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

by Kabir Sehgal

  The dollar isn’t what it used to be. It’s no longer backed by any gold (and hasn’t been since the early 1970s). It’s soft money. I define soft money as currency that is not backed by commodities like precious metals. A dollar bill has very little intrinsic worth, but it remains a symbol of value. A dollar’s worth is supposedly backed by the faith and credit of the US government. You could also say that the source of the dollar’s value isn’t determined by precious metals underground but reflects the underlying fundamentals of the US economy. But economist Milton Friedman explains it best: “The pieces of green paper have value because everybody thinks they have value.”9

  It’s difficult to pinpoint exactly why soft money was created in the first place. But here are a few possible reasons:

  First, convenience: A dollar bill is easier to handle than gold bullion and gold coins. Exchange is evolutionarily advantageous, and any tool that significantly helps us trade and cooperate more efficiently has a good chance of being widely adopted.

  Second, abstraction: As the human capacity for symbolic thought improved, we no longer had to see or touch the source of value. Money today is an abstraction of its evolutionary purpose of helping us obtain the resources we need to survive. Brain scans reveal that obtaining dollars triggers activity in the nucleus accumbens, part of the reward center, so we clearly understand that pieces of green paper represent something else of value.

  Third, universality: As the “super-brain” of society has become more global and interconnected, a common financial system, one supported by institutions that issue soft money, has become the standard. Just as it takes time for the brain to learn something new, it took more than a thousand years for the “super-brain” to widely adopt soft money as the prevailing form of currency.

  Last, power: Issuers of soft money can easily alter the money supply to achieve political and economic goals, shaping a society as they see fit. Issuers can design soft money so that it has worth within a jurisdiction; hard money may always have value outside territorial borders, making it a flight risk. Soft money is nothing short of financial alchemy. An issuer can create money out of thin air and fund its agenda without directly taxing its citizens.

  This final reason is cynical yet illuminating. Coinage had a democratizing effect in the ancient world. But once Rome’s leaders started to tinker with the value of coins, they realized the political usefulness of being the issuer. The large-scale manipulation of hard money abetted their goals and helped them alter the economy to their liking. “Give me control of a nation’s money supply, and I care not who makes its laws,” said Mayer Amschel Rothschild, the financier who started the Rothschild banking empire.10

  Metallists admit that hard money has historically been manipulated. But soft money, they reason, gives more power to the state. Nero was unable to affect uniformly his entire currency at once. When he issued a new batch of debased coins, there were still high-grade coins in circulation. The value of these high-grade coins would appreciate, yet it would take time for them to be hoarded and removed from circulation.11 With soft money, the state affects the value of all its notes simultaneously. When the Fed issues notes, it adjusts the overall money supply, which impacts the value of every dollar. Soft money renders Gresham’s law moot, as all good money becomes bad.

  It’s easier for the state to issue and alter soft money. Whereas the denarius was bounded by metal, the dollar is boundless by its absence. As of June 2013, there were 1.1 trillion in circulation, much of which is thought to be overseas.12 Other measures of the money supply are larger: The monetary base, the sum of money in circulation and bank balances maintained at the Federal Reserve, was $3.2 trillion in June 2013, a staggering amount.13 The arc of monetary history bends toward expansion and inflation, especially when encountering difficult economic times. Policies geared toward increasing the money and credit supply became a prescriptive doctrine to reboot the economy during and after the 2008 financial crisis, in an attempt to encourage the extension of credit, as well as to boost certain asset prices and drive investors into riskier investments, further supporting prices.

  Borrowers will be less troubled by unexpected increases in inflation because it erodes the value of money over time, which means they will pay back the lender with money that is worth less than it is today.14 Say I borrow $100 with a promise to pay you back next year with no interest. Suppose prices increase 3 percent over the year, so the purchasing power of the dollar decreases. After one year, the $100 holds only about $97 in purchasing power.15 It may not seem like a lot, but it can amount to a huge advantage for large borrowers at the expense of creditors. Say the United States borrows $50 million for a twenty-year term at a fixed interest rate, and prices increase at a faster-than-expected rate of 3 percent each year. At the end of the twenty years (assuming simple annual compounding), the government must pay $50 million, but with money that’s worth approximately $28 million, a good deal for the government.16 Consider the opposite case, in which prices decline unexpectedly by 3 percent each year. At the end of the twenty years the government must repay the $50 million principal to its creditors with money that now represents about $90 million in purchasing power, which is onerous.17

  Indeed, issuers that borrow heavily benefit from a system of soft money that is prone to money creation and inflation. But the nature of soft money also presents issuers a Faustian bargain. In the second part of Goethe’s Faust, the emperor doesn’t have enough money to pay his creditors and military. The devil convinces the emperor to issue paper money that is backed by gold that will be mined later. Money remains a symbol of value, but its value has become abstracted. Harvard professor Marc Shell articulates the devil’s viewpoint on this shift: “If one could mine the minds of men for credit then one would not need to mine the earth for… gold.” The devil realizes that the move from hard to soft money first occurs in the brain: Psychological change is antecedent to any economic adjustment. The emperor’s advisers side with the devil because “they are interested not in the source of monetary wealth… but only in becoming wealthy.”18 At first the paper money engenders incredible riches. Both the emperor’s creditors and military are paid. Even tailors see a boost in business activity. But eventually this wealth proves to be ephemeral, and it exacerbates the emperor’s spending problems. High inflation stirs social unrest, and the emperor faces opposition.19

  It sounds like a fanciful tale, but Goethe’s story was inspired by real events. He was familiar with events in eighteenth-century France, when soft money was introduced to rescue the ailing economy. It worked for a short period, until it precipitated financial ruin. Over the course of history, and in almost every region of the world, soft money has demonstrated both great promise and peril. It remains to be seen whether Faust foreshadows ominous events in the United States. The Fed expanded the money supply in response to the 2008 financial crisis, which arguably helped to rescue the economy, but uncertainty remains about the long-term consequences of its actions.

  Whether it leads to boom or bust, soft money is a powerful tool. It can enable issuers to pursue political goals through monetary measures. The policy decisions of issuers can also instantly affect other parts of the world through the currency markets. In a monetary system unconstrained by limited amounts of metals, soft money has become virtually limitless—supply at the discretion of the alchemists who make it. Issuers have long known what every child learns: Paper beats rock.

  Dragon Money

  Ts’ai Lun knew he was on to something. He was the head eunuch in Emperor Han Ho Ti’s court during the Han Dynasty in China.20 In AD 105, he informed the emperor of his creation, but he probably didn’t realize how it would forever change money and how governments institute monetary policy. Ts’ai Lun removed bark from a mulberry tree and stripped its fibers, which he then battered into a flat sheet. He created paper—though some historians suggest it may have been invented as early as the second century BC and used to wrap precious bronze items.

  The Chinese r
efined the craft of papermaking over hundreds of years, using fibers from rattan, sandalwood, bamboo, even seaweed. They also are said to have invented ink, and inkmaking was a craft of great repute practiced by artisans, scholars, and statesmen.21 What’s more, the Chinese invented block printing and movable type.22 In place were all the ingredients for making paper money. But until its invention, bronze coins were the prevailing currency throughout.

  In the early seventh century, the Tang Dynasty succeeded the brief Sui Dynasty and became, in the words of the Metropolitan Museum of Art, “one of the greatest empires in the medieval world.”23 The Tang period, which lasted through the ninth century, was characterized by relative stability and cultural ferment. Diplomats from distant lands like Persia visited. Musicians from Central Asia toured China, too. The Tang had actually categorized ten types of music, including foreign genres. It was also an environment for robust commerce and innovation. Merchants searched for better ways to serve customers. Shops stored valuable items for patrons, like a bank that rents out safe-deposit boxes, and issued paper drafts or receipts backed by the items. These drafts functioned like money, since they could be traded.24 Elsewhere, tea merchants wanting to communicate and transmit profits between regions used drafts so they didn’t have to carry heavy bronze coins.25

  Government officials explored ways in which to make tax collection easier since they needed revenues to finance the military to combat Turkic nomads in the west and Koreans in the east. The state also created drafts, or “flying money,” to minimize the need to lug coins long distances between far-flung provinces and the state capital.26 They were convertible into coins and used in transactions between local and state governments, as well as among merchants. The state realized the need to regulate these notes almost right away. In 811, it prohibited private entities from making flying money, and it instituted strict measures to protect its power.27 Listed on some notes was the penalty for counterfeiters who “shall be decapitated summarily in punishment for the crime; the first informant shall be given… silver.”28 The bills were used for specific transactions and didn’t circulate like a general-purpose currency, yet paper was the ultimate convenience.29

  The later Song Dynasty, which reigned from AD 960 to 1279, is often credited as the first to implement a paper-based monetary system. In AD 970, it established the “bureau of credit cash,” which issued money.30 These paper notes flourished partly because of the shortage of coins. It’s estimated that more than 260 billion coins were minted during the reign of the Northern Song Dynasty from 960 to 1127, but that still wasn’t enough to meet the demands of a growing number of merchants and a burgeoning military.31 This “currency famine” was reason enough for the state to consider other options.32 It found one in its western province of Sichuan.

  Coins were made from iron in Sichuan because the province lacked abundant amounts of copper and other metals needed to make bronze coins. It also bordered rival states, and the Northern Song wanted to minimize the flow of valuable bronze money to its enemies.33 Iron coins were left on deposit at banks, and customers were issued receipts that could be used in transactions. At the same time, Sichuan was long known for making paper from hemp, and the imperial court used it to issue decrees.34 It was a small step to issue money via paper, which it did around AD 1000.

  At first the court tolerated a fragmented monetary system, allowing sixteen banks to issue paper money. But in 1023, the state revoked this permission, realizing that some residents couldn’t work out who was issuing which notes. Moreover, the state could wield more power as the sole issuer. It established the “bureau of exchange medium” and assumed full production of paper money.35 Its notes were named jiaozi and later renamed qianyin, which was backed by iron and then silver. At the outset, the state exercised restraint by instituting an annual quota of paper money that could be made. The quota was meant to stabilize the value of the currency, curb government spending, and prevent inflation. But the limit was disregarded. The state lifted the quota 50 percent in 1072, and that was exceeded, too.36 Each additional issuance further demonstrated the provincial government’s considerable monetary power—and its inability to control its excess.

  The Southern Song, which reigned from 1127 to 1279, sought and eventually incorporated this monetary power. But since its northern lands were lost to the Jin through war, at first there was a fragmented monetary system composed of four territories in which different currencies circulated.37 The disunited currency system diminished trade.38 To make matters worse, the Song faced a currency famine because it didn’t possess enough of the metals necessary to make bronze coins.

  The Song employed another metal, silver. Already its price had appreciated considerably versus bronze because the northern regions, more abundant in copper, had been lost. The heightened value of silver also reflected the fact that the Song increasingly used it in administrative affairs: Taxes and military salaries were partly paid in silver. And eventually, silver replaced bronze as the standard store of value.39

  In 1170, the state recognized the huizi, a paper currency that had started to circulate among merchants. It prohibited private entities from issuing the currency, backed it with silver, and made it the legal tender of the land. Huizi eventually spread throughout the provinces, with the exception of Sichuan.40 These notes were redeemable for new notes as a way to maintain the currency’s value, but this practice was abandoned in the early thirteenth century, as the state needed more money to cover expenses. As more huizi was issued, Gresham’s law was reprised: Coins were hoarded as a store of value and ultimately removed from circulation.41

  Huizi was already circulating as a medium of exchange. And increasingly, this paper money was becoming the unit of account. Historian Richard von Glahn points out that prices once listed in the value of coins were marked in terms of huizi.42 As for serving as a store of value, the silver-backed huizi was a claim on a precious metal of intrinsic worth, even though in practice this promise had diminishing credibility as the state issued more notes. It would take longer still for paper money to delink completely from metal. But that time was coming, as the man who would untether paper was preparing for war.

  Despite efforts to maintain huizi’s value, its issuance continued almost unabated, even more so as the Song economy started to decline.43 In the early thirteenth century, the Song’s sustained warfare with the Jin left them weakened. In 1231, a large fire swept across the capital, destroying many buildings, which needed to be rebuilt. The state issued more huizi to cover the cost, and the value of the currency subsequently declined. The value of huizi dropped further when the state replaced its high-quality paper made from mulberry trees in Sichuan with locally available paper of lesser quality. To be sure, the state endeavored to restore the value of its currency. It made vouchers for silver and gold to reduce the huizi in circulation, and even mandated that everyone had to acquire a fixed amount of notes.44 But it couldn’t resist the temptation to print more notes to cover its significant expenses, and the Song’s economy deteriorated. After years of fighting, the Song were vanquished by Kublai Khan and the Mongols, who unified China under the Yuan Dynasty in 1279.

  During the thirteenth century, the Mongol Empire spanned Asia to Eastern Europe, making it one of the largest in history. The empire was a loose confederation of territories that relied on the leadership of local chieftains and required great administrative oversight. The empire had started to fragment in the mid-thirteenth century because of fighting among successors to the throne. One of those heirs, Kublai Khan, sought to maintain the strength of the empire, but the question was how. He was torn between expanding and controlling his sphere of influence via nomadic military expeditions, or serving in the state capital as the chief administrator and overseeing an expansive bureaucracy.45 He quickly learned that paper was mightier than the sword. He used money to unify the empire, promote trade among different regions, create more wealth for his court, and strengthen his grip on power.

  First printed in 1260,
Kublai’s paper money, known as zhongtong chao, was issued in eleven denominations, with no expiration date for when it had to be used, and was backed by silver.46 The selection of silver was on the advice of his financial ministers, who had experience dealing with silver-backed paper in other provinces. Moreover, the Mongols had historically benefited from an extensive tributary system in which silver was remitted from provinces to the capital, and silver was seen as a store of value.

  Kublai’s innovation was his diktat. He declared his currency the only acceptable currency of the land.47 Counterfeiters were put to death, and whistle-blowers who knew of counterfeiters were rewarded. He forced everyone to use his money or else face punishment. The state issued small denominations to eliminate the use of bronze coins entirely. So that chao would be without rival, Kublai banned the use of gold and silver in trade, and seized the metals of foreign merchants who visited his lands.48 These restrictions were later eased as chao reached wide circulation.

  At first, the state administered a careful monetary policy. To promote the notes and reaffirm their credibility, the state occasionally redeemed them in silver. The old notes were destroyed in public so that corrupt officials couldn’t pocket them. The notes spread throughout, unifying the empire under a single currency. They even circulated as far as modern-day Thailand, Myanmar (Burma), and Iran. Historians have suggested that early Western banking institutions were greatly influenced by the Yuan Dynasty’s monetary system.49

  However, from 1280 to 1350, the state endured bouts of inflation. The trouble began with the annexation of the Southern Song territories. The Song’s population of 60 million dwarfed that of Jin, the seat of Kublai’s initial power. Adding so many people generated giant demand for Kublai’s notes, and huizi were converted to chao at a rate of fifty to one. The state issued notes at heightened levels and exhausted its silver supply. With less silver, the state printed more paper, which reduced the credibility of the currency, and its convertibility to metal came into question. Ultimately, the value of the chao declined 90 percent, to an unsustainable level.50 To meet its growing expenses, the state sacrificed the value of its currency.