2.Money and Technology in Ancient Times

 Money and Technology in Ancient Times

Et maioures et posteros vestros cogitate.

__ Cornelius Tacitus

Ask two economists a question, and you will get three different answers - so a popular joke goes. This is an exaggeration, but with a grain of truth: Economists often disagree with one another, perhaps because their theories are so difficult to prove or disprove. When they agree, it may happen that their proposition is disproved by other scientists. This happened to a theory that interests us here: that of the origin of money.

Adam Smith, the father of classical economics, in his 1776 magnum opus An Inquiry on the Nature and the Causes of the Wealth of Nations, argued that money arises spontaneously from labor specialization. In primitive societies - so his story goes - each person procured the necessary for the self and the family and no exchange took place. Procurement and consumption remained confined within the same person or small community. As soon as hunter-gatherers settled down and became farmers and ranchers, which happened some 10,000 years ago, they realized that labor was more productive if each person specialized. With specialization, more can be produced, but exchange must take place; a producer of a certain good has too much of it, hence they must trade with those who have less of it than desired. Here is where money enters the picture. It is very difficult for a baker (this is the example Smith makes), who has a lot of bread—a perishable good—and no meat—another perishable good—to find at that exact moment a butcher who desires that amount of bread and has that amount of extra meat to give away. According to Smith, barter exchange is 'clogged and embarrassed' 2. A well-balanced diet becomes unlikely. The problem is overcome with an intermediate means of exchange—call it money—recognized and accepted by both. The baker can sell bread to anybody and use the monetary proceeds to buy meat, at the same or at a later time. The requirement of simultaneous desire—the double coincidence of wants, as economists call it—is eliminated; the acts of selling and buying are delinked. A more efficient 'monetary' economy is born.

This reasoning suggests a time sequence: Separation of labor gave rise to barter first; this gave rise to the invention of money and to an economy based on monetary exchange.

This story is logical and prima facie convincing. It also fits nicely into Smith's philosophical mind frame, in which human actions are driven by individual incentives. People specialize because by doing so they produce more; then they "invent" money to better exploit the value of that added production. The whole process is market-driven; money arises spontaneously from private tastes, decisions, and actions. No social coercion, no consensus gathering, and no government action or ruling are needed.

The problem with this theory is that no evidence was found to support it. Anthropologists gauge ancient peoples' customs from archaeological sites, and by studying modern primitive communities, under the admittedly dubious assumption that they behave like the ancient ones. From neither of these sources has anthropological research found any trace of barter leading to monetary exchange. Evidence of the contrary was actually found: Barter typically arises among people already accustomed to money, for example, if for whatever reason money becomes scarce or unusable. We will see an example later in this chapter. In primitive societies, barter and money may complement each other, for example, when trades of goods of unequal value need balancing. Some small communities rely on kinship to transfer goods without immediate compensation; “gifts” are offset at a later date, supported by bonds of trust in a sort of informal credit system. All these practices are interesting and tell something about how money can usefully serve basic human needs. And there is evidence of each of them. But none of them remotely resembles barter as intended by Smith.

By contrast, history offers repeated examples of a close link between the "forms of money" — the physical support that embodies the monetary concept — and the technology prevailing at any given time. Across the ages, money adopted the most advanced techniques available at each given time with the purpose of ensuring the fulfilment of certain desirable characteristics. Technology evolves over time, usually improving; so does money.

We will return to those characteristics in Chapter 4. Suffice here to say that a well-functioning monetary instrument must satisfy four broad requirements: be commonly familiar and accepted by all — which implies it should be hard to falsify; be transferable across space — meaning, easy and 

Safe to handle and to carry; be efficiently transferable over time — meaning not perishable in quality and value; and be easily divided into subunits — so as to serve as a convenient unit to exchange goods of different value. In catchwords, and not necessarily in order of importance, money should be: generally recognizable, movable across space, movable over time, and divisible.

In its essence, the history of money — a branch of history for which a large literature exists — tells the ways in which these requirements were gradually fulfilled across the epochs, by means of technology and institutions. A long process, unfinished to this day, featuring advancements and setbacks, breakthroughs and mistakes, discoveries and occasional mischiefs. Most of the time, users of money faced trade-offs among the different requirements: Instruments convenient for measuring, such as the barley or cocoa beads used by ancient civilizations, were too perishable and were abandoned; more resilient ones, like gold ingots or silver coins, could not be easily transported in large quantities and also featured security problems, hence were also superseded. In the end, technology mitigated the trade-offs and allowed progress in all dimensions. A regular intruder in this process was the state, with its temptation to exploit its monopoly over the currency as a firm of taxation: the so-called seigniorage.

We will now tell the story of the three main technological milestones of monetary history prior to the modern age. This will bring us from the dawn of human civilization until the end of the nineteenth century – a period during which money took mainly three forms: clay, coined metal, and paper. The remaining and more modern part of the story, from the twentieth century onward, is the subject of the rest of this book.

Our journey starts five millennia yeras ago, in the so-called land between two rivers: Mesopotamia.

Clay

Ashurbanipal, King of the Universe (how he liked to be called), king of Assyria, conqueror of Egypt, reigned between 668 BC and 631 BC. A skillful ruler and military commander, he was also, or perhaps mainly in his heart, a collector of books. More precisely: the greatest collector of books in ancient history. We owe him much of what we know about ancient Mesopotamia today. And, in particular, that we understand the remarkable role that the "land between two rivers" played in the history of money.

By "books" we do not mean stacks of paper bound on one side and opened on the other that we intend today. We mean tablets made of dried clay. Mesopotamia was, and still is now that it is called Iraq, the ideal place on earth to manufacture those kinds of tablets: rich in good clay from the banks of the rivers, fresh flowing water to mold the tablets, and a powerful sun to dry them up. Using those resources and developing unprecedented skills in the necessary technique, the Mesopotamians became the greatest masters in the craft of manufacturing clay tablets history remembers. Many important things followed. For one, the invention of modern writing: cuneiform, the intermediate step between ancient ideograms and modern alphabets. Being skillful writers, with lots of good tablets on hand, the Mesopotamians developed the habit of recording virtually everything that mattered in everyday life: from literature to inventory catalogues, from customs to price lists, letters and memo pads, legal contracts, and financial statements.

An intellectual before being a king, Ashurbanipal wanted to establish the greatest library of his time. For this purpose, he collected all tablets he could find in his own kingdom or loot in the territories he conquered.

Remains of that library survive in the ancient city of Nineveh, today Mosul, after resisting the corrosion of time and more recently the barbarism of the Islamic State. Those remains witness the intention of the farsighted ruler to pass on knowledge to future generations, besides preserving his own name.

His intention would not have been borne out, however, if not for an unforeseen event he would have considered a misfortune had he been able to predict it.

Shortly after his death, the city of Nineveh was conquered, and the library destroyed by fire. We don't know how many documents made of combustible materials perished; what we do know is that the clay tablets were "cooked" by fire, hence vitrified and made fit for eternity. Discovered by British archaeologists in the mid nineteenth century, Ashurbanipal's library is now kept largely in the British Museum, the object of active research between British and Iraqi scholars.

With countless others found elsewhere in the region, those tablets offer a detailed picture of the financial arrangements in use in the Sumerian-Babylonian-Assyrian civilization starting from around 3000 BC — a picture that is as fascinating as it is startling because of the many similarities it shares with modern financial and banking practices.

The fundamental monetary value for the Mesopotamians rested on two goods: barley and silver. They had, therefore, like others in later history, a two-commodity monetary standard. In contrast with later experiences with Multiple standards, however, it is hard to imagine two more radically different monetary means coexisting. Barley can be finely divided and amassed, therefore providing an excellent metric. But it is highly perishable, hence difficult to maintain through time. Silver ingots, by contrast, are not affected by time but are cumbersome to carry and difficult to divide into subunits. Perhaps complementarity was precisely the reason why the ancient Iraqis used barley and silver together.

The two forms of money were stored in temples and supervised by priests. Priests scrupulously recorded deposits and withdrawals, took care of good and orderly storage, administered the records of depositors and borrowers (the two types of money were also lent out), controlled the authenticity of the material, and certified it by means of specific seals. They were, in all effects, "bankers" responsible for the good administration of the monetary values entrusted to them. Gradually, the profession moved outside the temples, and families of bankers started to perform a similar role.

All contracts, transactions, arrangements, certificates of authenticity, deposit or loan operations, and so on related to barley and silver were recorded on clay tablets. Some of them displayed seals certifying the quality of the underlying values under the authority of the issuer - priests or others.

Some historians believe that tablets could also function as "bearer securities," representing the underlying asset, and could change hand - much like today’s transferable bank checks. The exact extent to which monetary circulation took place through movements of the underlying values, as opposed to simpler transfers of tablets, is unknown. One can conjecture that the ease with which Mesopotamians manufactured and handling of tablets and the complexity and risk of moving barley and silver outside the safety of the temple provided a powerful incentive to execute a good part of monetary transactions by a simple transfer of tablets.

We are witnessing here a skeleton banking system, with bankers (priests or specialized families) receiving deposits and lending out, guarding the real value (commodity in the form of barley and silver, sort of bank reserves), and ensuring that all transactions were always legitimate and based on the underlying value.

Depositors (usually merchants) would use clay tablets to record contracts and exchange, according to the needs of their business. A major difference with today’s banking operations, of course, was the absence of credit multiplication: Priests operated effectively on a 100 percent reserve constraint. Other differences seem largely cosmetic.

This system was good enough to survive for millennia. In the end, however, the Mesopotamians' highly sophisticated practices based on clay were not bound to last: technological advances led to their demise. The ashes of Ashurbanipal's library were barely cold when another monetary revolution was in the making, about a thousand miles west of Nineveh near the coast of the Aegean Sea.

Gold (and Other Precious Metals)

Croesus, king of Lydia (a region corresponding to the western part of today's Turkey) around the middle of the sixth century BC, was no modest man: Credited with the biggest wealth of his era, his name is still the archetype of extreme richness. Part of his wealth derived from the usual channel of sovereigns: taxes; the rest, from a gold-soaked river where, according to the legend, his mythical predecessor King Midas (the one with the "golden touch") used to swim.

The kingdom of Lydia was very advanced economically, commercially, and technologically. Its metal processing specialists were the first to discover a technique to separate base metal from precious metal, thereby obtaining pure gold. Gold nuggets contained a percentage of silver, giving rise to a league called electrum. Ingots or coins made of electrum could not be trusted because the gold content was uncertain. After the discovery of that technique, those minted in Sardis (Lydia's capital) became the first authentic and guaranteed gold coins in history. Oval ingots of pure gold started being minted, with a stamped profile of a lion, which was a trusted guarantee of quality. This stamp is, incidentally, the reason why coins still have a flat shape today.

Like Ashurbanipal, Croesus was the last king of his dynasty: Defeated by the Persians, he lost his kingdom and his life. His conqueror, King Cyrus of Persia, wasted no time in adopting the Lydian minting technique. The era of coinage was in full swing. It hasn’t ended yet.

The advent of coinage on the eastern shores of the Mediterranean in the sixth century BC is arguably the most important event in monetary history to date. Mankind would have to wait for well over 1,000 years before seeing another comparable technological advancement: paper money. Coins still circulate today and show no sign of being abandoned. They, therefore, represent the oldest still used monetary instrument.

Coins represented a major leap forward for several reasons. First, minting allowed standardization. Standardization made coins superior to beads and other natural commodity monies, each piece of which is different. Moreover, minting technology was not widely available, hence limiting forgery. Coins also outperformed barley and any other form of commodity money in terms of resilience and duration, thus making them better stores of value. They could be transported easily, at least in small quantities.

Coins also arose at the other end of the Eurasian landmass. But the Chinese followed a different path. At first, they replicated the form of cowry shells in copper. Sometimes they also gave copper ingots the form of knives, but these irregular forms were not practical and were soon abandoned. Starting from the second century BC the first unified dynasty standardized the currency, issuing copper coins with one practical innovation: a hole in the middle to make them easy to transport and count, if held on a string. This illustrates the importance of standardization and divisibility, a property that other forms (like metal cowry shells) did not have. Round copper coins with a square hole in the middle remained the basis of Chinese money for the next 2,000 years. This resistance of the Chinese monetary system to change over two millennia is a mystery.

A first distinctive aspect of Chinese coinage was the technology used: Western coins were minted (i.e., the piece of metal was hammered on a die), whereas Chinese coins were cast (the liquid metal was poured into a mold).

Casting has the advantage that it is possible to make a hole in the middle. This would be very difficult to achieve in minting (no European coins had a hole until modern times).

The disadvantage of casting is that finer details are often lost. This facilitates the work of forgers who can just produce a mold from a legitimate coin.

Nevertheless, the Chinese continued to use almost exclusively casting instead of minting, which was known and used in surrounding countries.

The second distinctive aspect of the Chinese monetary system was the continued reliance on copper or bronze coins only. Although it was clearly inconvenient to use kilos of copper coins to make major purchases, the Chinese did not adopt silver coins until modern times. Silver was known in China and considerable quantities were imported but was used only in the form of ingots for major transactions, never coined or minted on a large scale.

Despite these disadvantages, the Chinese never changed their system while Europe continued to experiment with gold and silver coins, leaving copper ones to small denominations.

The little round pieces of gold of the Lydian king were recognizable after being stamped with the lion's head. Their value was inherent, embodied in the coin itself, controllable "by sight" and therefore widely trusted. The king accepted them for taxes and other payments. The stamp of the king provided an authoritative certification of their value.

But precisely here lay a snag.

The technology to determine the exact content of a metal alloy was in the sovereign's hands. Sovereigns could mint honest coins, of value equal to the declared one, but didn’t have to. They soon learned that by not doing so, they could extract value from their citizen using coin production - a covert channel of wealth appropriation that the Sumerian system, where real value remained safely stored, did not allow. Sovereigns are among the most cash-hungry individuals in history, especially in times of war. Coinage, therefore, delivered to the sovereign a very effective new means of taxation: debasing the currency. The era of "seigniorage" had started.

The Greeks wasted no time in learning the trick. Politically fragmented in city-states constantly at war with one another and outside enemies, Greek rulers were often in acute need of money. When overt taxation did not suffice, coinage was available. The best-known case, unveiled in 405 BC by the playwright Aristophanes in the premiere representation of one of his comedies, happened in Athens. Short of specie during the Peloponnesian War, the Athenian leaders introduced bronze tokens to temporarily remedy the scarcity of more valuable coins. Whether the move was transparently communicated to the people or not is still debated by historians, but the reputational damage for Athens, the political and cultural leader of that time, was unquestionable. The scandal was compounded by the fact of being exposed, with irony, by the city's most popular comic author. As a result, the bronze tokens were quickly withdrawn and replaced by coins with proper silver content.

The debasement of coins in ancient Greece remains on record mainly because of that colorful episode, which also showed the limited scope Greek city-states had in manipulating the quality of their coins. They were likely to be discovered, and citizens could easily adopt coins of neighboring and maybe rival cities. Currency competition helped maintain the quality of coins stable. Especially after its failed attempt with copper coins, Athens made sure its coins would set the standard for others. Anybody could bring its silver to the mint in the city and, for a small fee, have it minted into Drachmas. This meant that the Athenian rulers could not debase their silver coins, which became the standard throughout the entire Greek world.

But while the Greeks were enjoying Aristophanes' plays, another power arose gradually further west, on the shores of the Italian peninsula. Rome over time conquered most of the known ancient world. Its history provides an example of both unparalleled monetary stability and equally unparalleled monetary debasement six centuries later. Historians disagree on whether monetary debasement was the consequence of, the cause of, or just a sideshow in the decline and eventual demise of the Roman empire. What is certain is that the phenomenon was unprecedented. Even today, economic historians refer to the Roman monetary debasement of the third century AD when they want to prove or disprove theories regarding the consequences of bad monetary management for inflation, economic prosperity, and the broader political fortunes or ills of civilizations.

Rome rose as an agricultural republic in which independent farmers had little need of money, using mainly coins from the Greek city-states in southern Italy. However, this changed as the republic grew in power and extension. The first major Roman coin, the denarius, was created in republican times, in 211 BC just when Rome was winning the war against its major Mediterranean rival: Carthage. This coin would last five centuries and pass on its name to many descendants until our times. The denarius was divided into ten parts (hence the word denarius) and was initially almost pure in its silver content. The Romans mastered the minting techniques and could perfectly measure the purity of metal, having learned that from the Greeks.

As in other areas, the Romans did not innovate the technology. They only exploited it like no others.

The main contribution of the Romans to monetary history was organizational. A gold coin is of little use in everyday life. It can be used to pay taxes (or bribes, the difference was not always clear in ancient times), but not to buy a loaf of bread on the market. The Chinese copper coins worked much better for this purpose. An entire system of coins with a wide range of different values is thus needed to fully exploit the advantages of coinage.

Modern cash spans a range of 10,000 to 1, going from a 100-dollar or 200-euro banknote to a single cent (euro or dollar). Such a range is difficult to achieve with coins made of one metal. The largest coin would have to weigh 10,000 times more than the smallest. The combination of banknotes makes this vast range possible. The Romans achieved something similar more than 2,000 years ago by using a single scale based on three different metals: gold, silver, and copper. Such a system is now usually called bi-metallic because the role of copper as "small change" is disregarded in the classification of monetary systems.

The first emperor, Augustus, overhauled the silver-based system inherited from the republic. The imperial monetary system was based on four coins: The gold aureus was equal to 25 silver denarii or 100 silver sestertii or 400 copper as. The range was 400:1. The weights (aureus 8.09 grams of gold, denarius 3.9 grams of silver, and as about 10 grams of copper) were roughly similar to modern coins. Roman literature reveals that the sestertius was by far the most common unit, followed by the denarius and then the aureus. Their real values can be grasped if one considers that one month's pay of a low-ranked legionary in the early empire was equivalent to one aureus, or 25 silver denarii, weighing about 100 grams still manageable. One would need two to three kilograms of the brass sestertius. Paying in as would require four kilograms of coins - clearly inconvenient. Ordinary Romans, including most legionaries, would rarely see an aureus in their life, but that unit was useful for measuring tributes from Rome's provinces or paying for a shipload of Greek wine.

The advantage of this system was that it provided coherent metric to accommodate a large range of small and large transactions - much better than the multitude of small Greek silver coins or the copper-only Chinese system. Using three different metals was crucial to having a wide range of values. In ancient times gold was worth about twelve times its weight in silver and silver was worth about forty times its weight in copper. About 480 units of copper would be needed for the same quantity of gold.

For a simple salary earner, the denarius was as valuable as the US dollar around 1900. At that time the average wage for an unskilled worker in the United States was about 1 dollar a day, compared to a daily salary of around one denarius in imperial Rome. The quarter dollar is now the largest denomination US coin and plays a minor role in daily life. But back in the 1900s, the quarter constituted a significant value, about as important as a sestertius for an average Roman.

A second distinguishing feature of the Roman monetary system was its stability for centuries, followed by accelerating decline. The eventual decline naturally attracts more attention than the long period of stability that preceded it. But while many monies in history have come and gone, few have survived and stayed as stable and long as the denarius. Its silver content was still essentially unchanged 200 years after its first introduction, when the republic morphed into an empire in 23 BC. The mint, located in the noblest site of the Eternal City, the top of the Capitol, was dedicated to the goddess Juno Moneta whence comes the name "money." The heydays of the denarius would last another two centuries. Early signs of danger came already in Augustus' family, when his great-grandson Nero, who reigned between AD 54 and AD 68, chopped off 5 percent of its value. That was a one-off event, nothing compared to what would follow later.

We do not have statistics on prices from ancient Rome. The one reliable indicator of inflation is the pay increase of legionaries, which was carefully recorded and whose evolution indicates the progression of the currency's debasement. The records indicate that around AD 200, under emperor Septimus Severus, the pay of soldiers had about doubled compared to the reign of Augustus. A doubling of the price level may seem like a lot, but in fact this corresponds to an annual inflation of about 0.5 percent Today we regard a 2 percent inflation as "price stability." But price increases at 2 percent per annum, which would cumulate in 200 years to an increase of the price level of about fifty times. The denarius was thus extraordinarily stable by today's standards.

The currency debasement that started in the third century originated in the economic structure of the empire. Rome (the city) produced virtually nothing: It received everything from the territories it conquered. Formidable as engineers, administrators, and warriors, but not equally good as

producers, the Romans increasingly faced a conundrum as their dominance expanded beyond the Italian peninsula. Their conquests procured the resources necessary to support their large territory and to satisfy the sophisticated desires of wealthy Romans for imported luxury goods. But those conquests required an ever-increasing army, initially to expand and later to defend the ever-growing borders of the empire. At some stage, military costs became overwhelming; looting and taxing were no longer

enough. Recourse to seigniorage, greatly facilitated by the enormous diffusion of the denarius within the empire and beyond, became necessary.

The process accelerated at the beginning of the third century AD under the Severians, a dynasty of emperors of military origin. One of them, Caracalla, familiar today mainly because of the monumental thermal baths whose ruins still impress tourists in the center of Rome, is reported to have said: "Nobody in the world should possess money but me, so that I can give it to my soldiers." No clearest statement was ever made by any ruler of his intention to exploit his own citizens by means of money. For that purpose, he introduced a different technique, or rather a smarter trick: rather than melting coins and reminting them with lower content, simply restamping them with a higher number. Easier and quicker.

The debasement of the denarius continued relentlessly throughout the third century; in a period of intense crisis, during which the average tenure of emperors was less than three years, the empire morphed into a military dictatorship and the borders of the empire became increasingly permeable and insecure. Under Diocletian (AD 284-305), the denarius had virtually lost all its value; it was replaced and continued to be minted only for ceremonial purposes. Gradually, the economy based on money exchanges ceased to function, alongside the loss of trust in the authenticity of the means. At the end of the Western Roman Empire (AD 476), the process was complete. The mint on the Capitol Hill ceased to function and was transferred to Constantinople, the new capital of the East founded on the Bosphorus.

From that time, and thereafter for centuries, the economy of Western Europe shrank, clustering around castles inhabited by the nobility surrounded by cultivated land. Most of the population engaged in subsistence agriculture, which did not necessitate much market exchange. Not many records of trade during that epoch survive. Money was known as a concept but was used little. No undisputed central authority was available to guarantee its value. For example, the duties of the serfs were determined by days of labor or wheat to be delivered, and the mill received a percentage of the grain to be transformed into flour. With the splintering of the Roman administration into small kinglets or fiefdoms of various and shifting shapes, there was no common institution to issue trustable monetary means.

For the few trades that took place in an impoverished economy, people made increasing recourse to exchanges in kind: The monetary economy morphed, to a large extent, into a barter economy. This practice is believed to have survived for long, during the era we now call the Middle Ages. 

Paper 

"Civilization was just emerging from that dark period, socially, economically, and politically, when the Venetian Marco Polo undertook his travels in the Far East. Rich merchant in a rich city, explorer and writer, Marco Polo reached China through the Silk Road and visited it extensively between 1271 and 1295. After returning, he joined the war Venice was waging against Genoa, was captured, and spent years in a Genoese prison. There he dictated his memoirs, known as Travels of Marco Polo, or Il Milione.

A passage of that book is worth reproducing here:

In this city of Kanbalu is the mint of the Grand Khan, who may truly be said to possess the secret of the alchemists, as he has the art of producing money by the following process. He causes the bark to be stripped from those mulberry-trees the leaves of which are used for feeding silk-worms, and takes from it that thin inner rind which lies between the coarser bark and the wood of the tree. This being steeped, and afterwards pounded in a mortar, until reduced to a pulp, is made

into paper, resembling (in substance) that which is manufactured from cotton, but quite black.

When ready for use, he has it cut into pieces of money of different sizes, nearly square, but somewhat longer than they are wide. Of these, the smallest pass for a denier tournois; the next size for a Venetian silver groat; others for two, five, and ten groats; others for one, two, three, and as far as ten besants of gold. The coinage of this paper money is authenticated with as much form and ceremony as if it were actually of pure gold or silver; for to each note a number of officers, specially appointed, not only subscribe their names, but affix their signets also; and when this has been regularly done by the whole of them, the principal officer, deputed by his majesty, having dipped into vermilion the royal seal committed to his custody, stamps with it the piece of paper, so that the form of the seal tinged with the vermilion remains impressed upon it, by which it receives full authenticity as current money, and the act of counterfeiting it is punished as a capital offence.

When thus coined in large quantities, this paper currency is circulated in every part of the Grand Khan's dominions; nor dares any person, at the peril of his life, refuse to accept it in payment. All his subjects receive it without hesitation, because, wherever their business may call them, they can dispose of it again in the purchase of merchandise they may have occasion for; such as pearls, jewels, gold, or silver. With it, in short, every article may be procured. 

All key aspects of modern banknote production and circulation, down to most minute details, are present in this passage. The production of paper, starting from wood transformed into wood pulp and eventually to the production of paper sheets. The cut into different sizes and shapes, according to the denominations of the banknotes. The print by means of colorful ink. The precautions adopted to authenticate the banknotes and limit counterfeiting, which was punished with a capital penalty. Finally, the enforcement of the value of money by law, resulting in its acceptance by everybody for all purposes.

The paper money of the Yuan (Mongol) dynasty constitutes the first fiat money in history. Some forms of paper money existed under earlier dynasties, but in a limited form and mostly as private depositary receipts, called flying money. The Yuan emperors decreed its value and ensured acceptance by means of the capital threat - not, as later in Europe, by promising redemption in precious metal.

Paper money did not survive very long in China, however. It was only as strong as the state that issued it. A useful invention, its weakness was in its top-down nature, based on command. When the top weakened, the entire system stopped working. Even a death threat may not be enough for people to surrender real for face value if they believe the paper is worthless. Paper money disappeared in China around the fifteenth century, just when it appeared in Europe in a different form.

Scholars debate why China's monetary sector developed in this way, under the aegis of the state rather than giving rise to a banking system, as happened in Europe. The experience of Europe, to which we now turn, provides a hint: It might be that in China private financial institutions could not find enough space to rise and develop as independent centers of operation and power, due to the overwhelming influence of the state.

At the end of the Middle Ages, conventionally dated by historians around the fall of Constantinople to the Ottomans in 1453 and the discovery of America in 1497, Europeans had not yet realized the potential synergies that existed between paper, which was well known, and the production and usage of money. Paper had been produced in Europe for centuries, but instead of using the bark of a tree, Europe had imported from the Arabs the technique of using rags as the raw material. With Marco Polo the idea that sheets of paper could acquire monetary value became known but was not exploited immediately as such. More fragmented politically than China, hence free from the dominance of a unified state, the European continent featured powerful private financial clusters around banking families, in Germany, Italy, and elsewhere. The monetization of paper thus started in a very different way.

Over the course of the late Middle Ages commerce started to revive. But longer-range trade was hindered by a fragmented monetary system with hundreds of coins and a shortage of good quality high value coins. This led, bottom-up, to the emergence of promissory notes and bills of exchange issued by merchants and negotiated by resourceful bankers. Promissory notes entitle the bearer to receive valuables at given locations from given persons or institutions—a bit like the Sumerian tablets—and they could comfortably change hands. The value of bills of exchange depended of course on the notoriety of the issuer as somebody who would reliably honor promissory notes. But not every merchant could know the solvency of every potential trading partner in a distant city. There was thus a need for a small number of well-known institutions (in fact mostly families) that could provide intermediate services. The usage of paper in the form of promissory notes proved to be complementary to the rise of banking in Europe. 

Originating in Italy in the late Middle Ages, banks were expanding their activity in Italy (Venice, Genoa, Florence), and northern Europe (Holland, Germany, Spain) while Marco Polo was writing his memoirs. The ancestors of modern credit institutions centered around rich families, like the Bardi and the Medici in Florence, or later the Fugger and Beremberg in Germany, leveraging on their established wealth to finance a variety of private and sovereign enterprises. Banking in the Renaissance was remarkably cross-border: The Florentine families, for example, played key roles in financing such important endeavors as the British crown's participation in the Hundred Years War, the ships which brought Columbus to America (which sailed from Spain), and in Italy the works of artists such as Leonardo da Vinci, Michelangelo, and Raffaello Banks did not issue sight deposits redeemable at par as they do today. They rather operated with a number of contracts written on paper. In some cases, those instruments closely resembled modern instruments currently classified as 'money,' or close substitutes of them. A key difference was that every 'deposit' was, unlike today, an individual contract. This made it impossible to transform these deposits into widely circulating money.

There is evidence that banks in some jurisdictions accepted written pay orders on their accounts. These differed from modern checks, however, in that they were issued not by banks but by individuals, hence less easily recognizable and more prone to fraud. This practice was not universal, due to the inherent risks, but gradually spread. The use of promissory notes was common during trade fairs, as were bills of exchange guaranteed by a bank, which the bearer could discount. Settlement, with possible netting, would take place usually at the end of the fair. Over time, these paper instruments became exchangeable, subject to specific provisions, and circulated in representation of the underlying debt obligation. 17 There was a major difference relative to the tablets of ancient Mesopotamia: Renaissance Banks would keep only part of the deposited specie in their vaults and lend out the rest. This gave rise to fractional banking, the multiplication of credit, and the expansion of "bank money" (deposits recorded in the banks' ledgers) alongside “base money" (specie in the vaults of the banks).

It should be emphasized that these activities were all private; the state was not involved as a direct actor. The state was never too far away, though.

For starters, some of the banking families either coincided with the government (as was the case for the Medici in the city of Florence) or had close ties with the government. Moreover, the state would normally intervene with laws to ensure the correct conduct of business. For example, contracts regarded as too risky could be banned in more conservative jurisdictions, while being allowed elsewhere. That was, for example, the case of checks, which were outlawed in Venice until after the sixteenth century.

It was only with the rise of central banks that the relationship between paper and money, until then one of cohabitation, albeit a very stable one, became an official marriage. A new industry was born: that of banknote production, soon to become the core business of central banks. The relevant technology that allowed or at least greatly facilitated this transition was the printing press using standardized moveable type. Invented once again - in China, this revolutionary technology was first applied in Europe around the middle of the fifteenth century by a resourceful goldsmith in the German city of Mainz: Johannes Gutenberg. His first output was, predictably, the Bible. But once introduced, the new technique could easily be extended to a more material realm: money, in the forms of banknotes and checks. Together with banknotes, checks, or the more French-sounding cheques, are one of the oldest forms of payment still in existence. The word is thought to derive from the Arabic sakk, meaning certificate or payment order. This type of financial instrument - an order issued by an individual, the drawer, to its bank to pay a sum to another party, the payee - was in use at the end of the first millennium AD among Muslim communities in the Eastern Mediterranean.

Like other banking practices, it came to Europe from the East, probably during the Crusades between the eleventh and thirteenth centuries AD.

In the Renaissance, banks contributed certainty (hence popularity) to checks and bills of exchange (promises to pay between two parties) by requiring the physical presence of both parties at settlement.

In their absence, checks were considered risky because of the possibility of forgery, so much so that at times they were forbidden — for example, as we have seen, they were for long outlawed in Venice.

Checks started to be negotiated – that is, to circulate after being issued – late in the sixteenth century in the Netherlands, partly to obviate strict regulations imposed on banks.

Negotiability initially concerned bills and promissory notes, then it extended to checks.

The receiver of a check would simply write on its back “payable to ….” This would oblige the bank on which the check was drawn to pay this other person or company.

Eventually, the practice of “endorsement” (derived from the French “dos,” or back, implying that they may be signed on the back) made the checks negotiable. Interestingly, the term “endorsing” has escaped the monetary sphere, being now used to mean confirming in every sense.

A specialized institution to clear and settle checks, the ancestor of the modern check-clearing function of central banks, was first founded in Amsterdam in the early seventeenth century. In England and its colonies, first and foremost the United States, the importance of checks increased with the rise of the deposit bank, institutions whose primary business was to

Collect deposits and grant credit. A boost to checks came from the restrictions imposed on banks on the issuance of banknotes.

After the Civil War (1861-65), bank deposits in the United States rose sharply, and their popularity increased after the newly founded Federal Reserve put in place an efficient clearing system.

This early lead in check processing might be in the United Stone reason why checks still play an important role in the United States, as we note in Chapter 7.

A Short History of Central Banks

Economists disagree on what sparked the rise of central banks. Some argue that they arose spontaneously from the need of private banks to organize themselves, ensuring stability to their business: like players who decide to join a "club" because they need common rules for their "game" to function. According to this view banks "need" a central bank, because the nature of their business inherently entails a risk of abuse and the possibility of destabilizing contagion. Most historians reject this explanation though, pointing to the key role governments always played in the establishment of central banks. 18 They argue that central bank monopoly over banknote production is not a natural outcome but a political construct, whose carefully concealed motive is for the government to have an easy channel of finance: seigniorage in disguise.

History sheds some light on this issue. It shows that, in fact, both elements were present at the outset, in a complex mix that depended on the national circumstances of the time. The state, no less than banks, has an interest in financial stability, which central banks are tasked to maintain.

Some central banks evolved from preexisting private banks; others, like the US Federal Reserve, were created anew to protect the banking sector from financial crises.

In most cases, however, the rise of central banking was not entirely spontaneous but always undertaken or facilitated by state intervention.

The availability of the printing press constituted in all cases a crucial backdrop; revealingly, all central banks immediately set up printing shops.

It is difficult to imagine the rise of central banks without this technology.

The Swedish Riksbank, the oldest central bank in existence, was founded in 1668 by the transformation of a private bank, Stockholm Banco.

The latter had enjoyed the privilege of issuing banknotes by appointment of the sovereign, which, in exchange, exercised broad powers in the bank's management.

In spite of this, Stockholm Banco eventually abused the trust of the sovereign by issuing banknotes in excess of its reserves and went bankrupt. Hence, the decision to "nationalize" the function, by creating a national bank under the auspices of the parliament. This feature is still reflected today in the role the Swedish parliament plays in the management of today's Swedish central bank, the Sveriges Riksbank, a role that has no equal in other jurisdictions.

For the second central bank, the Bank of England, created a quarter century later, the role of the sovereign was even clearer. Here the basic motivation behind King William III's decision to establish a new financial institution under the government's direct control was to raise funds to finance his naval war against France. The subscribers of the government's loan were incorporated into a joint stock company, which was given the monopoly of issuing banknotes. Only subsequently, due to the trust enjoyed by the tender issued by the Governor and Company of the Bank of England 

its name at the time - did the newly established financial institution develop into the role of "bank of the banks," or the "leader of the club.

The next great European power to establish a central bank was France in 1800.

The situation of France at that time was somewhat similar to that of England a century earlier: The Napoleonic empire, at war with England and almost everyone else, was in need of finance.

But the relation between the Banque de France and the British Isles runs much deeper and earlier than this. 

This story is relevant for the history we tell, and quite interesting in itself.

An attempt to establish something similar to a central bank had already been made by France under the reign of King Louis XV (1715-74). Five-year-old when he rose to the throne, the king was assisted by a regent, the Duke of Orleans, when a Scottish adventurer named John Law emigrated to France.

Adventurous and hot-blooded, Law had killed a man in a duel; condemned to death in England he fled across the Channel into France, where he decided to establish a bank based on his economic principles.

An economist and financier, Law is often credited for inventing paper money, though this is an overstatement as we have seen, the Chinese had made this invention centuries earlier.

As an economist, he introduced important ideas like the law of supply and demand, later developed by his compatriot Adam Smith:

The real novelty of Law's Banque Générale Privée was that it was funded by issuing banknotes. In Law's opinion, if banknotes were backed by sound credit extended by the bank to finance the production of goods, they would not cause either financial crises or inflation. This was another of Law's economic ideas, called the "real bills doctrine": a theory which would later be discredited, but not before causing considerable damage in France and in other countries. The French kingdom was close to bankruptcy due to the wars waged by the young king's predecessor: Louis XIV, the "Roi Soleil" or "Louis Le Grand." In need of money and not particularly versed in economics, the child and his regent endorsed Law's ideas and granted his bank the monopoly over the issuance of banknotes in France.

An embryo of Banque de France in all but the name was thus born in 1716, named Banque Royale. For the first time in history, paper banknotes were accepted for payments as well as for taxes. This early experiment of central banking did not end well. While Law was distracted by other businesses, Banque Royale started overissuing banknotes; extended beyond its reserves, it collapsed in 1720. A disaster for private investors but a bonanza for the sovereign, who managed to reduce France's national debt.

The oversupply of money caused inflation to rise – an early refutation of the "real bills doctrine." As a result, banking became so unpopular in France that another attempt to establish a central bank could happen only after the revolution and by the initiative of an absolute ruler: Napoleon Bonaparte.

At the top of its power, Napoleon founded the Banque de France as part of his effort to rebuild the nation’s institutions, but mindful of the earlier disaster he wanted the new creature to remain largely under state control — a state of dependence from which the Banque de France was freed only late in the twentieth century.

Our chronicle of the central bank build-up in the seventeenth to nineteenth centuries continues with two prominent examples, in Germany and Italy. These two examples bear some similarities, both illustrating the intricate link between money and the state.

The German Reichsbank, founded in 1876 shortly after the unification of Germany under the aegis of Prussia, was the brainchild of Otto von Bismarck, the mastermind of German unification and the chancellor of the country until 1890. Clear in his mind were the precedents of central banking in Britain and France, including their failures. Before unification, several banks of issue had existed in the territory of what would become Germany, and this had generated confusion in the circulation and the use of money in the constituent states. The newly established Reichsbank was supposed to end this confusion and provide a sound monetary basis for the nation's finances, within the framework of the Gold Standard (to be defined and described in Chapter 3).

The legal act establishing the Reichsbank is of particular interest.The new state bank of the German empire adopted from the outset a markedly "legalistic" imprint, which German central banking would retain until modern days.

Today’s readers cannot but be struck by the similarity of the Reichsbank with the post-World War II central bank, the Deutsche Bundesbank. The latter would in turn exert considerable influence over the treaty establishing the European Central Bank, founded in 1998.

The Reichsbank Act established the bank's monopoly over the creation and circulation of German banknotes. It listed in detail the types of credit operations that the bank could conduct, hence determining the broad structure of the central bank's balance sheets. Special provisions stipulated the backing of the banknotes with gold, legally establishing Germany's adherence to the Gold Standard. In particular, the Reichsbank should stand ready to exchange banknotes with gold at a given parity and hold a given ratio of gold reserves in its vaults. Of interest from a modern perspective are the articles regarding transparency: The bank should publish information on its balance sheet and the conditions applied to credit operations. Among the latter, was the so-called Lombard Rate, which the German central bank would continue to use for lender-of-last-resort operations until the adoption of the euro in 1999.

The Act stipulated that the bank would be tax-exempt but as a counterpart of that should provide cashiers and other monetary services to the German empire. The profits of the bank should be split between its shareholders and the empire. The bank thus maintained a trace of private ownership inherited by its ancestor, the Prussian Bank; full nationalization would come decades later by a decision of another and more infamous chancellor: Adolf Hitler.

Like the German one, the Italian state originated from a merger, in 1861, of several previously autonomous regions, each of which had its own currency, institutions, and conventions. A new national currency, the lira, was created, but there remained initially five banks entitled to issue lir as - or rather six, including the Banca Romana, which joined after Rome, previously held by the pope, became the capital of the unified country in 1871.

For about two decades, there were multiple banks issuing lir a banknotes, all convertible in gold. These multiple currencies competed with one another subject to restrictions and state supervision concerning the extent and modalities of their issuance.

Several circumstances contributed to the collapse of this system. At the heart, here again, was the perennial risk of currency management by private banks: overissuance of banknotes. Banca Romana was involved in multiple scandals regarding the financing of politicians, which gave rise to a conflict of interest in the exercise of surveillance. Moreover, in the decades after unification Italy underwent a real estate boom, especially in Rome, fueled by inflows of inhabitants after becoming the capital of Italy. Banca Romana and other banks financed real estate developments largely by issuing banknotes redeemable on demand. Last but not least, serious banking irregularities were discovered in the Banca Romana. When the construction bubble burst, at the turn of the 1890s, a scandal erupted as the attempt by the government to cover up irregularities was revealed. In 1893 Banca Romana was liquidated and the other banks of issues in the Center-North merged into a new entity, Banca d'Italia, while two other banks in the South continued to operate as issuers to a smaller scale until Mussolini centralized banknote issuance into the Banca d'Italia in 1926.

What Lessons from These Early Experiences?

As our narrative moves forward to the twentieth century and beyond, a “new era” dominated by electronic and digital money, it is worth reflecting on what these more ancient monetary experiences can tell us, in spite of their diversity. We are interested in whether such experiences may bring lessons which, though coming from far back in time, remain valid today.

The first message to be drawn is that a successful “monetary function”

creating money, guaranteeing its quality, and administering its orderly circulation - requires a mix of two elements: a “public administration” element, consisting of institutions and individuals pursuing the collective benefit, and a “private interest” one, with subjects acting freely to pursue their own benefit. The ancient Sumerians founded their system on the cooperation between merchants, deciding what money would be used, and priests, the guardians of reliability and trust. The Romans upset the partnership when an overwhelming and oppressive imperial power debased and finally debauched the currency. Similarly, paper money did not survive in China there were no well-established private forces to limit the power of the state to misuse money. In Renaissance Europe, the pendulum swung to the opposite extreme, to a system that relied too heavily on the power of private bankers.

The existence of multiple issuing banks eventually became a source of fragility in the absence of enforceable rules and effective supervision. However, partly because of Europe’s political fragmentation, a bank-based system of monetary issuance persisted long after the Renaissance. When banks abused their issuing power, financial crises and inflation followed. Banknote-issuing banks were ultimately destined to disappear, replaced in each country by a monopoly of issuance exercised by a single institution: the central bank.

The central bank essentially performs a public function regardless of its legal form — even when it is a privately owned joint-stock company subject to the civil code as well as constitutional provisions. The rise of central banks in Europe, and later elsewhere, restored the balance between private finance and state power. Yet even in modern times, this balance remains delicate and always at risk of being upset.

To use a popular expression, money is a public–private partnership. And for good reason, because it is both the means through which private economic interests are pursued and preserved and a basic collective infrastructure that allows the economy to function for the benefit of everyone. To be clear, we are referring here to market economies; centrally planned systems tend to make money disappear, as we will see in Chapter 3. In a recent book, economists Daron Acemoglu and James Robinson, both Nobel Prize recipients in 2024, have made a more general argument, theorizing that well‑functioning liberal‑democratic societies are based on a mix of public institutions and private initiative: They depicted this graphically as a "Narrow Corridor" at the center of a diagram where the axes represent the power of the state and the power of society. Inside that corridor, the state is strong enough to guarantee basic public goods like safety and the enforcement of contracts but not so strong that it unduly represses individual liberties, rights, and interests. Money, a key institution of a free society, must stay within that narrow corridor as well.

A second point that needs to be stressed is the complementarity between money and technology — the technology of clay first, then that of minting good, well-accepted coins, and eventually the technology of instilling value into printed paper. By the end of the nineteenth century, the entire monetary system was largely run on paper, based on technologies Europe had imported and adapted from the Chinese. Six centuries after Marco Polo visited the court of the Great Khan, most of Europe (and later the United States as well, as we will see) was using roughly the same “pulp… pounded by a mortar… made into paper” that had amazed the Venetian traveler. Paper to compile and maintain ledgers. Paper to record all documentation relating to deposits, among banks and between banks and their clients. Paper to exchange money deposited at banks among individuals and businesses in the form of checks. Paper to draft contracts regulating all banking activities. Finally, paper as physical money itself, in the form of banknotes.

A European innovation, or rather an improvement on a Chinese one, movable type proved decisive. The European alphabet, with its limited number of letters, is much more suitable for movable type than Chinese writing with its very large number of characters. Printing with movable type provided economies of scale and, at the same time, good protection against forgery because setting up a printing press required a lot of know‑how and a heavy investment. As noted earlier, money must be an effective channel for conveying information: high‑quality, standardized, and verifiable information about underlying value. In Mesopotamia, clay tablets could transmit such information. Precious coins improved on that technology until they were debased. Coins were eventually largely replaced by paper. The combination of movable type and paper greatly improved how easily information could be transmitted, in a standard format and relatively straightforward to verify.

the end of the nineteenth century, the age of paper money was at its peak but also nearing its end. Money was ready to move on to new technology.

Beyond Material Money

Transmitting signals over long distances by rapid, immaterial means has been a human aspiration since the earliest times—like flying, with which it has some similarities. The Greeks had words we still use to express the concept: tele, meaning “far away,” and graphe, meaning “writing,” hence telegraphy. Early forms of telecommunication used optical methods. The Greeks used them for military purposes; historians report that optical signals helped secure their victory against the Persians at Marathon. After them, optical telegraphy was used for centuries: by Roman soldiers, Medieval knights, sailors involved in exploration and trade, and Native Americans. There is no evidence that visual signals were ever used for financial messaging, though it is not inconceivable that this may have happened.

In modern times, the French mastered the practice of visual telegraphy. A young French engineer, Claude Chappe, introduced in the late eighteenth century the largest network of optical telegraphs ever built. At its height, the "Chappe system" stretched 5,000 kilometers across all of France, with hundreds of stations. Specific shapes and colors conveyed signals over long distances, using a code developed by a resourceful engineer. The revolutionary government recognized the strategic value of this invention: Robespierre, the mastermind of the Reign of Terror (the final phase of the French Revolution), authorized Chappe to remove any obstacles (trees, buildings, or anything else) that blocked his signals. In 1794, the Chappe system brought to Paris the news of the revolutionary army's victory over Austria and Prussia. Unfortunately for Robespierre, he could not rejoice: his head had already fallen beneath the guillotine.

While that system was still operating, experiments with electrical telegraphs had already begun in several places. At first they were rudimentary devices, sending basic signals over short distances. A breakthrough came with the Morse alphabet, developed in the United States by painter Samuel Morse. The strength of Morse’s system was in combining the telegraph with a dedicated cipher, the well-known sequence of dots and dashes. The system rapidly developed in the United States for military purposes: cables laid in the early 1860s helped the Union forces win the Civil War. More sophisticated transmitters and receivers were quickly introduced, eventually including telegraphic printers that greatly eased the receiving of messages. Cables laid under the sea connected islands and, eventually, continents. By the end of the nineteenth century, an extensive network of telegraphic cables had been established, enabling electrical telecommunication on a global scale.

At this point, everything was ready for money to start traveling on electrical signals, eventually in digital form.