Coined: The Rich Life of Money and How Its History Has Shaped Us

by Kabir Sehgal

  Rome suffered from years of economic misfortune. Prices rose nearly 23 percent per year from AD 293 to 301. Emperor Diocletian followed the economic playbook of Nero in the late third century AD. He enlarged the military and built more roads. He instituted monetary reform, returning to a bimetallic system of silver and gold, with new denominations marked by their fractional weight in bullion.92 Money was yoked back to metal with intrinsic worth. But metal prices moved north, too. Inflation remained, and bad money chased out good money. In AD 301, Diocletian issued an Edict on Maximum Prices, which capped the prices of more than one thousand goods, including wine, grain, and clothes. But it was largely ignored, and inflation became even more rampant.

  Scholars have long deliberated the causes of inflation in Rome. Meddling with the supply and value of hard money certainly played a pivotal role. Rome’s experience with debased money should give pause to anyone who thinks hard money is a panacea for economic problems. Yet the debasement of hard money pales in comparison to the devaluation of soft money that goes on today. The dollar isn’t backed by metal, and some have called for a return to the one metal that’s remained a fascination over the ages.

  The Golden One

  Years ago I descended into a South African gold mine, hundreds of feet belowground. There was a sign near the elevator shaft that read “205 days without an injury.” Hundreds of helmet lights worn by the workers flashed across cavernous passageways. Dozens of trucks and hauling buggies motored past me. Such a laborious operation yields little precious metal. Every ton of crushed rock produces but a few grams of gold. Yet these grams are monitored closely by Wall Street research analysts who adjust their economic forecasting models based on mine production data. The amount of aboveground gold in the world was estimated at about 174,000 metric tons at the end of 2012.93 Meanwhile, global steel production in 2012 alone was 1.5 billion metric tons.94

  Gold isn’t the only rare metal. Yet there is an obsession for it. Warren Buffett thinks gold lust is bizarre. He juxtaposes my journeys to the African mine and the New York Fed’s vault when he says, “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”95

  Yet some market strategists say that “gold is money.”96 How did this idea begin? The neurons that register “gold” and “value” wired long ago. Early humans were probably attracted to its shine and luster. Only a few naturally occurring materials, like gemstones, water, and ice, would have reflected light and displayed a natural shimmer.

  Even some animals like bright, shiny objects. Monkeys are quick to snatch objects like bangles and camera lenses from unsuspecting tourists. Among bowerbirds, a bird species native to Australia and New Guinea, the males construct elaborate lairs festooned with shiny and colorful natural and found objects such as fruit, stones, glass shards, bottle caps, foil bags, and hair ties. The fancy lair attracts females for mating. Colors are nature’s way of advertising. The color of gold sells.97

  Gold has long had a luring effect on humans. The Babylonians linked metals to objects in the solar system, with gold compared to the sun.98 The link between gold and the sun appears elsewhere. The Latin word aurora means “dawn,” when the sun appears, and it is similar to aurum, which means “gold”—and is abbreviated as Au on the periodic table. But the English word for gold comes the Old High German word gelo and the Old English word geolu, which means “yellow.”

  Some dig for gold. Others practice the abracadabra of alchemy. Early alchemists tried to transform base metals like copper, iron, and tin into “noble” metals like electrum, silver, and gold.99 Because of its lofty ambitions, alchemy has been associated with the mystical and divine, referred to at times as “the knowledge” or “the art.” The word alchemy is itself a mixture: Al- is of Arabic origin; chemy stems from a Greek word that means “melt” or “mixture.”

  Alchemy likely began in Egypt in the third century AD. Egyptians had already been experimenting with metalworking for thousands of years, and it was a natural home to alchemists. There are not many historical texts on alchemy from this period, because they were destroyed. Legend has it that the Roman emperor Diocletian banned alchemy because of the threat it posed to debased Roman money and his monetary reforms. Or he may have been fearful of someone financing an insurrection.100 Nevertheless, some recipes have been discovered. One calls for adding sulfur to silver, causing a reaction that results in a golden hue.101

  Alchemists gradually tried to make other metals take on more than a golden tinge. They wanted to transmute fully one metal into another. Chrysopoeia and argyropoeia were the names of the processes for turning materials into gold and silver, respectively.102 Alchemists also wrestled with the issue of what constitutes matter. Alchemy required a deep knowledge of chemical properties, yet alchemists still found that making hard money was difficult.

  Alchemy was practiced in many different societies. In The Secrets of Alchemy, Lawrence Principe describes how Arabs became interested in alchemy. In the eighth century, a Byzantine emperor showed an Arab ambassador that copper could be melted and, with a dash of red powder, transmuted into gold. Undoubtedly impressed, the Arabs translated Greek alchemical texts.103 Another culture’s obsession for gold making continued in earnest. Just as in the Roman Empire, leaders in the Arab world criticized alchemy as unnatural and alchemists as frauds, and sought to ban the practice altogether.

  During the Middle Ages in Europe, some alchemists saw themselves as practicing a divine art. Jesus Christ’s life was an allegory for alchemy, as he transformed from one state to another. To practice alchemy, then, was to improve oneself.104 Martin Luther’s father was an alchemist who believed the practice was consistent with Christian teachings on self-improvement.

  During the European Enlightenment, alchemy was studied as part of chemistry in educational institutions.105 Surprisingly, a scion of scientific thought, Isaac Newton studied and practiced alchemy, proving that trying to create precious metals can attract the most “rational” of minds. Though scientists eventually dismissed alchemy, occult groups incorporated the practice and kept its lore alive.106 Even today, the common use of the word alchemy and the reinterpretation of the practice in popular culture, from literature to movies, suggest that the fascination with gold making remains.

  Quality to Quantity

  It’s not just the emperors of Rome who have manipulated money for political ends. Today it’s still common practice for central banks to adjust the supply of money to abet political goals. There’s no need to mine metals, since the state can just create more soft money. For example, the central bank of Japan purchases massive amounts of securities to inject money into the banking system, which leads to depreciation of the yen and helps Toyota, Nissan, and other exporters sell their products at cheaper prices in the global marketplace. More sales can spell more jobs, an aim of the Japanese government.

  Such monetary strategies and currency manipulations have long been a part of the global economic system. However, the global financial crisis of 2008 sparked an era of large-scale currency adjustments as central banks tried to stimulate their respective economies by creating vast amounts of new money. The story goes that with more money flowing through the economy, prices will rise to reflect the reduced value of the currency, which will spur individuals and businesses to spend now rather than later, leading to a bump in economic activity.

  Many pundits and politicians have panned the state’s meddling with the supply and value of money. They reason that the historical debasement of hard money is nothing compared to the large-scale manipulation by the state of money that’s not backed by metal. To return to a gold standard would institute some check, the overall supply of gold, on monetary expansion.

  Returning to a gold standard invokes the debate between metallists and chartalists. It’s also a debate between creditors and debtors. Creditors have historicall
y tried to protect their investments, wanting to receive money owed to them that is of the same quality. Debtors, however, have historically looked to grow the money supply so they can make loan payments with money that is less valuable.107

  But the nature of money is an ever-shifting issue. It depends not only on whom you ask, but on when you ask them. In the late nineteenth century, bankers resisted attempts to institute bimetallism that would expand the supply of money. They wanted to be paid in full with quality, valuable, hard money. Today few bankers advocate a return to hard money, because it could limit loan issuance and curb business.

  The arc of monetary history bends toward soft money. Economist Glyn Davies mentions a “quality-to-quantity pendulum” in which the supply of money has increased dramatically over the centuries, at the expense of money’s value.

  The sheer amount of soft money in circulation is enormous, partly because it’s so easy to make. Maybe the state has been practicing another type of alchemy all along.

  CHAPTER FIVE

  Some Like It Soft

  A brief history of soft money

  You must know that he has money made for him… out of the bark of trees… Of this money the Khan has such a quantity made that with it he could buy all the treasure in the world. With this currency he orders all payments to be made throughout every province and kingdom and region of his empire. And no one dares refuse it on pain of losing his life.

  —Marco Polo1

  Money makes money, and the more money that money makes, makes more money.

  —Benjamin Franklin2

  If you think writing about the fortunes of the stock market is tricky, try getting your arms around currencies.

  —Bill Gross3

  Kublai Khan established the Yuan Dynasty and issued paper money that circulated throughout his Asian empire.

  The Bloomberg computer terminal blinked bloodred. But Jasper was seeing all green.4 He had worked on Wall Street for only a few short years and never witnessed a day like this before. The markets were going to hell, yet his team was making more money than ever.

  Jasper worked at the foreign exchange trading desk of a global investment bank in New York. With the bankruptcy of Lehman Brothers in September 2008, the dollar underwent sharp swings, initially depreciating more than 5 percent in one week and then appreciating 17 percent over the next two months.

  But it wasn’t the volatility that surprised him. That’s the nature of the currency market. It was the volume.

  Jasper was astonished with the quantity of dollars, the masses of money changing hands.

  “We can’t keep up with the flow,” he said exasperatedly.

  With global stock and bond markets under siege, money flooded into the currency market, rushing into cash, mostly dollars, like a tidal wave enveloping a coastal city—and stayed there. There was nowhere else to invest. The dollar was a safe haven, a port in the storm.

  Money has historically been a means. In Athens during the fourth century BC, people converted foreign currencies into drachmas so they could buy olives at the agora. In recent times, people and institutions have converted currencies for similar reasons. A Brazilian company buys Indian rupees to pay its Indian supplier in its local currency. Or a more sophisticated but perfectly sensible transaction: A French company that generates most of its revenue from Quebec locks in a favorable exchange rate for the Canadian dollar as a hedge against wild market swings that could erase profits.

  During the 2008 financial crisis, many investors kept their money in money, moving it from one currency to another. The crisis didn’t start this practice, but it certainly accelerated it. Not wanting to convert their money into other assets, many investors held on to these symbols of value. Even though money is an abstraction from its original evolutionary purpose of helping humans obtain energy to survive, many considered cash a concrete way to protect their financial well-being.

  The removal of money’s metal anchor caused currencies to float, their values rippling with the market. Investors fish for beneficial fluctuations and convert them into profits. Currencies are now, in investor parlance, an asset class, an investable group with its own set of attributes similar to stocks, real estate, or precious metals. Instead of dividing your investment portfolio among stocks, you can invest in a basket of currencies. Let’s say an investor allocates 10,000 US dollars: 50 percent in Japanese yen, 30 percent in Australian dollars, and 20 percent in New Zealand dollars. The investor expects a return on his or her basket as these currencies appreciate versus the US dollar for any number of reasons, such as surprising political news or changing expectations about where interest rates are headed.

  The currency market has become the deepest, largest, most liquid market in the world. The average daily trading volume of currencies, including more esoteric products like currency derivatives, exploded from $1.5 trillion in the late 1990s to $4 trillion in 2010, which exceeds the volumes traded in the stock market. By comparison, the S&P 500 averages $150 billion in volume per day. Another reason for the currency market’s liquidity is that it’s almost always open: Trading begins on Sunday night in Auckland, New Zealand, and ends Friday evening in New York.

  The United States dollar is the most significant currency in this market. That’s because its issuer has been the world’s leading economic (and some say, military) power since World War II. The US dollar is attractive to investors because it’s readily convertible into other currencies through the foreign exchange market. There are more than 170 currencies in the world, but 85 percent of currency transactions involve the dollar. Prices of global commodities like oil and many other tradable goods are set and settled in dollars even if the United States isn’t involved in these transactions; some 81 percent of global trade is settled in dollars.5 Because it’s the dominant global currency, the dollar gives the United States incredible monetary and economic advantages. It’s what Charles de Gaulle’s finance minister famously called America’s “exorbitant privilege.”6 When I was in Marrakech, merchants of pouf cushions preferred payment in US dollars to Moroccan dirham. Shelling out dollars made my life easier, but the local currency exchange shop lost my business. Another advantage for the United States is that it doesn’t have to sell real goods to acquire the liquid and versatile dollars. Economist Barry Eichengreen explains:

  It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 of actual goods and services in order to obtain one… About $500 billion of U.S. currency circulates outside the United States, for which foreigners have to provide the United States with $500 billion of actual goods and services.7

  Another benefit of issuing the world’s most dominant currency is that the United States can impact monetary systems beyond its borders. In response to the credit crisis, the Federal Reserve created more money and liquidity, which had international consequences. With so many new dollars flooding in, global asset markets started to move up again, causing other countries, notably China, to complain about inflation.

  But quantity comes at the expense of quality, as measured by market value. The surge in the value of the dollar during the crisis interrupted a long-term downward trend, which has resumed. A dollar doesn’t go as far as it used to: According to the Bureau of Labor Statistics, since 1971 there has been an 83 percent decline in the purchasing power of the dollar, from $1.00 to 17 cents.8 One primary reason for the decline is supply and demand of money itself—the Fed has created more dollars than the market demands.

  Certainly, the renewed weakness in the dollar isn’t bad for all parties. American exporters benefit from a weaker dollar because real prices become lower for customers in foreign markets. But the dollar’s outsized role in the global currency market, and its declining value, gives investors pause, especially since the 2008 financial crisis, which had roots in the US financial system and mortgage market. The United States accounts for 25 percent of the world’s gross domestic product, yet almost 60 percent of forei
gn central banks’ reserve holdings are still in US dollars. For central banks, there has been a gradual diversification into other currencies, as 70 percent of holdings were in US dollars in 1999. The crisis convinced more foreign central bankers that they need a Plan B, but in recent years good options weren’t obvious because the euro and yen faced their own challenges.

  Any currency that’s highly reliable, liquid, and convertible can theoretically serve as the world’s dominant currency. Great Britain’s pound was the world’s leading currency in the nineteenth and early twentieth centuries, until the dollar replaced it. Now the pound is involved in just over 10 percent of currency transactions. Already market prognosticators suggest China’s renminbi is but a decade from becoming a leading if not dominant world currency that will reflect China’s significant economic position in the world.

  Many have suggested ways to preserve America’s exorbitant privilege and maintain the dollar as the world’s reserve currency, or at least slow the pace of decline in its share of global reserves. One solution is to bolster the quality of the dollar in terms of value by reducing its quantity, contracting the money supply, even returning to a gold standard. However, history shows that the creation of money has been a temptation few have been able to resist.