Money and Technology in the Modern Age

 History is the flow of thought-stuff.

Thought-stuff goes through phases like water.

— Henry Adams

In the late 1800s, world monetary arrangements seemed to have reached a stable and lasting form. Banking practices in the advanced world, which at the time meant essentially Europe, mirrored those of Great Britain, the world leader of the time. Encompassing one-quarter of the world’s land and a higher share of its population, the British Empire dominated the globe economically, politically, and militarily. Its colonial system, the Commonwealth, accounted for most of the world’s trade and capital flows and encompassed all elements of a well-functioning economic system: ample availability of raw materials; a powerful industrial base; vast markets for consumer and investment goods; and, last but not least, a well-run political system, with liberal institutions supported by dominant military power.

Other European countries' monetary and financial structures tended to align with Britain's. At the core of most national financial systems was a central bank with exclusive or predominant power of issuing banknotes which everybody was legally or de facto obliged to accept for payments and the extinction of debts. Central banks oversaw the financial sector and conducted a variety of transactions with banks. These practices would evolve into what we call "monetary policy operations" today, mainly the rediscounting of notes and purchases or sales of securities. The banking business involved collecting deposits and extending credit, today's bread and butter of retail banking. European banks at the time entertained a vast web of cross-border transactions; never before, and rarely later, have the world's frontiers been so open to international trade and capital movements.

In the United States, safeguards were introduced after the Civil War to prevent the overissuance of banknotes by state-chartered banks (under the earlier "free banking" period), including the creation of a new authority, the Office of the Controller of the Currency. Yet amid brisk economic expansion, until the establishment of the Federal Reserve (1913) the US financial system continued to be punctuated by recurrent crises.

The years around the turn of the nineteenth century have been called la belle époque – the beautiful era. This French expression conveys, together with the gallic flavor of much of the culture and style of the time, the sense of a "golden age" carrying the promise of endless welfare and progress. It was indeed a remarkable era, with peace, stability, advances in scientific knowledge and living standards coexisting and reinforcing one another. The aristocracy, back in power after the French Revolution, the Napoleonic Wars, and the Restoration, had initially attempted to resist the rise of the middle class, but eventually shared power with it giving rise to mixed political arrangements – the “constitutional monarchies.” The wars and revolutions which had ravaged the continent until recently seemed gone for good. It looked like the end of history: Nothing suggested that the beautiful era would soon end, followed by the Great War and the horrors of the twentieth century. Or that humans would soon radically change their ways of living. Including – a sideshow perhaps – their ways of dealing with money.

Before we enter the “new world,” we need to look a bit more at the old one. Its monetary architecture was the Gold Standard, an arrangement introduced by Britain in the first half of the nineteenth century as the “monetary heart” of the Commonwealth and subsequently adopted by other nations. Because of the enduring and almost mythical fascination it still enjoys, and its importance for the history we tell, it is worth pausing a moment to understand what the Gold Standard really was, what it was not, and how it worked.

A Mountain of Paper on a Plinth of Gold

In essence, the Gold Standard is simple and intuitive – not surprisingly, since it originated from the rationalist philosophy called the Enlightenment. Few other topics have attracted so much fascination and attention from economic researchers. Among them, nobody has analyzed its properties, advantages, and limitations as persuasively as the Belgian-born Yale economist Robert Triffin, who wrote extensively about it between the 1960s and the 1980s. 

In the Gold Standard the values of currencies were fixed in terms of gold, hence against one another. However, the actual money ordinary people had daily contact with usually did not involve gold. Small transactions used silver or even copper coins; viler metals were used because in gold they would be too small to be practical. Rich households might use gold coins for pricey purchases; the poor might never own a single gold coin. 

Large financial market transactions would have been cumbersome and risky if executed in gold. Banks' deposits, credit, and other operations were thus conducted mainly on paper, including bank notes and gold certificates. Banks in each country were financed by the central bank through rediscount operations and purchases and sales of bills.

In spite of the name, in the Gold Standard gold was actually seen only in rare circumstances. Most of it remained in the vaults of central banks, much like seeds and silver in the temples of ancient Mesopotamia. Monetary circulation took the form of paper-based banking transactions: paper in the form of banknotes issued by banks or the state; paper to transfer bank deposits in the form of money orders; paper to record transactions in bank ledgers; paper to describe and certify contractual arrangements.

There was one situation, though, when gold did come back to life and played a fundamental role, namely as a mechanism to ensure adjustment to international trade imbalances. When a country imported more than it exported, the payments for the net import would result in a scarcity of money in the deficit country, leading to an increase in interest rates (the price paid to obtain money from banks or other lenders) in that country. The increase in interest rates would then stimulate monetary flows from the surplus country, attracted by the higher interest. That was one way in which adjustment could take place, but not the only one. The scarcity of money would also induce prices to fall in the deficit country, because less money normally leads to lower demand for goods and services and a decline in their price. The deficit country would become more competitive (lower domestic prices relative to foreign prices), which would stimulate exports and hence reduce the original imbalance.

Only when the mechanisms just described did not work well, or not fast enough, did gold see the light and actually move. The increasing demand for foreign currency to pay for its net imports tended to drive its price relative to the domestic currency (the exchange rate) up. Beyond a certain point, it became convenient to pay imports in gold, rather than in currencies; gold hence moved out from the deficit country, reducing its gold reserves and increasing the reserves of the surplus country. To the extent that this stimulated credit extension and deposit taking by banks in the surplus country, and the opposite in the deficit one, this mechanism tended to reinforce the price mechanism that we have referred to – an apparently infallible mechanism to restore and maintain balance, the monetary equivalent of the "communicating vessels" in physics.

This is how the theory went. In fact, as Triffin explained, the Gold Standard rarely functioned as its rulebook predicted.

The "rules" required that the counterbalancing movements in prices and interest rates were allowed to happen. Central banks, however, were powerful enough to prevent that from happening, at least in full. And they did. By extending credit to commercial banks, via rediscounting of paper or outright purchases of it, central banks in deficit countries compensated to a large extent the outflows of money deriving from external trade imbalances. The reason for doing so stemmed from domestic considerations: Declines in prices and wages faced stiff opposition at a time in which organized labor was rising as a political power. Central banks were thus tempted to neutralize (professional economists would say “sterilize”) the monetary outflows via the external sector by means of domestic monetary creation. The limit to neutralization was given by the availability of gold in the central bank vaults. As soon as the parity approached the “gold points,” making it profitable to pay directly in species, gold tended to flow out. Central banks experiencing gold scarcity were compelled to follow the “rulebook,” letting money shrink. This was often the case with Britain, for example, whereas France, more gold-rich, could afford to be less disciplined.

Economic historians debate whether the Gold Standard contributed to economic stability and financial order or rather hindered them. For us, what is of interest is what that system implied for the use of money. We can metaphorically describe the Gold Standard as a mountain of paper standing on a foundation of gold. The foundation was small relative to the mountain. Around 1900, that paper mountain not only was far bigger than its golden pedestal but was growing faster. On Triffin’s calculations, between 1885 and 1913 the total amount of money circulating in the eleven major economies (United States, United Kingdom, France, Germany, Italy, Netherlands, Belgium, Sweden, Switzerland, Canada, and Japan) grew threefold, from 8.4 billion to 26.3 billion dollars. In that same period, the price level remained broadly unchanged, oscillating up and down over shorter periods. This indicates that the growth of money in circulation was very large not only in itself but also in relation to the goods or services it could purchase. The increase was almost fully accounted for by the increase in what Triffin calls “credit money,” namely banknotes and bank deposits, whose volume increased from 5.6 billion to 22.4 billion dollars. The “base” of the mountain, represented by gold, and for a minor part silver, increased only from 2.8 billion to 3.9 billion dollars.

These numbers demonstrate that while gold with its intrinsic value provided the essential element of trust, most of the actual “work” of the monetary system relied on paper. Except that, on the eve of the twentieth century, the paper was already obsolete as an information-transmitting technology. New discoveries had started to replace graphical messages with telegraphic ones in an increasing number of applications. As with many revolutions, this one too started slowly, but then hastened and became irresistible. After the turn of the century, the face of money was about to change again, forever.

The “Great Acceleration” of the Early Twentieth Century

There are times when history accelerates and events happen more frequently in sequence, each leading to another. The European Renaissance was one: Advances in arts, scientific progress, and geographical discoveries all happened at the same time after centuries of near-immobility. Another one of sorts took place in the seventeenth and eighteenth centuries, with the Industrial Revolution, followed by political upheavals shifting the fulcrum of power from the aristocracy to the middle class.

As the nineteenth century was ending, a new acceleration was firing up in science and technology. The wave of discoveries in that period can hardly be overestimated. Wikipedia's list of major inventions counts one every ten years in the seventeenth century,⁴ one every three years in the eighteenth century (concentrated toward the end), and more than one per year in the nineteenth century and early twentieth century. These dry numbers still do not convey the importance of each of those innovations. Most of them are still with us: electric and combustion engines for autos, ships, and airplanes, wired and contactless communication devices, medical substances and techniques, plastic materials, cement, batteries, light bulbs, and so on. The list extends to such mundane but essential things as paper packaging, cameras, vacuum cleaners, ballpoint pens, and even the zippers which hold our pants up.

The American historian Henry Adams, a Harvard-educated scion of a prominent Bostonian family counting two US presidents, tried to explain this scientifically. In 1909 he conjectured the existence of inner laws explaining historical accelerations. He imagined the existence of similarities between physical and historical laws. Like matter, history would occasionally "heat up," changing state from solid to liquid and from liquid to gas, accelerating its motion in the process.⁵ His era, he thought, was one of those periods. Adam's fanciful theory got nowhere: Lacking proper arguments or evidence, it was dismissed by contemporaries and disregarded by later scholars. Yet it captured the zeitgeist, the enthusiasm and creativity of those tumultuous years. Only his imagination ran a bit too fast even for them.

The technological progress in those years was firmly rooted in major scientific advances; that is when scholars of nature ceased to be philosophers and became "scientists." In the span of a few years, our knowledge of nature changed forever. In physics, the explanation of the common nature of electrical and magnetic forces eventually led to Einstein's theory of relativity. Chemists compiled the catalogue of basic elements and identified their atomic structure. Medical research gave us vaccines, antibiotics, anesthetics, and radiology, just to name a few.

The wave of discoveries in that era resulted also in the replacement of paper as the predominant support of money, after centuries of domination. The new conduit, telegraphic and radio signals, allowed a much smoother and swifter performance. We already mentioned Chappe's "semaphores," sending light signals through revolutionary France. While those devices were still in use, in the mid nineteenth century, inventors were experimenting with forms of wire communication.

In 1816, the Londoner Francis Ronalds constructed the first machine to transmit writing over wires. His telegraph transmitted signals over a distance of eight miles. Grasping its military potential, he wrote to the British Admiralty presenting his invention as "a mode of conveying telegraphic intelligence with great rapidity, accuracy, and certainty, in all states of the atmosphere, either at night or in the day, and at small expense." The military dismissed the invention, arguing that, with Napoleon already defeated, visual semaphores were more than enough. Military myopia did not stop progress, though. In 1841, Alexander Bain, a Scot who had already patented the electrical clock, constructed a printer-connected telegraph, put to use to regulate railway traffic between Edinburgh and Glasgow. He later went further, patenting a prototype scan-fax machine equipped with a pendulum to detect printed letters and then transmit them telegraphically. Fully aware of the potential of his invention, Bain farsightedly predicted that one day any printed surface would be wire-transmittable.

As usual, the new technique was widely adopted when it could be put to practical use. In 1840, the Samuel Morse patented the line-and-point language that bears his name. This was the "killer app" because it allowed to convert the crude on/off signal arriving over the wire into text. After that, telegraphic messaging developed quickly across the Atlantic. Suited to long distances, at a time when the colonization of the West and the construction of the railways made communication critical, wire services became a flourishing business in America. At the mid nineteenth century, the Associated Press opened up in New York to provide telegraphic services and wire-transmitted news. A similar business was established in France by a gentleman whose name, Paul Julius Reuters, still rings loud in today's wire services industry. In the late nineteenth century, telegraphic transmission was in full swing. In America, it proved critical in the Civil War and the colonization of the Western territories. Railways and telegraphs moved West together, exploiting logistical complementarities; telegraph offices bloomed, usually combined with post offices. In 1881, when the sheriff Wyatt Earp, known for his gunfight at OK Corral, needed to recruit gunmen, the telegraph office of Tombstone (Arizona) was the place he visited first. Telecommunication was less advanced in Russia; still, Leon Trotsky made sure the St. Petersburg telegraph was controlled by Red Guards before storming the Winter Palace on November 8, 1917.

The telephone, which transmits voice, developed later and separately from the telegraph. Initially, it was complementary to telegraphy, for example, when wire transfers needed to be confirmed by voice for additional security. However, the two technologies differ, and early inventors initially struggled with the problem of recognizably transmitting voices. The story of how the telephone was invented is one of the most hotly contested chapters in the history of technology.

In the 1850s, the Italian-born Antonio Meucci developed an embryo voice transmitter to connect different parts of his New York home, which he needed to assist his ailing wife. The device, a development of an earlier model he had constructed while still in Italy, was composed of a vibrating diaphragm connected by an electrified wire to another diaphragm. He left but scanty written descriptions of his "telettrophone" (as he called it) and did not patent it. Years later Meucci's regular candle-producing business went bust; when he finally decided to patent his invention, he lacked the money needed for that. In 1876, Alexander Graham Bell submitted a patent application for a well-functioning telephone, complete with a proper technical description. Since then, the Canadian-naturalized Scotsman is generally recognized as the inventor of the telephone, in spite of numerous court cases brought by Meucci and his supporters. In 1877 the Bell Telephone Company was founded, which would eventually evolve into what is today's giant AT&T Corporation.

By the end of the century, well-functioning devices to transmit telegraphic and voice signals at long distances were available, including connections between Europe and the United States. Transoceanic cables had been laid on the Atlantic seabed since the 1860s. On the eve of the twentieth century, another Italian, Guglielmo Marconi, was successfully experimenting with radio transmission. All was in place for money to abandon its long-standing and comfortable support, paper, and start travelling securely and fast on wire and later on air.