful. The power of the navy made Britain the dominant world power in the late 18th and early 19th centuries”

The post then summarizes the history of the creation of central banking:

…It is in this spirit that we offer a “finance drives history” view of the creation of the first Central Bank. The history above can be encapsulated as follows:

1. Queen Elizabeth asserted and acquired the sovereign right to issue money.
2. The moneylenders (the mysterious 0.1% of that time) financed and funded a revolution against the king, acquiring many privileges in the process.
3. Then they financed and funded the restoration of the aristocracy, acquiring even more privileges in the process.
4. Finally, when the King was in desperate straits to raise money, they offered to lend him money at 8% interest, in return for creating the Bank of England, acquiring permanently the privilege of printing money on behalf of the king.

The process by which money was created by the Bank of England is extremely interesting. They acquired the debt of the King. This debt was used as collateral/backing for the money they created. The notes they issued were legal tender in England. Whenever necessary, they were prepared to exchange them for gold, at the prescribed rates. However, when the confidence of the public is high, the need for actual gold as backing is substantially reduced.

Origins of Central Banking (WEA Pedagogy Blog)

As I noted above, the importance of the Navy in the subsequent industrialization of England is often overlooked. There have been a few scholars who have argued that it was Britain’s emphasis on naval power which was a factor in England (and not somewhere else) becoming the epicenter of the Industrial Revolution. Many of its key inventions were sponsored by the government in order to more effectively fight and navigate at sea (from accurate clocks and charts to canned food). Even early mass production was prompted by the needs of the British Navy: pulley blocks were mass-produced by engineers and were one of the first items made this way via mechanization.

Just like in other countries, the needs of war caused the Bank to issue more and more notes, greatly increasing to the national debt. However, the vast profits of industrialization and colonialism were enough to support it. When convertibility was finally temporarily suspended in the mid 1800s by necessity, paper money continued to carry the trust of the public, unlike in France. Galbraith sums up the subsequent history of the Bank of England:

In the fifteen years following the granting of the original charter the government continued in need, and more capital was subscribed by the Bank. In return, it was accorded a monopoly of joint-stock, i.e., corporate, banking under the Crown, one that lasted for nearly a century. In the beginning, the Bank saw itself merely as another, though privileged, banker.

Similarly engaged in a less privileged way were the goldsmiths, who by then had emerged as receivers of deposits and sources of loans and whose operations depended rather more on the strength of their strong boxes than on the rectitude of their transactions. They strongly opposed the renewal of the Bank’s charter. Their objections were overcome, and the charter was renewed.

Soon, however, a new rival appeared to challenge the Bank’s position as banker for the government. This was the South Sea Company. In 1720, after some years of more routine existence, it came forward with a proposal for taking over the government debt in return for various concessions, including, it was hoped, trading privileges to the Spanish colonies, which, though it was little noticed at the time, required a highly improbable treaty with Spain.

The Bank of England bid strenuously against the South Sea Company for the public debt but was completely outdone by the latter’s generosity, as well as by the facilitating bribery by the South Sea Company of Members of Parliament and the government. The rivalry between the two companies did not keep the Bank from being a generous source of loans for the South Sea venture. All in all, it was a narrow escape.

For the enthusiasm following the success of the South Sea Company was extreme. In the same year that Law’s operations were coming to their climax across the Channel, a wild speculation developed in South Sea stock, along with that in numerous other company promotions, including one for a wheel for perpetual motion, one for ‘repairing and rebuilding parsonage and vicarage houses’ and the immortal company ‘for carrying on an undertaking of great advantage, but nobody to know what it is’. All eventually passed into nothing or something very near.
In consequence of its largely accidental escape, the reputation of the Bank for prudence was greatly enhanced.

As Frenchmen were left suspicious of banks, Englishmen were left suspicious of joint-stock companies. The Bubble Acts (named for the South Sea bubble) were enacted and for a century or more kept such enterprises under the closest interdict.

From 1720 to 1780, the Bank of England gradually emerged as the guardian of the money supply as well as of the financial concerns of the government of England. Bank of England notes were readily and promptly redeemed in hard coin and, in consequence, were not presented for redemption. The notes of its smaller competitors inspired no such confidence and were regularly cashed in or, on occasion, orphaned.
By around 1770, the Bank of England had become nearly the sole source of paper money in London, although the note issues of country banks lasted well into the following century. The private banks became. instead, places of deposit. When they made loans, it was deposits, not note circulation, that expanded, and, as a convenient detail, cheques now came into use. (Galbraith, 32-34)

By a complete accident, Britain was able to escape France’s fate. When the South Sea bubble popped, the Bank of England was able to reliably take up the slack and manage the government’s debt—an option that France did not have, since the central bank and the Company were all part of the same organization, and that organization had a monopoly over loans to the government, tax collection, and money creation.

Next time: An Instrument of Revolution.

The Origin of Paper Money 5

As noted last time, the issuance of printed money by Pennsylvania was highly successful. It increased trade and greatly expanded the economy.

One person who noticed this was a young printer by the name of Benjamin Franklin. At the age of only 23, he wrote a treatise strongly advocating the benefits of printing paper money to increase the domestic money supply.

Franklin arrived in Philadelphia the year paper money was first issued by Pennsylvania (1723), and he soon became a keen observer of and commentator on colonial money…Franklin noted that after the legislature issued this paper money, internal trade, employment, new construction, and the number of inhabitants in the province all in-creased. This feet-on-the-ground observation, this scientific empiricism in Franklin’s nature, would have a profound effect on Franklin’s views on money throughout his life. He will repeat this youthful observation many times in his future writings on money.

Benjamin Franklin and the Birth of a Paper Money Economy

Franklin had noted the effects that the chronic shortage of precious metal coins had on the local economy. Something needed to be done, he thought. Franklin, of course, being a printer by trade, felt that his printing presses might be the solution to this problem.

Franklin’s proposal–and this was key–was that paper money could not be backed by silver and gold; because the lack of silver and gold was what the paper money was designed to rectify in the first place!

Source

Franklin also noted a point that critics of the gold standard have made ever since: the value of gold and silver is not stable, but fluctuates over time with supply and demand, just like everything else! Backing one’s currency by specie was no guarantee of stable prices or a stable money supply. As was seen in Europe, a sudden influx could send prices soaring, and a dearth would send prices crashing. As we’ll see, this was a major problem with precious metal standards throughout the nineteenth century—a point conspicuously ignored by goldbugs. Instead, he proposed a land bank, which, as we saw earlier, was a very popular idea at this time. Even though the colonies didn’t have sources of previous metals—and couldn’t mint them even if they did—they did have an abundant supply of real estate, far more than Europe, in fact. Land could be mortgaged, and the mortgages would act as backing for the new government-issued currency.

Economist (and Harry Potter character) Farley Grubb has written a definitive account of Franklin’s proposal:

Franklin begins his pamphlet by noting that a lack of money to transact trade within the province carries a heavy cost because the alternative to paper money is not gold and silver coins, which through trade have all been shipped off to England, but barter. Barter, in turn, increases the cost of local exchange and so lowers wages, employment, and immigration. Money scarcity also causes high local interest rates, which reduces investment and slows development. Paper money will solve these problems.

But what gives paper money its value? Here Franklin is clear throughout his career: It is not legal tender laws or fixed exchange rates between paper money and gold and silver coins but the quantity of paper money relative to the volume of internal trade within the colony that governs the value of paper money. An excess of paper money relative to the volume of internal trade causes it to lose value (depreciate). The early paper monies of New England and South Carolina had depreciated because the quantities were not properly controlled.

So will the quantity of paper money in Pennsylvania be properly controlled relative to the demands of internal trade within the province?

First, Franklin points out that gold and silver are of no permanent value and so paper monies linked to or backed by gold and silver, as with bank paper money in Europe, are of no permanent value. Everyone knew that over the previous 100 years the labor value of gold and silver had fallen because new discoveries had expanded supplies faster than demand. The spot value of gold and silver could fluctuate just like that of any other commodity and could be acutely affected by unexpected trade disruptions. Franklin observes in 1729 that “we [Pennsylvanians] have already parted with our silver and gold” in trade with England, and the difference between the value of paper money and that of silver is due to “the scarcity of the latter.”

Second, Franklin notes that land is a more certain and steady asset with which to back paper money. For a given colony, its supply will not fluctuate with trade as much as gold and silver do, nor will its supply be subject to long-run expansion as New World gold and silver had been. Finally, and most important, land cannot be exported from the province as gold and silver can. He then points out that Pennsylvania’s paper money will be backed by land; that is, it will be issued by the legislature through a loan office, and subjects will pledge their lands as collateral for loans of paper money.

Benjamin Franklin and the Birth of a Paper Money Economy

Franklin argued that the amount of money circulating would be self-correcting. If too little was issued, he said, falling prices would motivate people to mortgage their land to get their hands on more bills. If too much money was circulating, its value would fall, and mortgagees would use the cheaper notes to buy back their land, thus retiring the notes from circulation and alleviating the oversupply.

Finally, Franklin argues that “coined land” or a properly run land bank will automatically stabilize the quantity of paper money issued — never too much and never too little to carry on the province’s internal trade. If there is too little paper money, the barter cost of trade will be high, and people will borrow more money on their landed security to reap the gains of the lowered costs that result when money is used to make transactions. A properly run land bank will never loan more paper money than the landed security available to back it, and so the value of paper money, through this limit on its quantity, will never fall below that of land.

If, by chance, too much paper money were issued relative to what was necessary to carry on internal trade such that the paper money started to lose its value, people would snap up this depreciated paper money to pay off their mortgaged lands in order to clear away the mort-gage lender’s legal claims to the land. So people could potentially sell the land to capture its real value. This process of paying paper money back into the government would reduce the quantity of paper money in circulation and so return paper money ’s value to its former level.

Automatic stabilization or a natural equilibrium of the amount of paper money within the province results from decentralized market competition within this monetary institutional setting. Fluctuations in the demand for money for internal trade are accommodated by a flexible internal money supply directly tuned to that demand. This in turn controls and stabilizes the value of money and the price level within the province.

Benjamin Franklin and the Birth of a Paper Money Economy

Given that the United States was the major pioneer in the Western world for a successful paper fiat currency, it is ironic that we have become one of the centers for resistance to the very idea today. This in large part due to the bottomless funding by billionaire libertarian cranks to promote shaky economic ideas in the United States, such as Austrian Economics, whereas in the rest of the world common-sense prevails. Wild, paranoid conspiracy theories about money (and just about everything else) also circulate widely in the United States, much more widely than the rest of the developed world which has far better educational systems.

Returning to the gold standard is—bizarrely—appropriated by people LARPing the American Revolution today in tri-corner hats, proclaiming themselves as the only true “patriots”. Yet, as we’ve seen, the young United States was the world’s leading innovator in issuing paper money not backed by gold–i.e. fiat currency. And this led to its prosperity. Founding Father Benjamin Franklin was a major advocate of paper money not backed by gold. This is rather inconvenient for libertarians (as is most of actual history).

The young have always learned that Benjamin Franklin was the prophet of thrift and the exponent of scientific experiment. They have but rarely been told that he was the advocate of the use of the printing press for anything except the diffusion of knowledge. (Galbraith, p. 55)

That’s right, Ben Franklin was an advocate of “printing money.” Something to remember the next time a Libertarian glibly sneers at the concept. Later advocates of “hard money”, i.e. goldbugs like Andrew Jackson, would send the U.S. economy crashing to its knees in the early nineteenth century by returning to a gold standard.

Here’s Galbraith describing the theory behind paper money:

There is very little in economics that invokes the supernatural. But by one phenomenon many have been tempted. In looking at a rectangular piece of paper, on frequent occasion of indifferent quality, featuring a national hero or monument or carrying a classical design with overtones of Peter Paul Rubens, Jacques Louis David or a particularly well-stocked vegetable market and printed in green or brown ink, they have been assailed by the question: Why is anything intrinsically so valueless so obviously desirable? What, in contrast to a similar mass of fibres clipped from yesterday’s newspaper, gives it the power to command goods, enlist service, induce cupidity, promote avarice, invite to crime? Surely some magic is involved; certainly some metaphysical or extraterrestrial explanation of its value is required. The priestly reputation and tendency of people who make a profession of knowing about money have been noted. Partly it is because such people are thought to know why valueless paper has value.

The explanation is wholly secular; nor is magic involved.

Writers on money have regularly distinguished between three types of currency:

(1) that which owes its value, as do gold and silver, to an inherent desirability derived from well-established service to pride of possession, prestige of ownership, personal adornment, dinner service or dentistry;

(2) that which can be readily exchanged for something of such inherent desirability or which carries the promise, like the early Massachusetts Bay notes, of eventual exchange; and

(3) currency which is intrinsically worthless, carries no promise that it will be redeemed in anything useful or desirable and which is sustained, at most, by the fiat of the state that it be accepted.

In fact, all three versions are variations on a single theme.

John Stuart Mill…made the value of paper money dependent on its supply in relation to the supply of things available for purchase.
Were the money gold or silver, there was little chance, the plethora of San Luis Potosí or Sutter’s Mill apart, for the amount to increase unduly. This inherent limit on supply was the security that, as money, it would be limited in amount and so retain its value.

And the same assurance of limited supply held for paper money that was fully convertible into gold and silver. As it held for paper that could not be converted into anything for so long as the supply of such paper was limited. It was the fact of scarcity, not the fact of intrinsic worthlessness, that was important. The problem of paper was that, in the absence of convertibility, there was nothing to restrict its supply. Thus it was vulnerable to the unlimited increase that would diminish or destroy its value.

The worthlessness of paper is a detail. Rock quarried at random from the earth’s surface and divided into units of a pound and upward would not serve very happily as currency. So great would be the potential supply that the weight of rock for even a minor transaction would be a burden. But rock quarried on the moon and moved to the earth, divided and with the chunks duly certified as to the weight and source, though geologically indistinguishable from the earthbound substance, would be a distinct possibility, at least for so long as the trips were few and the moon rock retained the requisite scarcity. pp. 62-64

NEXT: England and France get on the paper money train. England succeeds; France fails.

The Origin of Paper Money 4

What’s often considered to be the first recorded issuance of government-backed paper money in the Western world was in Colonial America, and it was quite by accident.

There had been precedents, but they were very limited, and we only know about them through historical records. Paper money tends to disappear in the archaeological record, while coins survive, which means that earlier experiments in paper money may simply be lost to history.

Repeatedly in the European records we find mention of money made from leather during times of warfare and siege. Reports indicate that European monarchs occasionally used paper money during periods of crisis, usually war, and they do maintain that in Catalonia and Aragon, James I issued paper money in 1250, but no known examples have survived. Then, when the Spanish laid siege to the city of Leyden in the Lowlands in 1574, Burgomeister Pieter Andriaanszoon collected all metal, including coins, for use in the manufacture of arms. To replace the coins, he issued small scraps of paper.

On July 1661, Sweden’s Stockholm Bank issued the first bank note in Europe to compensate for a shortage of silver coins. Although Sweden lacked silver, it possessed bountiful copper resources, and the government of Queen Christina (1634-1654) issued large copper sheets called platmynt (plate money), which weighed approximately 4 pounds each. In 1644 the government offered the largest coins ever issued: ten-daler copper plates, each of which weighed 43 pounds, 7 1/4 ounces. To avoid having to carry such heavy coins, merchants willingly accepted the paper bills in denominations of one hundred dalers. one such bill could be submitted for 500 pounds of copper plates. (Weatherford, p. 130)

For an example of platmynt, see this link: Swedish “plate money” (TYWKIIDBI)

The issuance was by Massachusetts in 1690. It was in the form of government IOU’s issued to pay for a failed raid on Quebec which was successfully repelled. Due to the failure of the raid, the expected booty to pay for the cost of the expedition did not materialize. The government, reluctant to raise taxes to pay for an expedition that was a failure, issued IOU’s instead. Due to the shortage of metal coins, these IOU’s began circulating at their face value as a substitute for coins. And thus, by accident, paper money was created in the Western world:

The first issue of paper money was was by the Massachusetts bay Colony in 1690; it has been described as ‘not only the origin of paper money in America, but also in the British empire, and almost in the Christian world’. It was occasioned, as noted, by war.

In 1690, Sir William Phips – a man whose own fortune and position had been founded on the gold and silver retrieved from a wrecked Spanish galleon near the shores of what is now Haiti and the Dominican Republic – led an expedition of Massachusetts irregulars against Quebec. The loot from the fall of the fortress was intended to pay for the expedition. The fortress did not fall.

The American colonies were operating on negligible budgets…and there was no enthusiasm for levying taxes to pay the defeated heroes. So notes were issued to the soldiers promising eventual payment in hard coin. Redemption in gold or silver, as these were returned in taxes, was promised, although presently the notes were also made legal tender for taxes. (Galbraith, pp. 51-52)

The colonial government intended to quickly redeem the certificates with tax revenues, but the need for money was so great that the certificates began changing hands, like money…[1]…For the next twenty years the notes circulated side by side with gold and silver of equivalent denomination. Notes and metal being interchangeable, there was pro tanto, no depreciation. (p. 52)…

The practice quickly caught on among the colonies as a means of supplying a circulating currency. The issuances were to be temporary, in fixed amounts, and accompanied by taxes and custom duties to redeem them. [1]

To retire these bills on credit, the colonial governments accepted them—along with specie—in payment of taxes, fines and fees. As with “bills on loan” the governments used any specie that they received in tax payments to retire and then burn the notes. Also like “bills on loan,” the notes circulated freely within the colonies that issued them and sometimes in adjacent colonies. [1]

[1] Paper Money and Inflation in Colonial America

This circulation of these paper IOUs gave cash-strapped governments an idea. Governments could issue IOUs (hypothetically redeemable in gold and silver coins) in lieu of levying taxes to enable the government to pay for stuff. Such IOUs could then circulate as cash money—valuable because they would theoretically be redeemed by governments for gold and silver, or be used to discharge debt obligations to the state like taxes, fines and fees. As noted above, when gold and silver did come into the state’s coffers, they could buy back the notes.

Unlike modern paper money, these IOUs typically had an expiration date. By redeeming the issued notes, the government could remove paper from circulation, lowering its debt obligations, while at the same time preventing paper money from losing too much of its value. (Note similarities with the Chinese system).

And so, as the 1700’s dawned, colonial governments started commonly issuing paper money—colonial scrip—in lieu of taxes to goose the domestic economy by increasing the amount of money in circulation. Since precious metals were in short supply, most of these schemes were based on the land banking concept (i.e. monetizing land):

The Pennsylvania legislature issued its first paper money in 1723 — a modest amount of £15,000 (the equivalent of just over 48,000 Spanish silver dollars), with another £30,000 issued in 1724. This paper money was not linked to or backed by gold and silver money. It was backed by the land assets of subjects who borrowed paper money from the government and by the future taxes owed to the government that could be paid in this paper money…after the legislature issued this paper money, internal trade, employment, new construction, and the number of inhabitants in the province all increased…The initial paper money issued in 1723 was due to expire in 1731. (Typically, paper money was issued with a time limit within which it could be used to pay taxes owed to the issuing government — the money paid in being removed from circulation.)

Benjamin Franklin and the Birth of a Paper Money Economy (PDF)

In addition to funding military spending, one major driver behind colonial governments issuing IOUs as currency came from the extreme recalcitrance of the colonists in paying their allotted taxes, which means that this unfortunate tendency was present in America from the very beginning, as Galbraith notes:

A number of circumstances explain the pioneering role of the American colonies in the use of paper money. War, as always, forced financial innovation. Also, paper money…was a substitute for taxation, and, where taxes were concerned, the colonists were exceptionally obdurate; they were opposed to taxation without representation, as greatly remarked, and the were also, a less celebrated quality, opposed to taxation with representation. ‘That a great reluctance to pay taxes existed in all the colonies, there can be no doubt. it was one of the marked characteristics of the American people long after their separation from England.’ (Galbraith, pp. 46-47)

In subsequent years, the various colonial governments would rely on more and more on issuing paper money. And when they did, it was noted, the volume of trade increased, and local economies expanded. There was always, however, the looming threat of too much colonial scrip being issued by governments, leading to depreciation:

Inevitably, however, it occurred to the colonists that the notes were not a temporary, one-time expedient but a general purpose alternative to taxation. More were issued as occasion seemed to require, and the promised redemption was repeatedly postponed.

Prices specified in the notes now rose; so, therewith did the price of gold and silver. By the middle of the eighteenth century the amount of silver or gold for which the note could be exchanged was only about a tenth of what it had been fifty years before. Ultimately the notes were redeemed at a few shillings to the pound from gold sent over to pay for the colonial contribution to Queen Anne’s War.

Samuel Eliot Morison has said of the notes issued by Massachusetts to pay off the soldiers back from Quebec that they were ‘a new device in the English-speaking world which undermined credit and increased poverty’. Other and less judicious historians have reflected the same view. But it is also known that rising prices stimulate the spirits of entrepreneurs and encourage economic activity just as falling prices depress both.

Were only so much paper money issued by a government as to keep prices from falling or, at most, cause a moderate increase, its use could be beneficial. Not impoverishment, but an increased affluence would be the result.

The question, obviously, is whether there could be restraint, whether the ultimate and impoverishing collapse could be avoided. The Law syllogism comes ominously to mind: If some is good, more must be better. (Galbraith, pp. 52–53)

The use of paper money as an alternative to government borrowing began to spread. More and more colonial governments (there obviously was no national government back then) would issue IOUs as a way to get around chronic shortages of gold and silver coins, and to avoid raising taxes. Meanwhile, although Europe had begun to experiment with paper money, it was still tied to amounts of gold and silver, limiting its application.

The results in the colonies were highly mixed. Some experiments were highly successful; other less so:

…the other New England colonies and South Carolina had also discovered paper money…Restraint was clearly not available in Rhode Island of South Carolina or even in Massachusetts. Elsewhere, however, it was present to a surprising extent. The Middle Colonies handled paper money with what must now be regarded as astonishing skill and prudence…The first issue of paper money there was by Pennsylvania in 1723. Prices were falling at the time, and trade was depressed. Both recovered, and the issue was stopped.

There appear to have been similar benefits from a second issue in 1729; the course of business and prices in England in the same years suggests that, in the absence of such action, prices would have continued down. Similar issues produced similarly satisfactory results in New York, New Jersey, Delaware and Maryland. As in Pennsylvania, all knew the virtue of moderation. (Galbraith, pp. 52-53)

Perhaps the most intriguing experiment was done by the state of Maryland. It had a combination of what looks like a UBI scheme, coupled with a public banking system (à la North Dakota):

The most engaging experiment was in Maryland. Elsewhere the notes were put into circulation by the simple device of using them to pay public expenses. Maryland, in contrast, declared a dividend of thirty shillings to each taxable citizen and, in addition, established a loan office where worthy farmers and businessmen could obtain an added supply which they were required to repay.

Remarkably, this dividend was a one-time thing; as in the other Middle Colonies the notes so issued were ultimately redeemed in hard money. A near contemporary historian with a near-gift for metaphor credited the experiment with ‘feeding the flame of industry that began to kindle’. A much later student has concluded that ‘this was the most successful paper money issued by any of the colonies’.

Two centuries later during the Great Depression a British soldier turned economic prophet, Major C.H. Douglas, made very nearly the same proposal. This was Social Credit. Save in much distant precincts as the Canadian Prairies, he acquired general disesteem as a monetary crank. He was two hundred years too late. (Galbraith, pp. 53-54)

Interestingly, we see some of those ideas once again being floated once again today.

As Galbraith notes, later economic historians would focus exclusively on the failures of such early experiments, and deliberately ignore the places were it was successful. Much of this was based on the “gold is real money” ideology, along with the ideas around the “inherent profligacy of governments” which would invariably cause inflation. In other words, the groupthink of the economics priesthood:

Towards the end of the nineteenth century expanding university facilities, an increased interest in the past and a pressing need for subjects on which to do doctoral theses and other scholarly research all led to a greatly expanded exploration of colonial economic history. By then, among historians and economists, the gold standard had become an article of the highest faith. Their research did not subordinate faith to fact.

By what amounted to a tacit understanding between right-thinking men the abandoned tendencies of Rhode Island, Massachusetts and South Carolina were taken to epitomize the colonial monetary experience. The different experience of the Middle Colonies was simply ignored.

A leading modern student of colonial monetary experience has noted that: ‘One looks in vain for any discussion of these satisfactory currency experiments in the standard works on American monetary and financial history.’ Another has concluded that ‘…generations of historical scholarship have fostered a mistaken impression of the monetary practices of the colonies’. (Galbraith, pp. 54-55)

History repeats itself: today we once again have an economics caste wedded to orthodoxy and unwilling to consider alternative points of view. The MMT school of economics is fighting a lonely battle against this tendency today.

Next: Ben Franklin discovers money printing

The Origin of Paper Money 3

Despite paper instruments like bills of exchange having existed for centuries, for most ordinary people, money was exclusively the gold and silver coins minted by various national governments. Gold was used for high-value transactions, and silver for smaller ones. When the precious metals from the New World began flowing into Europe, the amount of coins dramatically increased, leading to a continent-wide bout of inflation.

The Spanish, the major beneficiaries of this increased money supply from silver mines of Bolivia and Mexico, used the money to purchase all sorts of things from abroad and live large. Because they became so filthy rich with very little effort (the enslaved Native Americans did all the hard work of digging out the silver), the Spanish failed to develop any domestic industries or innovate much, and thus were passed over by the more industrious Northern Europeans—much like a wealthy, spoiled heir who never learns any practical skills until the money runs out—and by then it’s too late.

There were many in Europe after 1493 who knew only distantly of the discovery and conquest of lands beyond the ocean seas, or to whom this knowledge was not imparted at all. There were few, it can be safely said, who did not feel one of its principal consequences.

Discovery and conquest set in motion a vast flow of precious metal from America to Europe, and the result was huge rise in prices – an inflation occasioned by an increase in the supply of the hardest of hard money.

Almost no one in Europe was so removed from market influences that he did not feel some consequence in his wage, in what he sold, in whatever trifling thing he had to buy.

The price increases occurred first in Spain where the metal first arrived; then, as they were carried by trade (or perhaps in lesser measure by smuggling or for conquest) to France, the Low Countries and England, inflation followed there.

In Andalusia, between 1500 and 1600, prices rose perhaps fivefold. In England, if prices during the last half of the fifteenth century, i.e. before Columbus, are taken as 100, by the last decade of the sixteenth century they were roughly at 250; eighty years later, by the decade of 1673 through 1682, they were around 350, up by three-and-a-half times from the level before Columbus, Cortez and the Pizarros. After 1680, they levelled off an subsided, as much earlier they had fallen in Spain. (Galbraith, pp. 8-9)

Prior to this era, Europe had dealt with ongoing, chronic shortages of precious metals for coins, because much of the continent’s silver leaked out through trading with the Arab world, especially after the Crusades. This is why much of the European economy remained unmonetized for so long. In fact, northern Italian bankers had invented banking and bills of exchange specifically to deal with this problem. Thus, markets in Europe remained confined to specific market towns and “ports of trade” and were subject to strict regulations by rulers. It was not a lack of desire for profits on the part of rulers, but a lack of coins that kept capitalism in embryo.

The vast increase in the money supply from New World silver and gold is what made capitalism possible in Western Europe, but that’s a story for another time.

At its peak in the early 17th century, 160,000 native Peruvians, slaves from Africa and Spanish settlers lived in Potosí to work the mines around the city: a population larger than London, Milan or Seville at the time. In the rush to exploit the silver, the first Spanish colonisers occupied the locals’ homes, forgoing the typical colonial urban grid and constructing makeshift accommodation that evolved into a chaotic mismatch of extravagant villas and modest huts, punctuated by gambling houses, theatres, workshops and churches.

High in the dusty red mountains, the city was surrounded by 22 dams powering 140 mills that ground the silver ore before it was moulded into bars and sent to the first Spanish colonial mint in the Americas. The wealth attracted artists, academics, priests, prostitutes and traders, enticed by the Altiplano’s icy mysticism. “I am rich Potosí, treasure of the world, king of all mountains and envy of kings” read the city’s coat of arms, and the pieces of eight that flowed from it helped make Spain the global superpower of the period.

Potosí: The mountain of silver that was the world’s first global city (Aeon)

How silver turned Potosí into ‘the first city of capitalism’ (The Guardian)

This price spike led to an important realization that people started to have after prices finally leveled off in the late 1600’s: the number of economic transactions (and hence the overall size of the economy and the capacity to specialize) was dependent on the amount of money in circulation. In other words, the volume of trade is determined by the amount of currency in circulation.

Today this is known as the quantity theory of money.

This newfound abundance of silver in Europe caused rising prices–the so-called “Price Revolution”. For the first time there was enough money to create a new class of people whose wealth consisted primarily of money as oppose to land: moneyed men, or the merchant caste. It also caused Spanish coins to be widely used and distributed, function as the world’s first global currency from the Americas to the Middle East to Asia:

The silver of the America made possible a world economy for the first time, as much of it was traded not only to the Ottomans but to the Chinese and East Indians as well, bringing all of them under the influence of the new silver supplies and standardized silver values. Europe’s prosperity boomed, and its people wanted all the teas, silks, cottons, coffees, and spices which the rest of the world had to offer. Asia received much of this silver, but it too experienced the silver inflation that Europe underwent. In China, silver had one-fouth the value of gold in 1368, before the discover of America, but by 1737 the ratio plummeted to twenty to one, a decline of silver to one-fifth of its former value. This flood of American silver came to Asia directly from Acapulco across the pacific via Manila in the Philippines, whence it was traded to China for spices and porcelain. (Weatherford, Indian Givers, pp. 16-17)

The so-called “Price Revolution” taught Europeans another important lesson: What constituted money didn’t change, but it’s purchasing power did. Therefore, they concluded, the value of money depended on how much of it there was in circulation, and not on some intrinsic quality. If there was a shortage of cash, it was worth a lot (i.e. it had high purchasing power). If there was a surplus, it wasn’t worth nearly as much (i.e. it had lower purchasing power). They had seen this first-hand.

In other words, the value of money had to do with how much of it there was, more than any intrinsic, magical quality. The value attributed gold and silver was merely a cultural artifact.

In fact, money had to be useless, since if it were more useful as a commodity than as money, then that’s what it would be used for, and there would be perennial shortages of currency causing the economy to contract.

This led to the following conclusions: If money has no inherent value, but was merely an expedient for spot transactions, than why not paper? But it does have to be backed by something, otherwise people will lose confidence in it. Although precious metal coins could be devalued by government edicts, their worth could never fall to zero, since there was always a commodity market for gold and silver for things like jewelry and tea sets. Precious metals tended to flow from where they were undervalued to countries where the commodity price was higher, causing perennial spot shortages throughout Europe, along with the requisite economic chaos.

The basic problem people were struggling with was that, since all money at the time was dependent on precious metals, how could you increase the supply of money without stumbling upon new sources of precious metal, as the Spanish had done? The money in circulation had to be increased—that was obvious to a growing number of people. But the low-hanging fruit of gold and silver had already been harvested. And with vast new material wealth continuing to flow into Europe from the Americas, how could the money supply be increased enough to take advantage of this?

Paper was an obvious solution. Paper had come to Europe in the Middle Ages from China. After the Black Death, many of the cotton clothes worn by the deceased were turned into pulp, which helped spread the use of paper, and indirectly drive the commercial revolution of the Middle Ages, along with innovations like Arabic numerals and double-entry bookkeeping (aka the “Venetian method”). The printing press, invented in Mainz in 1502 by Gutenberg, further enhanced the power of paper printing. But the real use of paper was in banking:

In the West, paper found its most important use as a means of keeping ledgers in banks. Long before it was used as a means of printing more money, it was used by bankers to increase the money supply. Only later did it gradually emerge as a replacment for coins in daily commerce. The initial development and circulation of monetary bills of paper came about as a side effect of banking. (Weatherford, p. 128)

Paper instruments of credit were already widely circulating throughout Europe, such as Bills of Exchange. Yet, underneath it all, money was still ultimately tied to finite amounts of precious metal. Paper checks were simply transfers of monies from one account to another, similar to giro banking in the ancient world, while Bills of exchange were:

“…essentially a written order to pay a fixed sum of money at a future date. Bills of exchange were originally designed as short-term contracts but gradually became heavily used for long-term borrowing. They were typically rolled over and became de facto short-term loans to finance longer-term projects…bills of exchange could be re-sold, with each seller serving as a signatory to the bill and, by implication, insuring the buyer of the bill against default…”

Crisis Chronicles: The Commercial Credit Crisis of 1763 and Today’s Tri-Party Repo Market (Liberty Street)

One solution was just to issue credit in excess of the amount of gold and silver stored in your vaults—the so-called “goldsmith’s trick.” This became especially common around the time of he English Revolution, where goldsmiths acted as moneylenders and bankers. As long as there was enough gold and silver sitting in the vault to cover the amount people showing up to exchange their paper, you were all right. But if more paper was redeemed than the gold and silver you had at any one point, you were doomed. This is why governments were reluctant to embrace such a solution (later, this idea would underpin fractional reserve banking).

The question ultimately boiled down to, if not gold and silver, then what would give paper money its value? And what would limit its supply? Otherwise, any enterprising printer could just print up money in any amount and give it to himself. Ultimately, the answers would come down to some sort of government authority to regulate the issuance of such bills, and back it up with the government’s credit.

One very common idea floating around in the late 1600s and early 1700s were proposals for a land bank–essentially monetizing land. Such banks wouldn’t take deposits in gold or silver; Rather, they would issue government-backed paper money securitized by mortgages on land. “In these early cases the term “bank” meant simply the collection or batch of bills of credit issued for a temporary period. If successful, reissues would lead to a permanent institution or bank in the more modern sense of the term.” After all, even if a country didn’t have gold and silver mines, it did always have land. Land was valuable, and inherently limited in supply–even moreso than gold and silver (“Buy land – they aren’t making any more if it,” said Mark Twain). This was a variant of the idea of paper money as a claim on real resources. However, the problem was much the same as with the goldsmith’s trick: what happens if you print money in excess of the underlying resources?

[I]f we look at the world through the lens of the late 17th century…[m]oney was made of metal, and there was therefore no scope for creating more money without finding new supplies of silver and gold. There were two types of wealthy individual: moneyed men and landed men.

The land bank proponents were early contributors to the economic debate. In their pamphlets the principal problem that they identified was the sluggish economy. They all agreed that the situation could be improved and saw the best means of improvement as an increase in the supply of money.

Rather than doing this as the Spanish and Portuguese did by sailing to the new world and bringing back vast quantities of precious metals, they proposed using the banking model that had succeeded in Amsterdam and Venice. According to Schumpeter, they “fully realised the business potentialities of the discovery that money – and hence capital in the monetary sense of the term – can be manufactured or created”.

Britain, which was not rich in terms of gold and silver, had plenty of potential in its land. Therefore, a land bank appeared to be a sensible suggestion. None of the land banks that were set up succeeded…

Land Bank Proposals 1650-1705 (PDF)

Land banks had already been established in the American Colonies in a limited fashion:

In 1686, Massachusetts established the first American land bank. Others soon followed.

Despite the name, these were not true banks; they did not accept deposits. Instead, they issued “banks” or notes, or “bills on loan,” to borrowers who put up land as collateral with the bank.

To fortify confidence in the notes, colonial governments promised to issue only a fixed amount of notes and for a set term and to secure their loans with collateral typically equal to twice the amount of the loan.

These notes soon became legal tender for all public and private debts. Principal and interest payments were due annually, but the bank often delayed the first principal payment for a few years. Payments had to be made in notes or in specie.

While the notes furnished a circulating currency, the interest payments provided a revenue stream to the colonial governments.

Paper Money and Inflation in Colonial America (Owen F. Humpage)

National land banks were proposed in the early 1700’s by two people who would become very influential in the history of paper money: John Law (for France) and Benjamin Franklin (for Pennsylvania). Later on, this idea would be used by the revolutionary French government to back its own paper currency called assignats. They used the land seized from the Catholic Church and some aristocrats to back the money. And there was a lot of this land—the Church owned an estimated one-fifth of all the land in France prior to the Revolution.

We can think of this as the very earliest rumblings of today’s Modern Monetary Theory (MMT). Money wasn’t gold and silver after all—rather, it was any means of exchange by which trade was conducted. The medium could be anything, so long it retained its value in exchange. What really mattered was the supply of it: that it was somewhat commensurate with the amount of economic transactions desired. The Scotsman John Law, who would establish the first paper money system in France, had seen people at the gambling tables of England using bills of exchange, stocks, bonds, banknotes, IOUs—any sort of valuable paper instrument—as de facto money in a pinch. This gave him the essential insight that any paper people believed had intrinsic value could be used as money, not just gold and silver coins:

[John] Law thought that the important thing about money wasn’t its inherent value; he didn’t believe it had any. “Money is not the value for which goods are exchanged, but the value by which they are exchanged,” he wrote. That is, money is the means by which you swap one set of stuff for another set of stuff. The crucial thing, Law thought, was to get money moving around the economy and to use it to stimulate trade and business.

As Buchan writes, “Money must be turned to the service of trade, and lie at the discretion of the prince or parliament to vary according to the needs of trade. Such an idea, orthodox and even tedious for the past fifty years, was thought in the seventeenth century to be diabolical.”

The Invention of Money (The New Yorker)

What was undeniable was that the growing economies of the North Atlantic needed more money, and lots of it; far in excess of what any gold and silver mines anywhere in the world could reasonably provide.

Next: The first (Western) paper money

The Origin of Paper Money 2

When it comes to paper money in the West, the foremost innovator was the United States, as John Kenneth Galbraith points out:

If the history of commercial banking belongs to the Italians and of central banking to the British, that of paper money issued by a central government belongs indubitably to the Americans. (Galbraith, p. 45)

The reason the American colonies had to experiment with paper money was simple: “official” money in the American Colonies was gold and silver coins, and there was a perennial shortage of such coins.

The American colonies had no rich deposits of gold of silver, unlike the Spanish in Latin America. There were no mines, and, to make things worse, there no mints allowed in North America. And, to top it all off, the British government forbade the colonies from chartering banks, “Thus bank notes, the obvious alternative to government notes, were excluded.” (Galbraith, p. 47). Colonists used whatever coins they could get their hands on, most of which came from the Spanish colonies to the south. In particular, this meant the Spanish Peso de Ocho Reales, or Piece of Eight: the world’s first global currency. This was also the origin of the famed dollar $ign. Foreign coins would continue to circulate as money in the United States until after the Civil War.

The curious origin of the dollar symbol (BBC)

Since the colonies couldn’t mint their own coins, if you wanted to get your hands on gold and silver coins, you had no other choice but to trade with the outside world. If you didn’t trade with the outside world, then getting sufficient coins was really difficult, severely limiting internal trade. This wasn’t accidental—the British, like all colonial powers, wanted the colonies to be sources of raw materials for their domestic manufacturing industries, and not to be economically self-sufficient.

To help alleviate the ongoing shortage of previous metal coins, local authorities might have passed laws to restrict the export of gold and silver–what we would today call capital controls—but such laws were expressly forbidden by the British government. In the mercantilist world of the 1600-1700s, the strength of a nation lay in the amount of gold and silver stashed away in its vaults—probably a holdover from the time when gold and silver paid for mercenaries in Europe before the era of professional standing armies.

And so there was a perennial, ongoing shortage of currency for transactions. This was an anchor around the leg of the domestic economy of the colonies.

…the British colonies in North America suffered from a constant shortage of all coins. The mercantile policies then in vogue in London sought to increase the amount of gold and silver money in Britain and to do whatever was practical in order to prohibit its export, even to its own colonies.

Beginning in 1695, Britain forbade the export of specie to anywhere in the world, including to its own colonies. As a result, the American colonies were forced to use foreign silver coins rather than British pounds, shillings, and pence, and they found the greatest supply of coins in the neighboring Spanish colony of Mexico, which operated one of the world’s largest mints.

Because of the great wealth produced in Mexico and Peru, Spanish coins became the most commonly accepted currency in the world…The most common Spanish coin in use in the British colonies in 1776 was the pillar dollar, so named because the obverse side showed the Eastern and Western hemispheres with a large column on either side.

In Spanish imperial iconography, the columns represented the Pillars of Hercules, or the narrow strait separating Spain from Morocco and connecting the Mediterranean with the Atlantic. A banner hanging from the columns bore the words plus ultra, meaning “more beyond.” The Spanish authorities began issuing this coin almost as soon as they opened the mint in Mexico with the intent of publicizing the discovery or America, which was the plus ultra, the land out beyond the Pillars of Hercules.

Some people say that the modern dollar sign is derived from this pillar dollar. According to this explanation, the two parallel lines represent the columns and the S stands for the shape of the banner hanging from them. Whether the sign was inspired by this coin or not, the pillar dollar can certainly be called the first American silver dollar. (Weatherford, pp. 117-118)

Another thing the colonists did to get around this chronic shortage of metal coins was barter, which led to settling accounts with all sorts of things other than previous metal coins. They might settle accounts, for example, with so-called “county pay” or “country money,” typically cash crops: cod, tobacco, rice, grain, cattle, indigo, whiskey, brandy–whatever was at hand. During 1775 in North Carolina as many as seventeen different forms of money were declared to be legal tender.

Without the convenience of money, colonists resorted to many less-efficient methods of trading. Barter, of course, was common, particularly in rural areas, but individuals often had to accept goods that they did not particularly need or want only because they had no other way to complete a transaction. They accepted these goods hoping to pass them on in future trades. Some items, most famously tobacco in Virginia and Maryland, worked well in this way and became commodity monies directly or as backing for warehouse receipts. Various other types of warehouse receipts, bills of exchange against deposits in London, and individuals’ promissory notes might also circulate as money. In addition, shopkeepers and employers sometimes issued “shop notes,” a type of scrip—often in small denominations—redeemable at a specific store.

Out of necessity, merchants and wealthy individuals frequently extended credit to others. In an economy that depended heavily on barter, however, one could end up holding debts against many individuals and across a broad array of goods. People naturally hoped to net out some of these debts, but this is extremely difficult under barter. Fortunately, colonial creditors could tally debts in British pounds or colonial currencies even if these currencies were not readily available. In this way, money acted as a unit of account. By attaching a value to things, money accommodated the netting out of debts.

Paper Money and Inflation in Colonial America (Cleveland Fed)
One of the most popular substitutes in North America could be obtained domestically: beads made from marine sea shells called wampum, which were used extensively in the tribute economy of the the Iroquois nations. Wampum is a member of the huge amount of currencies all over the globe that were made from sea shells, including cowrie shells and dentalium. Since these were regarded as valuable by Native American tribes, they had the added advantage of being able to be traded for animal pelts bagged by the Native Americans (who soon stripped the forest bare in order to get more wampum—and hence more prestige). In 1664 Pieter Stuyvesant arranged a loan in wampum worth over 5,000 guilders for paying the wages of workers constructing the New York citadel. They were even subject to a form of counterfeiting:

The first substitute was taken over from the the Indians. From New England to Virginia in the first years of settlement, the wampum or shells used by the Indians became the accepted small coinage. In Massachusetts in 1641, it was made legal tender, subject to some limits as to the size of the transaction, at the rate of six shells to the penny.

However, within a generation or two it began to lose favor. The shells came in two denominations, black and white, the first being double the value of the second. It required by small skill and a smaller amount of dye to convert the lower denomination of currency into the higher.

Also, the acceptability of wampum depended on its being redeemed by the Indians in pelts. The Indians, in effect, were the central bankers for the wampum monetary system, and beaver pelts were the reserve currency into which the wampum could be converted. This convertibility sustained the purchasing power of the shells.

As the seventeenth century passed and settlement expanded, the beavers receded to the evermore distant forests and streams. Pelts ceased to be available; wampum ceased, accordingly, to be convertible and thus, in line with expectation, it lost in purchasing power. Soon it disappeared from circulation except as small change. (Galbraith, pp. 47-48)

Another very popular domestic currency in use was tobacco leaf. In fact, tobacco’s reign as currency in America lasted longer than gold’s:

Tobacco, although regionally more restricted, was far more important than wampum. It came into use as money in Virginia a dozen years after the first permanent settlement in Jamestown in 1607. Twenty-three years later, in 1642, it was made legal tender by the General Assembly of the colony by the interestingly inverse device of outlawing payments that called for payment in gold or silver.

The use of tobacco money survived in Virginia for nearly two centuries and in Maryland for a century and a half – in both cases until the Constitution made money solely the concern of the Federal government. The gold standard, by the common calculation, lasted from 1879 until the cancellation of the final attenuated version by Richard Nixon in 1971. Viewing the whole span of American history, tobacco, though more confined as to region, had nearly twice as long a run as gold. (Galbraith, p. 48)

And such practices might be where Adam Smith came up with his erroneous notion of primitive barter economies, which continues to plague economics and economic history to this day.

Early American Colonists Had a Cash Problem. Here’s How They Solved It (Time)

This illustrates another dictum about money: barter tends to occur in fully monetized market economies where the medium of exchange is in short supply. This is because internal exchanges in market economies take the form spot transactions among anonymous competing strangers. Anthropologists now know that pre-monetary economies were embedded in social relations and took the forms of reciprocity, redistribution, householding, and ceremonial exchange, rather than constant efforts to “truck, barter and exchange.” Anthropologists have never found an example of a barter economy anywhere in the world (e.g. “I’ll give you ten chickens for that cow”).

People in North America and other remote regions were using things like cod, tobacco, grain, brandy, and shells to settle accounts, sure—but these were fully monetized economies that just happened to have a chronic shortage of coins! To get around this, certain items which were particularly valuable because they could be traded with the outside world—like cod in Newfoundland, or tobacco in Virginia, were used to settle accounts. Or, because some items were particularly valuable inside the community, they could be used in subsequent trades as a medium of exchange (like iron nails in Scotland, another Smith example). One might include the “cigarette money” used in prisons in this category. A contemporary example is the use of spruce tips in remote Alaskan towns: spruce tips can only be harvested during a few weeks in the spring and are used in all sorts of exported products (beer, tea, soap, etc.) that are traded with the outside world.

A year after moving to Skagway, Alaska, John Sasfai walked into Skagway Brewing Co. and ordered the signature Spruce Tip Blonde Ale. But instead of pulling out his wallet, the guide for Klondike Tours put a sack of spruce tips on the bar to pay his tab. That’s because in this town, the bounty he foraged from trees near Klondike Gold Rush National Historical Park serves as a currency.

This village, with a year-round population just shy of 1,000, is notably remote – it’s about 100 miles north of Juneau and 800 miles south-east of Anchorage by car. And though stampeders established Skagway during the late-19th-Century gold rush, these days the nuggets of value are plucked from the forest, not panned or mined. While spruce tips – the buds that develop on the ends of spruce tree branches – are only good for cash at Skagway Brewing Co., bartering with spruce tips for food, firewood or coffee (which are delivered by barge once a week) is not uncommon.

The Alaska town where money grows on trees (BBC)

However, in all of Smith’s cases, prices were denominated in standard units of account, but people settled their debts in whatever was at hand. But none of these things were the origin of prices and money, as Smith incorrectly claimed.

To start, with Adam Smith’s error as to the two most generally quoted instances of the use of commodities as money in modern times, namely that of nails in a Scotch village and that of dried cod in Newfoundland, have already been exposed [as fraudulent] … and it is curious how, in the face of the evidently correct explanation … Adam Smith’s mistake has been perpetuated.

In the Scotch village the dealers sold materials and food to the nail makers, and bought from them the finished nails the value of which was charged off against the debt. The use of money was as well known to the fishers who frequented the coasts and banks of Newfoundland as it is to us, but no metal currency was used simply because it was not wanted.

In the early days of the Newfoundland fishing industry there was no permanent European population; the fishers went there for the fishing season only, and those who were not fishers were traders who bought the dried fish and sold to the fishers their daily supplies. The latter sold their catch to the traders at the market price in pounds, shillings and pence, and obtained in return a credit on their books, with which they paid for their supplies. Balances due by the traders were paid for by drafts on England or France.

A moment’s reflection shows that a staple commodity could not be used as money, because ex hypothesi, the medium of exchange is equally receivable by all members of the community. Thus if the fishers paid for their supplies in cod, the traders would equally have to pay for their cod in cod, an obvious absurdity. In both these instances in which Adam Smith believes that he has discovered a tangible currency, he has, in fact, merely found—credit.

Then again as regards the various colonial laws, making corn, tobacco, etc., receivable in payment of debt and taxes, these commodities were never a medium of exchange in the economic sense of a commodity, in terms of which the value of all other things is measured. They were to be taken at their market price in money. Nor is there, as far as I know, any warrant for the assumption usually made that the commodities thus made receivable were a general medium of exchange in any sense of the words. The laws merely put into the hands of debtors a method of liberating themselves in case of necessity, in the absence of other more usual means. But it is not to be supposed that such a necessity was of frequent occurrence, except, perhaps in country districts far from a town and without easy means of communication.

What is money? (Alfred Mitchell-Innes)

All of this experience showed colonists that multiple things could be used as money, if needed. There was no more magic to a gold standard, then to a cowrie standard, or a tobacco standard, a grain standard, or a cattle standard, or anything else for that matter. This would prove to be an instrumental lesson in the creation of paper money in the colonies.

Galbraith, for his part, gives an alternative explanation for the chronic lack of precious metals in the American colonies:

Many countries or communities had gold and silver in comparative abundance without mines. Venice, Genoa, Bruges had no Mother Lode (Nor today does Hong Kong or Singapore.) While the colonists were required to pay in hard coin for what they brought from Britain, they also had products – tobacco, pelts, ships, shipping services – for which British merchants would have been willing, and were quite free, to expend gold and silver.

Much more plausibly, the shortage of hard money in the colonies was another manifestation of Gresham. From the very beginning the colonists experimented with substitutes for metal. The substitutes, being less well regarded than gold or silver, were passed on to others and this were kept in circulation. The good gold or silver was kept by those receiving it or used for those purchases, including those in the mother country, for which the substitutes were unacceptable. (p. 47)

So the colonists were forced by economic necessity to experiment with paper money, and that’s why the United States is the cradle of rolling out this innovation. As Galbraith notes of the above cases, “None of these substitutes was important as compared with paper money.” (Galbraith p. 51).

Next: Europe rethinks money

The Origin of Paper Money 1

Where did paper money come from? That’s the question behind this article from The New Yorker: The Invention of Money. It’s a review of recent biographies of John Law and Walter Bagehot. The author concludes:

The present moment in financial invention therefore has some similarities with the period when money in the form we currently understand it—a paper currency backed by state guarantees—was first created. The hero of that origin story is the nation-state. In all good stories, the hero wants something but faces an obstacle. In the case of the nation-state, what it wants to do is wage war, and the obstacle it faces is how to pay for it.

At the same time, I’ve been reading a few popular books on monetary history. One is Jack Weatherford’s The History of Money. Weatherford, best known for his books about Genghis Khan, is eminently readable, and hits most of the major developments. However, he is clearly in the Ron Paul school of economics: gold alone is money, governments are profligate and can’t be trusted, free banking is good, central banks are bad, etc. There are also a number of basic factual errors in the book, which leads me to recommend it only if you take it as a brief survey that gets many things wrong and is a bit outdated.

Weatherford’s major reference for his chapter on paper money is John Kenneth Galbraith’s: Money, Whence It Came and Where It Went. So I decided to go directly to the source. Galbraith, a lauded economist, has a view that is much more authoritative and nuanced than Weatherford’s. Galbraith’s book concentrates mainly on the origins of banking and the modern money system, and not so much on the deep history of money in the ancient world or the Medieval period.

I’d like to take these (and others) and give an account of how the money system works today. While Modern Monetary theory is a good descriptor of how money works in nation states in the present, it often doesn’t describe how that system initially came about, and what makes it so radically different from how the money system functioned in ancient economies.

But first, I’d like to say a few brief words on why any of this matters.

Like it or not, money runs the world. If you want to understand how the world works—and how to change it—it’s important to know how the systems comprising it work. Money may seem like a boring topic (sorry!), but I would argue that no knowledge is more fundamental and useful for trying to make things marginally better. I can’t tell you how many people I’ve met who call themselves “Socially liberal but fiscally conservative.” And what do they mean by “fiscally conservative?” Nine times out of ten, it’s this: money is inherently scarce; debt is evil; and government budgets should be balanced down to the penny. You also have libertarian Bitcoin cranks, who are convinced that algorithms will save mankind once the state somehow withers away. These views are extraordinarily resistant to any kind of challenge, almost as if they were a de facto religion (in fact, they are probably even more resistant to rational analysis that most people’s religious faith!) Such people would be amenable to a more progessive message if not for the universal brainwashing about what money is, and what it does. History can provide a useful guide.

China’s False Start

All paper money all rests on the same fundamental basis: they are circulating IOU’s. The name of the creditor backing them and what’s used to securitize them changes over time, however. Sometimes it’s a particularly reputable member of the community. Sometimes it’s a king or other ruler. Sometimes it’s a democratically-elected government–or more precisely, the future anticipated revenues of that government. Sometimes it’s backed by something tangible, like silver, gold, or real estate (the most common options). Sometimes it’s not. Nowadays, sovereign money is usually backed by the government’s ability to redistribute and to impose binding liabilities on its citizens  (and, by extension, it’s monopoly on the use of legitimate force).

Paper money began where papermaking began: in China. The usual sources were hemp and mulberry bark, and printing blocks were made of wood or metal. Because of China’s strong imperial state structure, centrality, and geographic reach, it could command officially stamped pieces of paper to be accepted by its citizens as currency in lieu of precious metals. The story is told in this excellent podcast by Tim Harford on the origins of paper money: Paper Money (50 Things that Made the Modern Economy)

In Harford’s telling, paper money begins in Sichuan province, where iron coins were used rather than gold and silver in order to keep specie from leaking out of China to the hostile territories surrounding China, such as those of the Jurchen. Iron coins had holes in the middle and were carried around on cords, called cash.
The problem, as you might expect, was that these strings of heavy iron coins were extremely cumbersome. You would be turning over larger weights of coins that the weight of the things you were trying to buy: 10 pounds of coins for a five pound chicken, or something like that.

Sichuan’s iron currency suffered from serious deficiencies. The low intrinsic value of iron coins, worth no more than a tenth of the equivalent amount of bronze coin, imposed a great burden on merchants who needed to convey their purchasing capital from one place to another, and on ordinary consumers as well. A housewife would have to bring a pound and a half of iron coin to the marketplace to buy a pound of salt, and a merchant from the capital would receive ninety-one and a quarter pounds of iron coin in exchange for an ounce of silver.

Of course, the inconvenience of transporting low-value coin affected bronze currency as well. In the early ninth century, the Tang government created depositories at its capital of Chang’an where merchants could deposit bronze coin in return for promissory notes (known as feiqian, or “flying cash”) that could be redeemed in provincial capitals. “Flying cash” was especially popular among tea merchants who wished to return their profits from the sale of tea in the capital to the distant tea-growing areas of southeastern China. The Song dynasty continued this practice under the rubric of “convenient cash” (bianqian), accepting payments of gold, silver, coin, or sil in return for notes denominated in bronze coin. (The Origins of Value, pp. 67-68)

In the mid-990s, Sichuan was captured by rebels (partly angered by depreciating currency), who shut down the mint. It remained shut even after the government regained control of the province. This prompted some private merchants to issue their own paper bills to compensate for the acute shortage of coins. Such bills represented debt—the debt of the private merchant, of course. These bills soon began to circulate, and people began using them in place of iron coins, as Harford describes:

Instead of carrying around a wagonload of iron coins, a well-known and trusted merchant would write an IOU, and promise to pay his bill later when it was more convenient for everyone.

That was a simple enough idea. But then there was a twist, a kind of economic magic. These “jiaozi”, or IOUs, started to trade freely. Suppose I supply some goods to the eminently reputable Mr Zhang, and he gives me an IOU. When I go to your shop later, rather than paying you with iron coins – who does that? – I could write you an IOU.

But it might be simpler – and indeed you might prefer it – if instead I give you Mr Zhang’s IOU. After all, we both know he’s good for the money. Now you, and I, and Mr Zhang, have together created a kind of primitive paper money – it’s a promise to repay that has a marketable value of its own – and can be passed around from person to person without being redeemed.

This is very good news for Mr Zhang, because as long as people keep finding it convenient simply to pass on his IOU as a way of paying for things, Mr Zhang never actually has to stump up the iron coins. Effectively, he enjoys an interest-free loan for as long as his IOU continues to circulate. Better still, it’s a loan that he may never be asked to repay.

No wonder the Chinese authorities started to think these benefits ought to accrue to them, rather than to the likes of Mr Zhang. At first they regulated the issuance of jiaozi, but then outlawed private jiaozi and took over the whole business themselves. The official jiaozi currency was a huge hit, circulating across regions and even internationally. In fact, the jiaozi even traded at a premium, because they were so much easier to carry around than metal coins.

How Chinese mulberry bark paved the way for paper money (BBC)

Over the next ten years, these “exchange bills” became important in China’s intraregional trade, but the problem of bogus private bills issued by unscrupulous traders remained an ongoing problem for government officials. There were growing calls for government to get more involved in the circulation of bills. Enter the new prefect of Chengdu, one Zhang Yong. He issued a series of government reforms to address this problem in 1005. He:

1.) reopened Sichuan’s mints and introduced a new large iron coin that was equivalent to ten small iron coins, or two bronze coins;

2.) restricted the right to issue exchange bills to a consortium of sixteen merchant houses in Chengdu that were known to have sufficient financial resources to back the bills up, and;

3.) standardized the bills by mandating that they be issued in a specified size, color and format, using government-supplied labor and materials (although merchants could add their own watermark).

There were no standard denominations; rather, the merchants ascribed the value of the note in ink as needed. A three percent fee was charged for cashing in the notes. There was no limit on the number of bills issued. The amount of bills in circulation tended to vary with the seasons: more bills were issued in the early summer when new silk reached the market and in the fall during the rice harvest.

There were still problems with the paper currency, however, such as counterfeiting and overissuance of bills without sufficient backing. In 1024 under a new governor, Xue Tian, the government took over the issuance of jiaozi. A state-run Jiaozi Currency Bureau was established in Chengdu and given exclusive rights to issue jiaozi. The bills had the same format, but were issued in fixed denominations: one and ten guan. Most significantly, the bills had an expiration date of two years, exchangeable for fresh ones, giving the government a modicum of control over the amount issued and preventing the counterfeiting of worn or outdated bills. Also, quotas were established for the issue of the currency. Tea merchants engaged in intraregional and international trade were the most enthusiastic users of the currency, as it eliminated the need to transport heavy coins and prevented robbery by bandits (note that the needs of traveling merchants were also instrumental in the creation of Bills of Exchange issued by banks in medieval Europe centuries later).

Yet there were still problems. The government issued notes to procure military supplies from the merchants; and the ongoing costs of wars on the frontier led to their overissue. Plus, a new emperor nationalized the tea industry, meaning that the major consumers of jiaozi—the tea merchants—no longer had as much use for them. This loss of demand alongside oversupply caused a sharp depreciation in the value of the currency in the market. Instead of trading at a ten percent premium, the bills were now accepted at a ten percent discount. In 1107 the government issued a new paper currency—the qianyin—at a rate of 1:4 to the old, depreciating the earlier jiaozi bills in effort to reduce the supply.

The rest of the history of China’s bills is basically a cycle of the same thing: issuing new bills, overspending due to military needs on the frontier, rampant counterfeiting, bills depreciating, demonetizing old notes, new dynasties issuing new bills, etc. Bills were still in use in trade when Marco Polo vistied China. This is the description from the fourteenth century by the Arab Traveller ibn Battuta:

The Chinese use neither [gold] dinars nor [silver] dirhams in their commerce. All the gold and silver that comes into their country is cast by them into ingots, as we have described. Their buying and selling is carried on exclusively by means of pieces of paper, each of the size of the palm of the hand, and stamped with the sultan’s seal. Twenty-five of these pieces of paper are called a balisht, which takes the place of the dinar with us [as the unit of currency]

This demonstrates some of the essential dictums of Modern Monetary Theory.

The first is Hyman Minsky’s dictum: Anyone can create money, the secret is in getting it accepted.

The second is Felix Martin’s definition of money: Money is tradeable debt.

The other is the observation that that: The credit that is bears highest reputation is typically that of the sovereign. Gresham’s Law being what it is, this usually means that sovereign’s money will drive out all competitors, as we’ll see much later in the United States during the Civil War.

As a reminder, Gresham’s Law is this: Bad money drives out good, or perhaps, more accurately, people spend “lesser” money if they can, and hoard “greater” money for themselves.

Gresham’s Law…is perhaps the only economic law that has never been challenged, and for the reason that there has never been a serious exception. Human nature may be an infinitely variant thing. But it has it’s constants. One is that, given a choice, people keep what is best for themselves, i.e. for those whom they love the most. (Galbraith, p. 8)

A similar rationale led to the establishment of banks and banking in Northern Europe during the Age of Sail. You deposited coins and got a receipt for the amount of coins stashed in the vault. These receipts could be used to pay for things, with the value equivalent to the coins traded (in fact, the notes were more valuable, since they couldn’t be melted down or devalued).

A final interesting note: overissuance of paper currencies and lavish spending by the Yongle emperor Zhu Di (on wars, but also notably on the Chinese treasure ship voyages) led to China going back onto a silver standard just in time for the European discovery and conquest of the New World. The Chinese demand for silver is what fueled the European trade with the Far East, since the Europeans had nothing else that the Chinese wanted to exchange for goods like silks and porcelain. Without that silver standard, who knows what would have happened?

The sizable deficits incurred by Yongle’s costly foreign expeditions, including the famous maritime explorations of Admiral Zheng He and his fleet, and the emperor’s decision to relocate the Ming capital from Nanjing to Beijing were abated, albeit temporarily, by printing more money. Finally, in the 1430s, the Ming yielded to economic realities, abandoning its paper currency and capitulating to the dominance of silver in the private economy. The Ming state gradually converted its most import and sources of revenue payments in silver, while suspending emission of paper money and minting in bronze coin.

Though still uncoined, silver prevailed as the monetary standard of the Ming and subsequent Qing dynasty (1644-1911), fueled from the sixteenth century onward by the import of vast quantities of foreign silver from Japan and the Spanish colonies in the Americas. In times of fiscal crisis, such as on the eve of the fall of the Ming dynasty in 1644 and during the worldwide depression of the 1830s to 1840s, appeals to restore paper currency were renewed, but ignored. In the nineteenth century private banks, both Chinese and foreign, began to issue negotiable bills, but the weakness of the central government after its defeat in the Opium War precluded the emergence of a unified currency…Not until 1935, under the Republic of China, did China once again have a unified system of paper currency. (The Origins of Value, p. 87-89)

Although paper money first originated in China, the paper money we use today has no direct lineage with these systems. Government-issued paper money was invented independently in Western Europe, and under very different circumstances. We’ll take a look at that next time.

Despite the importance of paper money in Chinese history, the modern world system of paper money did not develop in China, or even in the Mediterranean homeland of Marco Polo or ibn-Batuta. It evolved in the trading nations around the North Atlantic. (Weatherford, p. 129)

The Origin of Religion – Part 3

[Blogger note: I have apparently lost my USB drive, which contained all of my subsequent blog posts, thus, I’ll have to cut this short. I’ll try and finish this up using my recollection and some snippets lift on my hard drive]

In addition to what we spoke of before, there are several other “alternative” psychological ideas behind the origin and development of religion that the BBC article does not mention. Nonetheless, I feel these ideas are too important to be left out of the discussion. What follows is my summary below.

Terror Management Theory

Terror Management Theory (TMT) stems from a book written by psychotherapist Ernest Becker in 1973 called The Denial of Death. In it, he asserted that we invest in what are, in essence, “immortality projects” in order to stave off the subconscious fear of our own inevitable demise.This tendency is not exclusive to religions, but is also applicable to all sorts of other secular philosophies and behaviors.

The introduction to Becker’s book online provides a good summary:

Becker’s philosophy as it emerges in Denial of Death and Escape from Evil is a braid woven from four strands.

The first strand. The world is terrifying…Mother Nature is a brutal bitch, red in tooth and claw, who destroys what she creates. We live, he says, in a creation in which the routine activity for organisms is “tearing others apart with teeth of all types — biting, grinding flesh, plant stalks, bones between molars, pushing the pulp greedily down the gullet with delight, incorporating its essence into one’s own organization, and then excreting with foul stench and gasses the residue.”

The second strand. The basic motivation for human behavior is our biological need to control our basic anxiety, to deny the terror of death. Human beings are naturally anxious because we are ultimately helpless and abandoned in a world where we are fated to die. “This is the terror: to have emerged from nothing, to have a name, consciousness of self, deep inner feelings, an excruciating inner yearning for life and self-expression — and with all this yet to die.”

The third strand. Since the terror of death is so overwhelming we conspire to keep it unconscious. “The vital lie of character” is the first line of defense that protects us from the painful awareness of our helplessness. Every child borrows power from adults and creates a personality by introjecting the qualities of the godlike being. If I am like my all-powerful father I will not die. So long as we stay obediently within the defense mechanisms of our personality…we feel safe and are able to pretend that the world is manageable. But the price we pay is high. We repress our bodies to purchase a soul that time cannot destroy; we sacrifice pleasure to buy immortality; we encapsulate ourselves to avoid death. And life escapes us while we huddle within the defended fortress of character.

Society provides the second line of defense against our natural impotence by creating a hero system that allows us to believe that we transcend death by participating in something of lasting worth. We achieve ersatz immortality by sacrificing ourselves to conquer an empire, to build a temple, to write a book, to establish a family, to accumulate a fortune, to further progress and prosperity, to create an information-society and global free market. Since the main task of human life is to become heroic and transcend death, every culture must provide its members with an intricate symbolic system that is covertly religious. This means that ideological conflicts between cultures are essentially battles between immortality projects, holy wars.

Here’s Becker himself:

…of course, religion solves the problem of death, which no living individuals can solve, no matter how they would support us. Religion, then, gives the possibility of heroic victory in freedom and solves the problem of human dignity at its highest level. The two ontological motives of the human condition are both met: the need to surrender oneself in full to the rest of nature, to become a part of it by laying down one’s whole existence to some higher meaning; and the need to expand oneself as an individual heroic personality.

Finally, religion alone gives hope, because it holds open the dimension of the unknown and the unknowable, the fantastic mystery of creation that the human mind cannot even begin to approach, the possibility of a multidimensionality of spheres of existence, of heavens and possible embodiments that make a mockery of earthly logic — and in doing so, it relieves the absurdity of earthly life, all the impossible limitations and frustrations of living matter. In religious terms, to “see God” is to die, because the creature is too small and finite to be able to bear the higher meanings of creation. Religion takes one’s very creatureliness, one’s insignificance, and makes it a condition of hope. Full transcendence of the human condition means limitless possibility unimaginable to us. [1]

Becker’s ideas are thoroughly grounded in the Freudian school, and Freud’s essential insight was that human actions, beliefs, desires and intentions are often motivated by hidden, subconscious forces which we are not fully aware of. In this case, the subconscious fear of death motivates us to embrace belief systems that allow us to symbolically transcend our own mortality.

One common trope I often hear about religion is that we simply came up with a bunch of fairy tales to cope with our existential fear of death, and that this explains religion.

But, as we’ve already seen, this is far from adequate in explaining the persistence and diversity of religious beliefs. As we saw, most ancient religions did not believe in a comfortable, cushy afterlife, and the tales of wandering spirits of the dead requiring constant appeasement do not provide much reassurance about what comes after death. If we just wanted to reassure ourselves in the face of our mortality, why didn’t we invent the “happy ending,” country-club afterlife straightaway? Why did such beliefs have to wait until after the Axial Age to emerge? And what about religions that believed in metempsychosis (transference of consciousness to a new body, i.e. reincarnation), rather than a comfortable afterlife?

Plus, this does not explain our beliefs in ghosts, spirits, and other invisible beings. Nor does it explain the extreme wastefulness and costliness of religion. The book itself says little about the origin and development of actual religion, and where it does, it deals exclusively with Western Judeo-Christian religions (the Christian existentialist Kierkegaard is especially cited).

Nevertheless, Terror Management Theory’s ideas have been empirically shown to have an effect on our belief systems and behavior. When knowledge of one’s own death has been subconsciously induced in test subjects (a technique called “priming”), people have been shown to be more clannish, more hostile to outsiders, more harsh to deviants, more likely to accept and dole out harsh punishments, and so forth (in short, more conservative). And, certainly the motivations for many strange behaviors—from the lust for power, to obsessive work and entrepreneurship, to desperate attempts to achieve lasting fame and stardom, to trying to create a “godlike” artificial intelligence, to beliefs about “uploading” one’s personal consciousness into computers, to scientific attempts to genetically “cure” aging and disease—can be seen as immortality projects motivated by a subconscious fear of death.

I would argue that a case can be made that the reason almost every culture known to man has believed that some sort of “life essence” survives the body after death stems from an existential fear of death similar to what Becker described. But the reason it took the forms that it did has more to do with some of the things we looked at last time–Theory of Mind, Hyperactive Agency Detection, the Intentional Stance, and so forth.

The noted anthropologist Bronislav Malinowski wrote an essay on the purpose of religion which in many ways echoes the ideas of Becker:

…in not a single one of its manifestations can religion be found without its firm roots in human emotion, which…grows out of desires and vicissitudes connected with life. Two affirmations, therefore, preside over every ritual act, every rule of conduct, and every belief. There is the affirmation of the existence of powers sympathetic to man, ready to help him on condition that he conforms to the traditional lore which teaches how to serve them, conjure them, and propitiate them. This is the belief in Providence, and this belief assists man in so far as it enhances his capacity to act and his readiness to organize for action, under conditions where he must face and with not only the ordinary forces of nature, but also chance, ill luck, and the mysterious, even inculculable designs of destiny.

The second belief is that beyond the brief span of natural life there is compensation in another existence. Through this belief man can act and calculate far beyond his own forces and limitations, looking forward to his work being continued by his successors in the conviction that, from the next world, he will still be able to watch and assist them. The sufferings and efforts, the injustices and inequalities of this life are thus made up for. Here again we find that the spiritual force of this belief not only integrated man’s own personality, but is indispensable for the cohesion of the social fabric. Especially in the form which this belief assumes in ancestor-worship and the communion with the dead do we perceive its moral and social influence.

In their deepest foundations, as well as in their final consequences, the two beliefs in Providence and Immortality are not independent of one another. In the higher religions man lives in order to be united to God. In simpler forms, the ancestors worshiped are often mystically identified with environmental forces, as in Totemism. At times, they are both ancestors and carriers of fertility, as the Kachina of the Pueblos. Or again the ancestor is worshiped as the divinity, or at last as a culture hero.

The unity of religion in substance, form and function is to be found everywhere. Religious development consists probably in the growing predominance of the ethical principle and in the increasing fusion of the two main factors of all belief, the sense of Providence and the faith in Immortality.

As we climb Maslow’s hierarchy of needs, we look for different things from our religions. Due to the “vicissitudes of life” ancient peoples often sought after more basic things related to material security: adequate rainfall, bountiful harvests, growing herds, protection form diseases, protection from raids, and so forth. They consulted spirits for decisions—whom to marry, when to go to war, how to bring back the rains, and so on. Today, with most of us living in societies where our basic material needs are met, we look for things like fulfillment, purpose, belonging and meaning using the same religious framework.

Religion as a Memeplex

The idea of memetics was first proposed by biologist Richard Dawkins in his 1976 book, The Selfish Gene. Dawkins made an explicit analogy between biological information (genes) which differentially reproduce and propagate themselves through time by using living organisms, and cultural information (memes), which live in human minds and reproduce via cultural imitation. A collection of related and reinforcing memes is called a memeplex (from the term, “coadapted meme complex”).

The underlying mechanisms behind genes (instructions for making proteins, stored in the cells of the body and passed on in reproduction), and memes (instructions for carrying out behavior, stored in brains, and passed on via imitation) were both very similar, Dawkins thought, and the ideas underlying Darwinism could apply to both. This is sometimes referred to as “Universal Darwinism”:

The creator of the concept and its denomination as a “meme” was Richard Dawkins. Other authors such as Edward O. Wilson and J. D. Lumsden previously proposed the concept of culturgen in order to designate something similar. At the present time the term of Dawkins has been imposed, although the theory of memes now includes contributions from many other authors. Therefore, talking of memes today is not simply the theories of memes of Dawkins.

Daniel Dennett, Memes and Religion: Reasons for the Historical Persistence of Religion. Guillermo Armengol (PDF)

The behavior of both memes and genes are based around three principle factors: variation, competition (or selection), and retention (or persistence):

For something to count as a replicator it must sustain the evolutionary algorithm based on variation, selection and retention (or heredity).

Memes certainly come with variation–stories are rarely told exactly the same way twice, no two buildings are absolutely identical, and every conversation is unique—and when memes are passed on, the copying is not always perfect….There is memetic selection – some memes grab the attention, are faithfully remembered and passed on to other people, while others fail to get copied at all. Then, when memes are passed on there is retention of some of the ideas of behaviours in that meme – something of the original meme must be retained for us to call it imitation or copying or learning by example. The meme therefore fits perfectly into Dawkins’ idea of a replicator and Dennett’s universal algorithm…

Where do new memes come from? They come about through variation and combination of old ones – either inside one person’s mind, or when memes are passed from person to person…The human mind is a rich source of variation. In our thinking we mix up ideas and turn them over to produce new combinations…Human creativity is a process of variation and recombination. [2]

Memetics is more of a theory about the evolution of religions that about their origins. Why do some ideas catch on while others die out? How and why do religions change over time? Memetics can provide an explanation.

One of my favorite definitions of “culture” is given by David Deutsch in his book The Beginnings of Infinity:

A culture is a set of ideas that cause their holders to behave alike in some ways. By ‘ideas’ I mean any information that can be stored in people’s brains and can affect their behavior. Thus the shared values of a nation, the ability to communicate in a particular language, the shared knowledge of an academic discipline and the appreciation of a given musical style are all, in this sense, ‘sets of ideas’ that define cultures…

The world’s major cultures – including nations, languages, philosophical and artistic movements, social traditions and religions – have been created incrementally over hundreds or even thousands of years. Most of the ideas that define them, including the inexplicit ones, have a long history of being passed from one person to another. That makes these ideas memes – ideas that are replicators. [3]

We see by this definition that it is difficult to distinguish religion from any other form of culture—they all cause their adopters to behave alike in certain ways, and adopt similar ideas. This has caused some scholars to question whether we can even define such a thing as “religion” apart from every other type of social behavior, or whether it’s simply an academic invention:

[Jonathan Zittell] Smith wanted to dislodge the assumption that the phenomenon of religion needs no definition. He showed that things appearing to us as religious says less about the ideas and practices themselves than it does about the framing concepts that we bring to their interpretation. Far from a universal phenomenon with a distinctive essence, the category of ‘religion’ emerges only through second-order acts of classification and comparison…

A vast number of traditions have existed over time that one could conceivably categorise as religions. But in order to decide one way or the other, an observer first has to formulate a definition according to which some traditions can be included and others excluded. As Smith wrote in the introduction to Imagining Religion: ‘while there is a staggering amount of data, of phenomena, of human experiences and expressions that might be characterised in one culture or another, by one criterion or another, as religious – there is no data for religion’. There might be evidence for various expressions of Hinduism, Judaism, Christianity, Islam and so forth. But these become ‘religions’ only through second-order, scholarly reflection. A scholar’s definition could even lead her to categorise some things as religions that are not conventionally thought of as such (Alcoholics Anonymous, for instance), while excluding others that are (certain strains of Buddhism).

Is religion a universal in human culture or an academic invention? (Aeon)

It used to be thought that ideas were passed down through the generations simply because they were beneficial to us as a species. But memetic theory challenges that. One important concept from memetics is that the memes that replicate most faithfully and most often are not necessarily beneficial—they are simply the ones most able to replicate themselves. For this reason, religion has often been called a “virus of the mind” by people attempting to apply the ideas of memetics to religion.

If a gene is in a genome at all, then, when suitable circumstances arise, it will definitely be expressed as an enzyme…and it will cause its characteristic effects. Nor can it be left behind if the rest of the genome is successfully replicated. But merely being present in the mind does not automatically get a meme expressed as behaviour: the meme has to compete for that privilege with other ideas – memes and non-memes, about all sorts of subjects – in the same mind. And merely being expressed as behavior does not automatically get the meme copied into a recipeient along with other memes: it has to compete for the reipients’ attention and acceptance with all sorts of behaviours by other people, and with the recipients’ own ideas. All that is in addition to the analogue of the type of selection that genes face, each meme competing with rival versions of itself across the population, perhaps by containing the knowledge for some useful function.

Memes are subject to all sorts of random and intentional variation in addition to all that selection, and so they evolve. So to this extent the same the same logic holds as for genes: memes are ‘selfish’. They do not necessarily evolve to benefit their holder, or their society – or, again, even themselves, except in the sense of replicating better than other memes. (Though now most other memes are their rivals, not just variants of themselves.) The successful meme variant is the one that changes the behaviour of its holders in such a way as to make itself best at displacing other memes from the population. This variant may well benefit its holders, or their culture, or the species as a whole. But if it harms them, it will spread anyway. Memes that harm society are a familiar phenomenon. You need only consider the harm done by adherents of political views, or religions, that you especially abhor. Societies have been destroyed because some of the memes that were best at spreading through the population were bad for a society. [4]

In this formulation, religions are seen as actually harmful, simply “using” us to replicate themselves for their own benefit, and to our own detriment, just like a virus. This is the stance taken by, for example, Dawkins and Dennett—both strident atheists. For them, it would be best if we could “disinfect” our minds and free ourselves from these pesky thought viruses.

Dawkins coined the term ‘viruses of the mind’ to apply to such memeplexes as religions and cults – which spread themselves through vast populations of people by using all kinds of clever copying tricks, and can have disastrous consequences for those infected…This theme has been taken up in popular books on memetics, such as Richard Brodie’s Viruses of the Mind and Aaron Lynch’s Thought Contagion, both of which provide many examples of how memes spread through society and both of which emphasize the more dangerous and pernicious kinds of memes. We can now see that the idea of a virus is applicable in all three worlds – of biology, of computer programs and of human minds. The reason is that all three systems involve replicators and we call particularly useless and self-serving replicators ‘viruses.’ [5]

Nevertheless, such “idea viruses” cannot inflict too much damage on their recipients, otherwise they will undermine their own viability:

The overarching selection pressure on memes is towards being faithfully replicated, But, within that, there is also pressure to do as little damage to the holder’s mind as possible, because that mind is what the human uses to be long-lived enough to be able to enact the meme’s behaviors as much as possible. This pushes memes in the direction of causing a finely tuned compulsion in the holder’s mind: ideally, this would be just the inability to refrain from enacting that particular meme (or memeplex). Thus, for example, long-lived religions typically cause fear of specific supernatural entities, but they do not cause general fearfulness or gullibility, because that would both harm the holders in general and make them more susceptible to rival memes. So the evolutionary pressure is for the psychological damage to be confined to a relatively narrow area of the recipients’ thinking, but to be deeply entrenched, so that the recipients find themselves facing a large emotional cost if they subsequently consider deviating from the meme’s prescribed behaviors. [6]

Blackmore herself, however, has retreated from this notion, citing all the apparently beneficial effects from adherence to various religions: more children, longer lifespans, a more positive outlook, and so on:

Are religions viruses of the mind? I would have replied with an unequivocal “yes” until a few days ago when some shocking data suggested I am wrong.

The idea is that religions, like viruses, are costly to those infected with them. They demand large amounts of money and time, impose health risks and make people believe things that are demonstrably false or contradictory. Like viruses, they contain instructions to “copy me”, and they succeed by using threats, promises and nasty meme tricks that not only make people accept them but also want to pass them on.

This was all in my mind when Michael Blume got up to speak on “The reproductive advantage of religion”. With graph after convincing graph he showed that all over the world and in many different ages, religious people have had far more children than nonreligious people…

All this suggests that religious memes are adaptive rather than viral from the point of view of human genes, but could they still be viral from our individual or societal point of view? Apparently not, given data suggesting that religious people are happier and possibly even healthier than secularists. And at the conference, Ryan McKay presented experimental data showing that religious people can be more generous, cheat less and co-operate more in games such as the prisoner’s dilemma, and that priming with religious concepts and belief in a “supernatural watcher” increase the effects.

So it seems I was wrong and the idea of religions as “viruses of the mind” may have had its day. Religions still provide a superb example of memeplexes at work, with different religions using their horrible threats, promises and tricks to out-compete other religions, and popular versions of religions outperforming the more subtle teachings of the mystical traditions. But unless we twist the concept of a “virus” to include something helpful and adaptive to its host as well as something harmful, it simply does not apply. Bacteria can be helpful as well as harmful; they can be symbiotic as well as parasitic, but somehow the phrase “bacterium of the mind” or “symbiont of the mind” doesn’t have quite the same ring.

Why I no longer believe religion is a virus of the mind (The Guardian)

I think memetics is a good way to describe cultural transmission, and I wish that it was used much more freely by sociologists, historians, anthropologists, economists, and other students of human behavior. Memes are a good way to describe how religions are transmitted, and why some religious ideas predominate over others. They provide a good description of how religious ideas evolve over time. But it does not provide much information about how and why religions got started in the first place.

Bicameral Mind Theory

Bicameral Mind Theory (BMT) was proposed by psychologist Julian Jaynes in his 1976 book, The Origin of Consciousness in the Breakdown of the Bicameral Mind (coincidentally, the same year as Dawkins and only three years after Becker).

Jaynes argued that what ancient peoples referred to as the “gods” were, in reality, aural hallucinations produced by their own mind. Such hallucinations stemmed from the partitioning of the human brain into two separate hemispheres (bicameral). Spoken language was produced primarily by the left hemisphere, while the right hemisphere was mostly silent. Jaynes noted from research on split-brain patients that if portions of the right hemisphere were electrically stimulated, subjects would tend to hallucinate voices.

This caused him to hypothesize that the thought patterns of ancient man were radically different than our own. In times of stress caused by decision-making, he argued, internal speech was perceived as something “alien” that was guiding and directing one’s actions from somewhere outside oneself.

One of his major pieces of evidence was a thorough study of ancient literature. Jaynes noted that ancient literature lacked a conception of the “self” or anything like a “soul” in living beings. Self-reflective and contemplative behavior simply did not exist. In addition, the gods are described as controlling people’s actions, and people frequently communicate directly with the gods. Most scholars simply took this communication as some sort of elaborate metaphor, but Jaynes was willing to take these descriptions seriously. Such depictions are very common in the Old Testament, for example. And he notes that in the Iliad—the oldest work of Western literature compiled from earlier oral traditions—the characters seem to have no volition whatsoever; they are merely “puppets” of the gods:

The gods are what we now call hallucinations. Usually they are only seen and heard by particular heroes they are speaking to. Sometimes they come in mists or out of the gray sea or a river, or from the sky, suggesting visual auras preceding them. But at other times, they simply occur. Usually they come as themselves, commonly as mere voices, but sometimes as other people closely related to the hero. [7]

The characters of the Iliad do not sit down and think out what to do. They have no conscious minds such as we have, and certainly no introspections. It is impossible for us with our subjectivity to appreciate what it was like…In fact, the gods take the place of consciousness. The beginnings of action are not in conscious plans, reasons, and motives; they are in the actions and speeches of gods. To another, a man seems to be the cause of his own behavior. But not to the man himself… [8]

In distinction to our own subjective conscious minds, we can call the mentality of the Myceneans a bicameral mind. Volition, planning, initiative is organized with no consciousness whatever and then ‘told’ to the individual in his familiar language, sometimes with the visual aura of a familiar friend or authority figure of ‘god’, or sometimes as a voice alone. The individual obeyed these hallucinated voices because he could not ‘see’ what to do by himself…[9]

The preposterous hypothesis we have come to…is that at one time human nature was split in two, an executive part called a god, and a follower part called a man. Neither part was conscious…[10]

The gods would reveal themselves to people in times of stress. We saw earlier that stress—even in modern people—often causes an eerie sense of a “felt presence” nearby:

If we are correct in assuming that schizophrenic hallucinations are similar to the guidances of gods in antiquity, then there should be some common physiological instigation in both instances. This, I suggest, is simply stress.

In normal people, as we have mentioned, the stress threshold for release is extremely high; most of us need to be over our heads in trouble before we would hear voices. But in psychosis-prone persons, the threshold is somewhat lower…This is caused, I think, by the buildup in the blood of breakdown products of stress-produced adrenalin which the individual is, for genetic reasons, unable to pass through the kidneys as fast as a normal person.

During the eras of the bicameral mind, we may suppose that the stress threshold for hallucinations was much, much lower than in either normal people or schizophrenics today. The only stress necessary was that which occurs when a change in behavior is necessary because of some novelty in a situation. Anything that could not be dealt with on the basis of habit, any conflict between work and fatigue, between attack and flight, any choice between whom to obey or what to do, anything that required any decision at all was sufficient to cause an auditory hallucination. [11]

Jaynes’ other line of evidence was physiological, and came from the structure of the human brain itself:

The evidence to support this hypothesis may be brought together as five observations: (1) that both hemispheres are able to understand language, while normally only the left can speak; (2) that there is some vestigial functioning of the right Wernicke’s area in a way similar to the voices of the gods; (3) that the two hemispheres under certain conditions are able to act almost as independent persons, their relationship corresponding to that of the man-god relationship of bicameral times; (4) that contemporary differences between the hemispheres in cognitive functions at least echo such differences of function between man and god as seen in the literature of bicameral man; and (5) that the brain is more capable of being organized by the environment than we have hitherto supposed, and therefore could have undergone such a change as from bicameral to conscious man mostly on the basis of learning and culture. [12]

It’s important to note that when Jaynes uses the term “consciousness”, he is using it in a very specific and deliberate way. He is not talking about the state of simply being awake, or being aware of one’s surroundings. Nor is he talking about reacting to stimulus, or having emotional reactions to events. Obviously, this applies to nearly all animals. Rather, he’s talking about something like “meta-consciousness”, or the ability to self-reflect when making decisions:

The background of Jaynes’ evolutionary account of the transition from bicamerality to the conscious mind is the claim that human consciousness arises from the power of language to make metaphors and analogies. Metaphors of “me” and analogous models of “I” allow consciousness to function through introspection and self-visualization. According to this view, consciousness is a conceptual, metaphor-generated inner world that parallels the actual world and is intimately bound with volition and decision. Homo sapiens, therefore, could not experience consciousness until he developed a language sophisticated enough to produce metaphors and analogical models.

Jaynes recognizes that consciousness itself is only a small part of mental activity and is not necessary for sensation or perception, for concept formation, for learning, thinking, or even reasoning. Thus, if major human actions and skills can function automatically and unconsciously, then it is conceivable that there were, at one time, human beings who did most of the things we do – speak, understand, perceive, solve problems – but who were without consciousness. [13]

Jaynes saw echoes of this bicameral mentality in psychological phenomena such as schizophrenia and hypnosis. Hypnosis, he argued, was a regression to a conscious state prior to that of the modern type which constantly narratizes our lived experience:

If one has a very definite biological notion of consciousness and that its origin is back in the evolution of mammalian nervous systems, I cannot see how the phenomenon of hypnosis can be understood at all, not one speck of it. But if we fully realize that consciousness is a culturally learned event, balanced over the suppressed vestiges of an earlier mentality, then we can see that consciousness, in part, can be culturally unlearned or arrested. Learned features, such as analog ‘I’, can under the proper cultural imperative be taken over by a different initiative works in conjunction with the other factors of the diminishing consciousness of the induction and trance is that in some way it engages a paradigm of an older mentality than subjective consciousness. [14]

…[W]hy is it that in our daily lives we cannot get above ourselves to authorize ourselves into being what we really wish to be? If under hypnosis we can be changed in identity and action, why not in and by ourselves so that behavior flows from decision with as absolute a connection, so that whatever in us it is that we refer to as will stands master and captain over action with as sovereign a hand as the operator over a subject?

The answer here is partly in the limitations of our learned consciousness in this present millennium. We need some vestige of the bicameral mind, our former method of control, to help us. With consciousness we have given up those simpler more absolute methods of control of behavior which characterized the bicameral mind. We live in a buzzing cloud of whys and wherefores, the purposes and reasonings of our narratizations, the many-routed adventures of our analog ‘I’s. And this constant spinning out of possibilities is precisely what is necessary to save us from behavior of too impulsive a sort. The analog ‘I’ and the metaphor ‘me’ are always resting at the confluence of many collective cognitive imperatives. We know too much to command ourselves very far. [15]

And schizophrenia, he argued, was a vestige of how the bicameral mind routinely worked, but was now only present in those with the genetic disposition for it, perhaps because of some quirk of neurotransmitter functioning or something similar:

Most of us spontaneously slip back into something approaching the actual bicameral mind at some part of our lives. For some of us, it is only a few episodes of thought deprivation or hearing voices. But for others of us, with overactive dopamine systems, or lacking an enzyme to easily break down the biochemical products of continued stress into excretable form, it is a much more harrowing experience – if it can be called an experience at all. We hear voices of impelling importance that criticize us and tell us what to do. At the same time, we seem to lose the boundaries of ourselves. Time crumbles. We behave without knowing it. Our mental space begins to vanish. We panic, and yet the panic is not happening to us. There is no us. It is not that we have nowhere to turn; we have nowhere. And in that nowhere, we are somehow automatons, unknowing what we do, being manipulated by others or by our voices in strange and frightening ways in a place we come to recognize as a hospital with a diagnosis we are told is schizophrenia. In reality, we have relapsed into the bicameral mind. [16]

It is the very central and unique place of these auditory hallucinations on the syndrome of many schizophrenics which it is important to consider. Why are they present? And why is “hearing voices” universal throughout all cultures, unless there is some usually suppressed structure of the brain which is activated in the stress of this illness? And why do these hallucinations of schizophrenics so often have a dramatic authority, particularly religious? I find that the only notion which provides even a working hypothesis about this matter is that of the bicameral mind, that the neurological structure responsible for these hallucinations is neurologically bound to substrates for religious feelings, and this is because the source of religion and of gods themselves is in the bicameral mind. [17]

Interestingly, modern research has revealed that anywhere from 5-15 of the population hears voices on occasion, and sometimes quite regularly. Most of these people are non-clinical—only about 1 percent of the population is considered to be schizophrenic. These percentages happen to approximate those in tribal societies who are considered to be able to perform as religious priests or shamans. In many tribal cultures, the ability to hear voices is considered to be a sign of being able to communicate with gods and spirits and move “between worlds” and thus highly desirable, rather than stigmatized. Indeed, many scholars of religion have seen clear links between symptoms of schizophrenia and so-called shamanic abilities.

Wither hallucinations?

Whether of not one fully accepts Jaynes’ hypothesis, I would argue that there’s one clear point he makes that has influenced beliefs in unseen spirits and survival of ancestors after death: the presence of hallucinations.

It turns out that hallucinating dead relatives is extremely common, even in rationalist Christian Western countries. If that’s the case, how much more common was this phenomenon in ancient times?

Up to six in ten grieving people have “seen” or “heard” their dead loved one, but many never mention it out of fear people will think they’re mentally ill. Among widowed people, 30 to 60 per cent have experienced things like seeing their dead spouse sitting in their old chair or hearing them call out their name, according to scientists.

The University of Milan researchers said there is a “very high prevalence” of these “post-bereavement hallucinatory experiences” (PBHEs) in those with no history of mental disorders. They came to their conclusions after looking at all previous peer-reviewed research carried out on the issue in the English language.

Jacqueline Hayes, an academic at the University of Roehampton, has studied the phenomenon, interviewing people from across the UK who have lost spouses, parents, children, siblings and friends. She told the Daily Mail: “People report visions, voices, tactile sensations, smells, and something that we call a sense of presence that is not necessarily related to any of the five senses.”

She added: “I found that these experiences could at times be healing and transformative, for example hearing your loved one apologise to you for something that happened – and at other times foreground the loss and grief in a painful way.”

Six in ten grieving people ‘see or hear dead loved ones’ (Telegraph)

Now, you might think that those are just hallucinations, and no one could seriously take this as a sign that their dead relatives were still alive. But, it’s important to remember that ancient peoples did not make the distinction between “real” and “not real” the way we do. To them, all phenomena which were experienced—whether in visions, trances, dreams, or “normal” waking consciousness—were treated as equally “real”. The stance we would take in modern times—that our subjective consciousness is not real, while at the same time there is an objective reality which is exclusively real—is not one which would have been operative in past pre-scientific cultures, especially pre-literate ones.

And, indeed, we can see that there are valid reasons for believing this to be so:

Let’s count the many ways that hallucinated voices are real:

– They are real neurological patterns that exist in real human brains.

– They are subjectively real. The listener actually hears them.

– They satisfy the criterion for reality put forward by David Deutsch in his book The Fabric of Reality: they kick back.

– They have metaphorical reality. We can reason about the voices the same way we talk about a movie with our friends (discussing the characters’ motivations, their moral worth, etc.).

– They have real intelligence — because (this is crucial) they’re the products of a bona fide intelligent process. They’re emanating from the same gray matter that we use to perceive the world, make plans, string words together into sentences, etc. The voices talk, say intelligent things, make observations that the hearer might not have noticed, and have personalities (stubborn, encouraging, nasty, etc.).

They are, above all, the kinds of things toward which we can take the intentional stance — treating them like agents with motivations, beliefs, and goals. They are things to be reasoned with, placated, ignored, or subverted, but not things whose existence is to be denied.

Accepting Deviant Minds (Melting Asphalt)

By this criteria, whether or not people really experienced gods as aural hallucinations at one point in time, it is quite likely that they did experience hallucinations which they would have regarded as legitimate and real. Thus, beliefs in disembodied souls would have been a product of actual, lived experience for the majority of people, rather than just an “irrational” belief.

[1] Ernest Becker, The Denial of Death, pp. 203-204

[2] Susan Blackmore, The Meme Machine, pp. 14-15

[3] David Deutsch, The Beginnings of Infinity, p. 369

[4] David Deutsch, The Beginnings of Infinity, pp. 378-379

[5] Susan Blackmore, The Meme Machine, p. 22

[6] David Deutsch, The Beginnings of Infinity, p. 384

[7] Julian Jaynes, The Origin of Consciousness in the Breakdown of the Bicameral Mind, p. 74

[8] ibid., p. 72

[9] ibid., p. 75

[10] ibid., p. 84

[11] ibid., p. 84, p. 93

[12] ibid., p. 84, p. 106

[13] The “bicameral mind” 30 years on: a critical reappraisal of Julian Jaynes’ hypothesis, A.E. Cavanna, et. al. Functional Neurology, January 2007

[14] Julian Jaynes, The Origin of Consciousness in the Breakdown of the Bicameral Mind, p. 84, p. 398

[15] ibid., p. 402

[16] ibid., p. 404

[17] ibid., p. 413

The Origin of Religion – Part 2

Let’s take a look at the major components of religious belief according to scientists working on this problem:

1. Hypersensitive Agency Detection (HAD or HADD)

This is one of the things that almost always gets mentioned in the evolutionary psychology of religious belief. Basically, it’s a “false positive”—a default assumption that some event is caused by a conscious entity rather than by random chance. It is thought that such “constructive paranoia” helped us avoid attacks from predators and other hostiles:

Scientists working in the cognitive science of religion have offered…explanations, including the hyperactive agency-detecting device (HADD). This tendency explains why a rustle in the bushes in the dark prompts the instinctive thought: ‘There’s someone there!’ We seem to have evolved to be extremely quick to ascribe agency – the capacity for intention and action – even to inanimate objects.

In our ancestral environment, this tendency is not particularly costly in terms of survival and reproduction, but a failure to detect agents that are there can be very costly. Fail to detect a sabre-toothed cat, and it’ll likely take you out of the gene pool. The evolution of a HADD can account for the human tendency to believe in the presence of agents even when none can actually be observed. Hence the human belief in invisible person-like beings, such as spirits or gods.

There are also forms of supernatural belief that don’t fit the ‘invisible person-like being’ mould, but merely posit occult forces – eg, feng shui, supernaturally understood – but the HADD doesn’t account for such beliefs…

Belief in supernatural beings is totally natural – and false (Aeon)

2. Theory of Mind (ToM) and Existential Theory of Mind. (EToM)

Theory of Mind (ToM), or Theory of Mind Mechanism (ToMM) is basically our intuitive ability to read other people’s minds. It’s “the understanding that others have beliefs, desires and goals, influencing their actions. ToM allows us to have sophisticated social relationships and to predict how others will behave. You couldn’t “put yourself in someone else’s shoes” without it…” [1]

…we can think of ToM as the cognitive system that humans typically use to engage in social interactions with other people. By engaging your ToM when you interact with someone else, you are able to attribute human mental states – such as thoughts, emotions, and intentions – to that person.

It’s adaptive to engage your ToM when interacting with another person, because your ‘theory’ will usually be correct: the other person usually will, in fact, have a normal human mind. So if you assume they do have such a mind, you’ll generally be able to have a more successful social interaction than you would if you assumed that they had no mind, or some kind of non-human mind.

What religion is really all about (Psychology Today)

The perils of an overactive Theory of Mind

Humans, due to their social nature, possess the most sophisticated Theory of Mind in the animal kingdom, and this gives rise not only to the ability to model other people’s inner states and intentions, but also our own, leading to reflective self-consciousness:

It therefore appears at present that human beings, although probably not unique in possessing Theory of Mind, are nonetheless unusual in the degree of its sophistication, specifically in the extent to which they can accurately model the minds of others. It seems highly likely that those who possessed an accurate Theory of Mind enjoyed an advantage when it came to modelling the intentions of others, an advantage that continues to this day, and was an active ingredient in the evolution of human consciousness.

The self-conscious animal: how human minds evolved (Aeon)

Furthermore, “Humans…show extreme ToM, ascribing minds to inanimate or imagined things…” [1] In real life, people apply ToM to forces of nature, ancestor spirits and invisible gods. And they seem to think about these supernatural actors the same way they conceive of fellow humans: “fMRI studies have found ToM-related regions of the brain activate when people hear statements about God’s emotions and involvement in worldly affairs.” [1]

Experiments have confirmed that we attribute human characteristics and intentions to objects that we know do not have them, such as balloons and abstract shapes. A famous experiment in the 1940s demonstrated that even abstract shapes moving around in a film were perceived as having intentions and could be used to tell a story that the researchers wished to tell.


For example, there are a large number of movies where an inanimate object becomes a “character” in the film, and we apply our theory of mind to it just as much as we do for the flesh-and-blood characters. If we couldn’t do so, such films would make no sense. Take the French movie The Red Balloon. It is all about attributing human characteristics to a rubber ball filled with helium. Or take the “Herbie” movies by Disney. Herbie was a Volkswagen beetle who got into all sort of adventures with his human friends.

Functional MRI scans have confirmed that, in contemplating religious ideas, the theory of mind mechanism of our brain is engaged:

…researchers gave 40 religious volunteers functional magnetic resonance imaging (fMRI) brain scans as they responded to statements reflecting three core elements of belief. …Overall, the parts of the brain activated by the belief statements were those used for much more mundane, everyday interpretation of the world and the intentions of other people. Significantly, however, they also correspond with the parts of the brain that have evolved most recently, and which appear to which give humans more insight than other animals.

“Our results are unique in demonstrating that specific components of religious belief are mediated by well-known brain networks, and support contemporary psychological theories that ground religious belief within evolutionary adaptive cognitive functions,” say the researchers.

“It’s not surprising that religious beliefs engage mainly the theory-of-mind areas, as they are about virtual beings who are treated as having essentially human mental traits, just as characters in a novel or play are,” comments Robin Dunbar, an anthropologist at the University of Oxford.

‘Theory of mind’ could help explain belief in God (New Scientist)

Existential Theory of Mind (EToM) is the related idea that our theory of mind is so complex that we engage it not just with people, animals, and inanimate objects, but even with existence itself!

The idea of EToM is that people tend to engage their ToM in interactions not just with other people, but with ‘existence’ in general.
That is, humans seem naturally inclined to perceive their lives as ongoing interactions with some kind of transcendent mind(s) that, at least in some respects, seem(s) human-like. Across cultures, this transcendent mind-like power may be conceptualized as an explicitly-specified god or gods, or in more abstract terms (such as a universal spirit, karma, or ‘the force’).

It appears that more complex “higher order” religions may be connected with more recursive modes of Theory of Mind:

According to Robin Dunbar, it is through Theory of Mind that people may have come to know God, as it were… Dunbar argues that several orders of intentionality may be required, since religion is a social activity, dependent on shared beliefs. The recursive loops that are necessary run something like this: I suppose that you think that I believe there are gods who intend to influence our futures because they understand our desires. This is fifth-order intentionality. Dunbar himself must have achieved sixth-order intentionality if he supposes all of this, and if you suppose that he does then you have reached seventh-order…[3]

Interestingly, both the concept of the “soul” and such “higher-order” religions, religions where the participants are united by mutual self-professed beliefs in some sort of transcendent doctrine –emerge at roughly the same time. This appears to reflect the dawn of something approaching self-consciousness. I’ve previously argued that this has to do with recursion—see my review of The Recursive Mind.

Another consequence of Theory of Mind is that under times of stress, people often perceive a kind of conscious “presence” around them, somewhat analogous to the feeling of being watched. For example, the some of the members of Shackleton’s expedition independently experienced an invisible “felt presence” watching over them:

On 20 May 1916, Ernest Shackleton, Frank Worsley, and Tom Crean reached Stromness, a whaling station on the north coast of South Georgia. They had been walking for 36 hours, in life-threatening conditions, in an attempt to reach help for the rest of their party: three of their crew were stuck on the south side of the island, with the remainder stranded on Elephant Island. To reach the whaling station, the three men had to cross the island’s mountainous interior with just a rope and an axe, in a journey that few had attempted before or since. By reaching Stromness they managed to save all the men left from the ill-fated Imperial Transantarctic Expedition.

They did not talk about it at the time, but weeks later all three men reported an uncanny experience during their trek: a feeling that “often there were four, not three” men on their journey. The “fourth” that accompanied them had the silent presence of a real person, someone walking with them by their side, as far as the whaling station but no further. Shackleton was apparently deeply affected by the experience, but would say little about it in subsequent years, considering it something “which can never be spoken of”.

Encounters such as these are common in extreme survival situations: guardian angels, guides, or even Christ-like figures have often been reported. We know them now as “third man” experiences…

The strange world of felt presences (The Guardian)

3. Minimally Counterintuitive (MCI) Concepts.

Minimally Counterintuitve Concepts (MCI) ultimately stem from what some researchers have called non-reflective beliefs. There are beliefs which are so ingrained in our psyche that we don’t even think twice about them. Of course, these intuitive beliefs are not always correct. For example, before Galileo, people assumed that heavier objects would fall to earth faster than lighter ones. It turns out that they were wrong.

HADD (see above) is what [Justin] Barrett calls a non-reflective belief, which are always operating in our brains even without our awareness of them. Reflective beliefs, on the other hand, are ones we actively think about. Non-reflective beliefs come from various mental tools, which he terms “intuitive inference systems”.

In addition to agency detection, these mental tools include naive biology, naive physics, and intuitive morality. Naive physics, for example, is the reason children intuitively know that solid objects can’t pass through other solid objects, and that objects fall if they’re not held up. As for intuitive morality, recent research suggests that three-month old “infants’ evaluations of others’ prosocial and antisocial behaviours are consistent with adults’ moral judgments”.

Barrett claims that non-reflective beliefs are crucial in forming reflective beliefs. “The more non-reflective beliefs that converge the more likely a belief becomes reflectively held.” If we want to evaluate humans’ reflective beliefs about God, then we need to start with figuring out whether and how those beliefs are anchored in non-reflective beliefs.

But how do we go from non-reflective beliefs like HADD and Naive Biology to reflective ones like a God who rewards good people and punishes bad ones? It’s here that Barrett invokes the idea of minimally counterintuitive (MCI) concepts…

A Minimally Counterintutive Concept is one that is congruent with our non-reflective belief systems. It’s something that’s very similar to the things we encounter in everyday life, but just different enough to be more memorable. “MCI concepts are basically intuitive concepts with one or two minor tweaks.”

Barrett gives the example of a flying carpet, which “behaves” like a regular carpet in every way except one. “Such ideas combine the processing ease and efficiency of intuitive ideas with just enough novelty to command attention, and hence receive deeper processing.”
It’s not surprising, then, that cross-cultural studies have shown that MCI concepts are easily recalled and shared. There are two reasons for this, says Barrett. First, MCI concepts maintain their conceptual structure. Second, MCI concepts tend to stand out from among an array of ordinary concepts. “What captures your attention more,” he writes, “a potato that is brown, a potato that weighs two pounds, or an invisible potato?”

Religious beliefs are shared – and they’re shared by human animals with a shared neural anatomy. Our mental toolkit contains built-in biases, such as HADD, which is responsible for a number of false positives. (Most of the time it is just the wind!) For brains that seem wired to find agency and intention everywhere, religion comes very naturally.

Do humans have a religion instinct? (BBC)

A Maximally Counterintutive Concept, by contrast, is one which we have a hard time relating to, so we tend to dismiss it as false, instinctively, regardless of its actual veracity.

I think this explains a lot of the stubborn resistance surrounding Darwinian evolution, as well as a lot of other scientific concepts. The idea that slow, incremental change over time gave rise to the teeming multitude of life around us (including ourselves) seems impossible to believe, as even evolution’s staunchest defenders acknowledge. This is because we think on time scales of years, or maybe decades, based on our lifespans. We simply cannot understand—except at the most abstract, intellectual level—a thousand years, let alone a million years. (1 million is a thousand thousands).

Thus, I would call biological evolution a Maximally Counterintutive Concept.

By contrast, the idea of a creator god is minimally counterintuitive, since we humans intentionally create things all the time. Often, in ancient mythology, God creates the world and man the same way we might create, say, a clay pot or a loaf of bread. That’s not hard for us to understand at all, hence it’s a minimally counterintutive concept. And the concept of a “loving, caring” God is really just a step removed from our own parents.

Another way of putting this is that MCI’s are “viral” from a memetic standpoint; they are especially good at becoming memes. Minimally counterintutive concepts make excellent memes, and so they spread more rapidly and easily than their maximally counterintutive rivals. We’ll take a look at memetic theories of religion a bit later.

In fact, it turns out that a great many scientific concepts are maximally counterintutive. The earth is billions of years old? The universe is expanding? Time slows down with your velocity, or moves faster the higher up you go? Solid matter is mostly empty space? Invisible particles in the atmosphere are changing the climate? Really??? Even simple concepts—like the fact that the earth revolves around the sun and is a sphere—are the opposite of how we actually experience them in daily life.

Richard Dawkins may well be right when he describes the theory of natural selection as one of our species’ finest accomplishments; it is an intellectually satisfying and empirically supported account of our own existence. But almost nobody believes it. One poll found that more than a third of college undergraduates believe that the Garden of Eden was where the first human beings appeared. And even among those who claim to endorse Darwinian evolution, many distort it in one way or another, often seeing it as a mysterious internal force driving species toward perfection. (Dawkins writes that it appears almost as if “the human brain is specifically designed to misunderstand Darwinism.”)…

What’s the problem with Darwin? His theory of evolution does clash with the religious beliefs that some people already hold. For Jews and Christians, God willed the world into being in six days, calling different things into existence. Other religions posit more physical processes on the part of the creator or creators, such as vomiting, procreation, masturbation, or the molding of clay. Not much room here for random variation and differential reproductive success.

But the real problem with natural selection is that it makes no intuitive sense. It is like quantum physics; we may intellectually grasp it, but it will never feel right to us. When we see a complex structure, we see it as the product of beliefs and goals and desires. Our social mode of understanding leaves it difficult for us to make sense of it any other way. Our gut feeling is that design requires a designer—a fact that is understandably exploited by those who argue against Darwin.

Is God an Accident? (The Atlantic)

It turns out that Dawkins is right, our brains are designed to misunderstand evolution. It’s much easier to attribute things like thunder and lightning to the “anger” of Zeus or Thor than to something like static electricity differentials, and so forth. It’s a lot easier for the average person to comprehend God’s wrath than plate tectonics. As Insane Clown Posse declared, “I don’t want to hear from no scientist; you fuckers are lyin’ and gettin’ me pissed!” For them, and many others like them, biological reproduction and magnets are simply “miracles”.

4. The Intentional Stance (IS):

This is similar to Theory of Mind: attributing deliberate intentions to other human beings and animals, but also to many things that do not have—and cannot have—intentions and beliefs of their own. This idea was developed by the philosopher Daniel Dennett.

According to Daniel Dennett, there are three different strategies that we might use when confronted with objects or systems: the physical stance, the design stance, and the intentional stance. Each of these strategies is predictive. We use them to predict and thereby to explain the behavior of the entity in question. (‘Behavior’ here is meant in a very broad sense, such that the movement of an inanimate object—e.g., the turning of a windmill—counts as behavior.)

The physical stance stems from the perspective of the physical sciences. To predict the behavior of a given entity according to the physical stance, we use information about its physical constitution in conjunction with information about the laws of physics…

When we make a prediction from the design stance, we assume that the entity in question has been designed in a certain way, and we predict that the entity will thus behave as designed…we often gain predictive power when moving from the physical stance to the design stance…

Often, we can improve our predictions yet further by adopting the intentional stance. When making predictions from this stance, we interpret the behavior of the entity in question by treating it as a rational agent whose behavior is governed by intentional states.

The intentional stance (Dictionary of Philosophy of Mind)

A good example might be crossing the street. You can predict from the physical stance how fast you can walk, or how quickly a car can stop taking inertia into account, and so on. You also know the basic mechanics of how a car operates by using the design stance—a car has an engine, brakes, a transmission, an ignition, rubber tires, and so forth. It was designed deliberately by human beings for their use. You know that stoplights are designed to change color to regulate traffic. But to really predict what’s going on, you need to understand what’s in the mind of the driver. For that, you adopt the intentional stance to ascribe beliefs, intentions, motivations, and limitations to the driver. This will ultimately tell you whether the car will stop or not, beyond just the physical and design considerations.

Dennett’s argument (as I understand it) is that the benefits of using the intentional stance cause us to apply it to all sort of things where it does not belong. For example, we tend to attribute intentions, characteristics, and deliberate behavior even to inanimate objects that we know are inanimate objects (like the geometric shapes in the movie, for example). Taken to its logical conclusion, you get things like animism and pantheism.

The sun wants us to have two scoops of raisins in the morning. No clue as to how the raisins feel about being eaten, though.

As Rupert Sheldrake points out, young children often draw the sun with a smiley face in it, like on the box of Raisin Bran. This indicates, according to Sheldrake, that children are “instinctive animists,” attributing human mental characteristics to all sorts of inanimate things in the world around them. Indeed, toddlers will often explain scenarios involving inanimate objects in terms of intentions—i.e. the box “wants” this, or the pencil “feels” that. Cloudy days are when the sun “doesn’t feel like” coming out, or “refuses to shine,” for example.

5. Full Access Agents (FAA):

We’ve previously talked about how we are “instinctive dualists,” dividing the world into one of bodies—subject to the laws of physics and physiology; and one of minds—subject to the laws of human psychology. But for some reason, we attribute superior knowledge to the invisible minds which surround us. These “invisible minds” can be in places we cannot, and can read the beliefs and intentions of others in a way we cannot.

These beings have been called “Full Access Agents”: “By full access agents I mean agents that have an unlimited access to other person’s minds: they are omniscient in the sense that they know all mental contents there are to be known.” [4] p. 31

Closely related to the idea of agency is what Dennett refers to as a cards-up phenomenon. Agency detection carries with it certain risks: do you know about that bad thing I did? How can I be sure you know, and how can I be sure about what you think about me because of it? These are complex questions and human beings aren’t good at managing all the options.

What’s needed for learning how to navigate these muddy waters is for everyone to be taught the rules of the game by placing all of our cards face up on the table. The teacher, then, is something of a full-access agent: they see everything and can instruct us accordingly.

The original full-access agents, says Dennett, were our dead ancestors. But eventually, the seeds of this idea became more formalised in various theologies…

Do humans have a religion instinct? (BBC)

Furthermore, such Full Access Agents have disproportionate access, in particular, to something called “socially strategic information.” Socially strategic information is “information that activates the mental systems used for social interaction. And, “Some theorists have argued that humans throughout history have committed themselves to “the gods” rather than countless other anthropomorphized and supernatural beings (e.g., dragons, trolls, and Mickey Mouse), precisely because the gods have access to socially strategic information.” [5]

Put another way, FAAs help resolve what are called “Multipolar Traps” where equilibrium depends on people not defecting from sort of collective social norm. A multipolar trap can be described as, “a situation where cooperating is in one’s interest only if doing so caused everyone (or almost everyone) else to cooperate.” However, there is always a risk of defection where the defector benefits at the cost of everyone else. Thus, to prevent the defector from winning, everyone needs to update their behavior, and the equilibrium falls apart: “If you cooperate in an environment where most people are defecting, you are only hurting yourself, both in the short-run and in the long-run. If you defect in an environment where most people are cooperating, you benefit yourself in the short and long runs, as well.” Full Access Agents, then, may have helped us escape from the consequences of this trap, allowing for greater cooperation:

“Humans are not very good at behaving just because you punish them for not behaving,” says evolutionary psychologist Robin Dunbar, “otherwise we would all be driving well under 70 on the motorway.” The real problem isn’t how bad the punishment is, but how risky it is to be caught.

If the risk is low, he says, we’re prepared for the punishment. This would have been a major issue in prehistory. As hunter-gatherer groups grow, they need to be able enforce a punishment mechanism – but the greater the size of the group, the less chance there is of being found out.

Enter full-access agents: “We don’t see what you do on Saturday night, but there is somebody who does, so beware,” as Dunbar puts it. This idea was consonant with the intuitive mental tools such as HADD and intuitive morality, so it was well-received by our ancestors’ evolved brains. Plus it had the added bonus of regulating behaviour from the bottom up. “You always get better behaviour from individual commitment,” says Dunbar, “not coercion.”

Do humans have a religion instinct? (BBC)

Full Access Agents (FAA), or later, the “Universal Mind” (see EToM, above) were the enforcers of proper behavior: they were the original “Big Brother” from George Orwell’s 1984 (and, in the case of ancestor worship at least, it might literally be your big brother!). While we are fully aware that flawed, flesh-and-blood human beings can be tricked, deceived, and possess false knowledge, for some reason these invisible spirits are not subject to the same deficits:

Across cultures, even children seem to think that gods know more than normal humans. This is borne out by experiments using what psychologists call the ‘false-belief task’, which tests whether individuals can detect that others have false beliefs.

In one version of the test, researchers put a bag of rocks into a box of crackers, showed children what’s inside, and then asked what various entities would think was in the box. If the children said: ‘Mom thinks rocks are in there’, then they haven’t passed the false-belief task. If they said: ‘Mom thinks crackers are in there, but there are really rocks’, they have a handle on the incorrect mental states of others.

What’s curious is that, with age, children come to know that Mom, dogs, and even trees will have incorrect thoughts, but they never extend that vulnerability to God. In fact, the quality of omniscience attributed to God appears to extend to any disembodied entity…Louisville Seminary researchers found that children think imaginary friends know more than flesh-and-blood humans. There appears to be a rule, then, deep in our mental programming that tells us: minds without bodies know more than those with bodies.

Furthermore, we also seem to instinctively believe that the Full Access Agents’ knowledge about moral intentions is superior to that of any other actor, and this belief is consistent across cultures:

Christian students from the University of Connecticut who claim that God knows everything will nonetheless rate His knowledge of moral information as better than His knowledge of non-moral information…As reported in a 2012 article in Cognitive Science, our lab at the University of Connecticut examined what might be called this ‘moralisation bias’ of omniscient beings…What these studies suggest is that we intuitively attach moral information to disembodied minds. And this subtle association can alter our behaviour in significant ways.

In one study, in the Journal of Experimental Child Psychology in 2011, the psychologist Jared Piazza of Lancaster University and colleagues told children a story about a ghostly princess living in their lab. Though these children never heard a peep from the ghost, they cheated less on a difficult game than a control group of children who were not told the story. This suggests that gods, ghosts and other incorporeal minds might just get us to behave – particularly if we assume that the gods know about our behaviour, and especially if we think they can interfere in our affairs.

From an evolutionary perspective, the gods facilitate social bonds required for survival by raising the stakes of misconduct. Having a cosmic Wyatt Earp on the beat aids survival and reproduction by curbing others’ banditry. If you’re tempted to steal from someone, but know that God cares and has the power to do something about it, you might think twice. If God knows your thoughts, perhaps you wouldn’t even think twice. The Abrahamic God appears to be a punitive, paranoia-inducing Big Brother always watching and concerned with our crimes…

Why God knows more about misbehavior than anything else (Aeon)

As the above essay points out, exactly what the full access agents are interested in tends to vary based on the cultural norms. Some are not particularly concerned with sexuality; others are quite judgemental. In either case, they are hitched to basic human feelings of guilt and shame to enforce pro-social norms. For example, in Tuva (a culturally Mongolian society in Russia), gods are tutelary deities rather than all-knowing patriarchal fathers. Nevertheless, they still enforce social norms concerned with environmental stewardship that cannot be enforced by any external living entity:

The [Tuvan] spirit-masters aren’t as vindictive or punishing as the God of Abraham. However, if you disrespect them or forget to make an offering, your luck can quickly change. They also aren’t omniscient. ‘Does the spirit-master of this area know what happens in another area?’ I would ask when in the field. Responses often consisted of: ‘No, but those spirits know what happens in that area.’

The local gods in Tuva aren’t concerned with morality in the Abrahamic or Western sense; instead, they care about rituals and protecting resources such as natural springs, lakes and hunted animals in their area of governance…through conversations, interviews and a variety of other questioning techniques, Tuvans communicated that their gods care about rituals and practices associated with resource conservation. But when asked, for example: ‘Does this God care about theft?’ they’re more inclined to give affirmative responses than to non‑moral questions ..

It looks as if gods can tap into our mental moral systems regardless of what our explicit beliefs tell us. Even though Tuvans might think that their spirit-masters are unconcerned with how they treat each other (or simply do not talk about their gods in this way), these gods might still contribute to co‑operation. If they trigger Tuvans’ moral cognition, the gods might curb ‘immoral’ behaviour especially when associated with territory.

Unlike the God-as-Big-Brother model of the Abrahamic faiths, spirit-masters follow more of a God-as-shy-but-watchful-landlord model…

Why God knows more about misbehavior than anything else (Aeon)

Once societies became to large for external enforcement agents, it is thought, these invisible spirits stepped in to enforce pro-social behavior: “representations of full-access agents have directly helped reciprocal altruism to evolve because they can help one view things from others’ point of view and can make systems of moralistic punishment possible.” [4] p. 32

…morality predates religion, which certainly makes sense given what we know about the very old origins of empathy and play. But the question remains as to why morality came to be explicitly connected with religion. [Pascal] Boyer grounds this connection in our intuitive morality and our belief that gods and our departed ancestors are interested parties in our moral choices.

“Moral intuitions suggest that if you could see the whole of a situation without any distortion you would immediately grasp whether it was right or wrong. Religious concepts are just concepts of persons with an immediate perspective on the whole of a situation.”
Say I do something that makes me feel guilty. That’s another way of saying that someone with strategic information about my act would consider it wrong. Religion tells me these Someones exist, and that goes a long way to explaining why I felt guilty in the first place. Boyer sums it up in this way: “Most of our moral intuitions are clear but their origin escapes us…Seeing these intuitions as someone’s viewpoint is a simpler way of understanding why we have these intuitions.” Thus, Boyer concludes, religious concepts are in some way “parasitic upon moral intuitions”.

Do humans have a religion instinct? (BBC)

Full access agents, thanks to their all-knowing nature, can also be consulted when big, important decisions need to be made and there is a large element of random chance:

Representation of full-access agents help in strategic decisions: as these are often difficult to make because people do not believe their strategic information is perfect or automatic, they consult full-access agents for advice. In addition, a decision is sometimes difficult to make because the issue at hand is relatively trivial or no alternative stands out as superior. Should I buy this or that gift from my wife? Your place or mine?
Finally, some decisions are difficult to make because too much is at stake. Should I go for the operation when the risk of paralysis is 50 percent? Should we try to bust the terrorists at the risk of losing the hostages lives? [4] p.32

The religion equation.

So, then, our “religion equation” ends up looking something like this: HADD + ToMM + FAA = Religion; or at least the basic form of it.

In Supernatural Agents: Why We Believe in Souls, Gods and Buddhas, Iikka Pyysiainen derives a slightly different, but similar, equation:

I distinguish three overlapping cognitive mechanisms that contribute to agentive reasoning. The first is hyperactive agent detection (HAD): the tendency to postulate animacy–this mechanism is triggered by cues that are so minimal that it often produced false positive, for example, we see faces in the clouds, mistake shadows for persons, and so forth. Second is hyperactive understanding of intentionality (HUI): the tendency to postulate mentality and to see events as intentionally caused even in the absence of a visible agent. Third is hyperactive teleofunctional reasoning (HTR): the tendency to see objects as existing for a purpose. [4] p. 13

When HADD, HUI, and/or HTR are triggered, giving a false positive, three alternative supernatural explanations are available: the triggering event was caused by (1) a natural agent acting from afar, (2) a present but invisible and intangible agent; or (3) some impersonal force or very abstract kind of agency. The first alternative is represented by beliefs in telepathy, psychokinesis, clairvoyance, and the like; as well as the example of a picture miraculously falling off from the wall. Examples of the second are beliefs about gods, spirits, and other supernatural agents. Third would be a “numinous” force or a very abstract agent such as “the ground of being”. [4] p. 30

These beliefs in noncorporeal beings (agentive reasoning), in whatever form they take—ancestors, nature spirits, or ‘the universal spirit’—who can see into our inner souls and car about our moral choices, is the scaffolding upon which all subsequent religion is erected. Of course, the forms that it takes will vary greatly across cultures and across time. But such universals which give us clues as to religion’s fundamental nature and origin, while looking past the myriad superficial forms it may take.

In the next part of this series, I would like to briefly discuss some other ideas that were not mentioned in the BBC article, but have also been posited as giving rise to religion. These are Terror Management Theory (TMT), Bicameral Mind Theory (BMT) and the Memetic theory of religion.

[1] The Human Brain Evolved to Believe in Gods (Discover Magazine)

[3] The Recursive Mind by Michael Corballis, pp. 137-138

[4] Supernatural Agents: Why We Believe in Souls, Gods, and Buddhas by Iikka Pyysiainen

[5] What Does God Know? Supernatural Agents’ Access to Socially Strategic and Non‐Strategic Information (Cognitive Science)