Money

by Felix Martin

  THIS IS A BORZOI BOOK

  PUBLISHED BY ALFRED A. KNOPF

  Copyright © 2013 by Failu Ltd.

  All rights reserved.

  Published in the United States by Alfred A. Knopf, a division of Random House LLC, New York, and in Canada by Doubleday Canada, a division of Random House of Canada Limited, Toronto, Penguin Random House Companies. Originally published in Great Britain by The Bodley Head, a division of the Random House Group Limited, London, in 2013.

  www.aaknopf.com

  Knopf, Borzoi Books, and the colophon are registered trademarks of Random House LLC.

  Library of Congress Cataloging in Publication Data is available.

  ISBN 978-0-307-96243-0 (hardcover) ISBN 978-0-307-96244-7 (eBook)

  Jacket design by Evan Gaffney

  v3.1

  To Kristina

  Contents

  Cover

  Title Page

  Copyright

  Dedication

  1 What Is Money?

  2 Getting Money’s Measure

  3 The Aegean Invention of Economic Value

  4 The Monetary Maquis

  5 The Birth of the Money Interest

  6 The Natural History of the Vampire Squid

  7 The Great Monetary Settlement

  8 The Economic Consequences of Mr. Locke

  9 Money Through the Looking-Glass

  10 Strategies of the Sceptics

  11 Structural Solutions

  12 Hamlet Without the Prince:

  How Economics Forgot Money …

  13 … and Why It Is a Problem

  14 How to Turn the Locusts into Bees

  15 The Boldest Measures Are the Safest

  16 Taking Money Seriously

  Notes

  Bibliography

  Acknowledgements

  Illustration Credits

  A Note About the Author

  1 What Is Money?

  Everyone, except an economist, knows what “money” means, and even an economist can describe it in the course of a chapter or so …

  —A.H. Quiggin, A Survey of Primitive Money: the Beginnings of Currency, p. 1

  THE ISLAND OF STONE MONEY

  The Pacific island of Yap was, at the beginning of the twentieth century, one of the most remote and inaccessible inhabited places on earth. An idyllic, subtropical paradise, nestled in a tiny archipelago nine degrees north of the equator and more than 300 miles from Palau, its closest neighbour, Yap had remained almost innocent of the world beyond Micronesia right up until the final decades of the nineteenth century. There had, it is true, been a brief moment of Western contact in 1731 when a group of intrepid Catholic missionaries had established a small base on the island. When their supply ship returned the following year, however, it discovered that the balmy, palm-scattered islands of Yap had not proved fertile ground for the Christian gospel. The entire mission had been massacred several months previously by local witch doctors aggrieved at the competition presented by the Good News. Yap was left to its own devices for another one hundred and forty years.

  It was not until 1869 that the first European trading post—run by the German merchant firm of Godeffroy and sons—was established in the Yap archipelago. Once a few years had passed, with Godeffroy not only avoiding summary execution but prospering, Yap’s presence came to the attention of the Spanish, who by virtue of their colonial possessions in the Philippines—a mere 800 miles to the west—considered themselves the natural overlords of this part of Micronesia. The Spanish laid claim to the islands, and believed that they had achieved a fait accompli when in the summer of 1885 they erected a house and installed a Governor in it. They had not counted, however, on the tenacity of Bismarck’s Germany in matters of foreign policy. No island was so small, or so remote, as to be unworthy of the Imperial Foreign Ministry’s attention if it meant a potential addition to German power. The ownership of Yap became the subject of an international dispute. Eventually, the matter was referred—somewhat ironically, given the island’s track record—to arbitration by the Pope, who granted political control to Spain, but full commercial rights to Germany. But the Iron Chancellor had the last laugh. Within a decade and a half, Spain had lost a damaging war with America, and its ambitions in the Pacific had disintegrated. In 1899, Spain sold Yap to Germany for the sum of $3.3 million.

  The absorption of Yap into the German Empire had one great benefit. It brought one of the more interesting and unusual monetary systems in history to the attention of the world. More specifically, it proved the catalyst for a visit by a brilliant and eccentric young American adventurer, William Henry Furness III. The scion of a prominent New England family, Furness had trained as a doctor before converting to anthropology and making his name with a popular account of his travels in Borneo. In 1903 he made a two-month visit to Yap, and published a broad survey of its physical and social make-up a few years later.1 He was immediately impressed by how much more remote and untouched it was than Borneo. Yet despite being a tiny island with only a few thousand inhabitants—“whose whole length and breadth is but a day’s walk,” as Furness described it—Yap turned out to have a remarkably complex society. There was a caste system, with a tribe of slaves, and special clubhouses lived in by fishing and fighting fraternities. There was a rich tradition of dancing and songs, which Furness took particular delight in recording for posterity. There was a vibrant native religion—as the missionaries had previously discovered to their cost—complete with an elaborate genesis myth locating the origins of the Yapese in a giant barnacle attached to some floating driftwood. But undoubtedly the most striking thing that Furness discovered on Yap was its monetary system.

  The economy of Yap, such as it was, could hardly be called developed. The market extended to a bare three products—fish, coconuts, and Yap’s one and only luxury, sea cucumber. There was no other exchangeable commodity to speak of; no agriculture; few arts and crafts; the only domesticated animals were pigs and, since the Germans had arrived, a few cats; and there had been little contact or trade with outsiders. It was as simple and as isolated an economy as one could hope to find. Given these antediluvian conditions, Furness expected to find nothing more advanced than simple barter. Indeed, as he observed, “in a land where food and drink and ready-made clothes grow on trees and may be had for the gathering” it seemed possible that even barter itself would be an unnecessary sophistication.2

  The very opposite turned out to be true. Yap had a highly developed system of money. It was impossible for Furness not to notice it the moment that he set foot on the island, because its coinage was extremely unusual. It consisted of fei—“large, solid, thick stone wheels ranging in diameter from a foot to twelve feet, having in the centre a hole varying in size with the diameter of the stone, wherein a pole may be inserted sufficiently large and strong to bear the weight and facilitate transportation.”3 This stone money was originally quarried on Babelthuap, an island some 300 miles away in Palau, and had mostly been brought to Yap, so it was said, long ago. The value of the coins depended principally on their size, but also on the fineness of the grain and the whiteness of the limestone.

  At first, Furness believed that this bizarre form of currency might have been chosen because, rather than in spite, of its extraordinary unwieldiness: “when it takes four strong men to steal the price of a pig, burglary cannot but prove a somewhat disheartening occupation,” he ventured. “As may be supposed, thefts of fei are almost unknown.”4 But as time went on, he observed that physical transportation of fei from one house to another was in fact rare. Numerous transactions took place—but the debts incurred were typically just offset against each other, with any outstanding balance carried forward in expectation of some future exchange. Even when open balances were felt to require settlement, it was not
usual for fei to be physically exchanged. “The noteworthy feature of this stone currency,” wrote Furness, “is that it is not necessary for its owner to reduce it to possession. After concluding a bargain which involves the price of a fei too large to be conveniently moved, its new owner is quite content to accept the bare acknowledgement of ownership and without so much as a mark to indicate the exchange, the coin remains undisturbed on the former owner’s premises.”5

  The stone currency of Yap as photographed by William Henry Furness III in 1903, with people and palm trees for scale.

  (illustration credit 1.1)

  When Furness expressed amazement at this aspect of the Yap monetary system, his guide told him an even more surprising story:

  [T]here was in the village near by a family whose wealth was unquestioned—acknowledged by everyone—and yet no one, not even the family itself, had ever laid eye or hand on this wealth; it consisted of an enormous fei, whereof the size is known only by tradition; for the past two or three generations it had been and was at that time lying at the bottom of the sea!6

  This fei, it transpired, had been shipwrecked during a storm while in transit from Babelthuap many years ago. Nevertheless:

  [I]t was universally conceded … that the mere accident of its loss overboard was too trifling to mention, and that a few hundred feet of water off shore ought not to affect its marketable value … The purchasing power of that stone remains, therefore, as valid as if it were leaning visibly against the side of the owner’s house, and represents wealth as potentially as the hoarded inactive gold of a miser in the Middle Ages, or as our silver dollars stacked in the Treasury in Washington, which we never see or touch, but trade with on the strength of a printed certificate that they are there.7

  When it was published in 1910, it seemed unlikely that Furness’ eccentric travelogue would ever reach the notice of the economics profession. But eventually a copy happened to find its way to the editors of the Royal Economic Society’s Economic Journal, who assigned the book to a young Cambridge economist, recently seconded to the British Treasury on war duty: a certain John Maynard Keynes. The man who over the next twenty years was to revolutionise the world’s understanding of money and finance was astonished. Furness’ book, he wrote, “has brought us into contact with a people whose ideas on currency are probably more truly philosophical than those of any other country. Modern practice in regard to gold reserves has a good deal to learn from the more logical practices of the island of Yap.”8 Why it was that the greatest economist of the twentieth century believed the monetary system of Yap to hold such important and universal lessons is the subject of this book.

  GREAT MINDS THINK ALIKE

  What is money, and where does it come from?

  A few years ago, over a drink, I posed these two questions to an old friend—a successful entrepreneur with a prospering business in the financial services industry. He responded with a familiar story. In primitive times, there was no money—just barter. When people needed something that they didn’t produce themselves, they had to find someone who had it and was willing to swap it for whatever they did produce. Of course, the problem with this system of barter exchange is that it was very inefficient. You had to find another person who had exactly what you wanted, and who in turn wanted exactly what you had got—and what is more, both at exactly the same time. So at a certain point, the idea emerged of choosing one thing to serve as a “medium of exchange.” This thing could in principle be anything—so long as, by general agreement, it was universally acceptable as payment. In practice, however, gold and silver have always been the most common choices, because they are durable, malleable, portable, and rare. In any case, whatever it was, this thing was from then on desirable not only for its own sake, but because it could be used to buy other things and to store up wealth for the future. This thing, in short, was money—and this is where money came from.

  It’s a simple and powerful story. And as I explained to my friend, it is a theory of money’s nature and origins with a very ancient and distinguished pedigree. A version of it can be found in Aristotle’s Politics, the earliest treatment of the subject in the entire Western canon.9 It is the theory developed by John Locke, the father of classical political Liberalism, in his Second Treatise of Government.10 To cap it all, it is the very theory—almost to the letter—advocated by none other than Adam Smith in his chapter “Of the Origin and Use of Money” in the foundation text of modern economics, An Inquiry into the Nature and Causes of the Wealth of Nations:

  But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations … The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for … In order to avoid such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few other people would be likely to refuse in exchange for the produce of their industry.11

  Smith even shared my friend’s agnosticism as to which commodity would be chosen to serve as money:

  Many different commodities, it is probable, were successively both thought of and employed for this purpose. In the rude ages of society, cattle are said to have been the most common instrument of commerce … Salt is said to be the common instrument of commerce and exchange in Abyssinia; a species of shells in some parts of the coast of India; dried cod in Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is to this day a village in Scotland where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the alehouse.12

  And like my friend, Smith also believed that in general, gold, silver, and other metals were the most logical choices:

  In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion of those parts can easily be re-united again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation.13

  So I told my friend he could congratulate himself. Without having studied economics at all, he had arrived at the same theory as the great Adam Smith. But that’s not all, I explained. This theory of money’s origins and nature is not just a historical curiosity like Ptolemy’s geocentric astronomy—a set of obsolete hypotheses long since superseded by more modern theories. On the contrary, it is found today in virtually all mainstream textbooks of economics.14 What’s more, its fundamental ideas have formed the bedrock of an immense body of detailed theoretical and empirical research on monetary questions over the last sixty years. Based on its assumptions, economists have designed sophisticated mathematical models to explore exactly why one commodity is chosen as money over all others and how much of it people will want to hold, and have constructed a vast analytical apparatus designed to explain every aspect of money’s value and use. It has provided the basis for the branch of economics—“macroeconomics” as it is known—which seeks to explain economic booms and busts, and to recommend how we can moderate these so-called business cycles by managing interest rates and government spending. In short, my friend’s ideas not only had history behind them. They remain today, amongst amateurs and experts alike, very m
uch the conventional theory of money.

  By now, my friend was positively brimming with self-congratulation. “I know that I’m brilliant,” he said with his usual modesty, “but it does still amaze me that I—a rank amateur—can match the greatest minds in the economic canon without ever having given it a second thought before today. Doesn’t it make you think you might have been wasting your time all those years you were studying for your degrees?” I agreed that there was certainly something a bit troubling about it all. But not because he had hit upon the theory without any training in economics. It was quite the opposite. It was that those of us who have had years of training regurgitate this theory. Because simple and intuitive though it may be, there is a drawback to the conventional theory of money. It is entirely false.

  STONE AGE ECONOMICS?

  John Maynard Keynes was right about Yap. William Henry Furness’ description of its curious stone currency may at first appear to be nothing more than a picturesque footnote to the history of money. But it poses some awkward questions of the conventional theory of money. Take, for example, the idea that money emerged out of barter. When Aristotle, Locke, and Smith were making this claim, they were doing so purely on the basis of deductive logic. None of them had ever actually seen an economy that operated entirely via barter exchange. But it seemed plausible that such an arrangement might once have existed; and if it had existed, then it also seemed plausible that it would have been so unsatisfactory that someone would have tried to invent a way to improve on it. In this context, the monetary system of Yap came as something of a surprise. Here was an economy so simple that it should theoretically have been operating by barter. Yet it was not: it had a fully developed system of money and currency. Perhaps Yap was an exception to the rule. But if an economy this rudimentary already had money, then where and when would a barter economy be found?