Posts Tagged ‘silver’

Let’s tell the history another way around…

Part II of..From Austrian Economics to MMT – a short guide in 7 steps

Of course, the above tale wouldn’t be the sequence many MMT followers would accept as historically correct.

For Step 1, we have to acknowledge that man is rarely a solitary being, and certainly not in his upbringing. So an accidently isolated person (as Robinson Crusoe) or a person choosing the solitude of a hermit life might encounter such a situation, but he/she would still have grown up in a group.

And therefore, the step 2 situation – barter economy with few participants – never was the historical norm. Hunter-Gatherer societies usually lived in (extended) family groups. The men went hunting as a group, the women collected fruit and fungi, and looked after the children. Some individuals might have special skills – like making pottery or bows – and were allowed to take some time off from other group duties to exercise those crafts – but there was barely private property, and all products were shared among the members of the group. So, within the group, trade didn’t exist, and would have been considered anti-social behavior. There might have been some barter trade between groups – but those were rare, as were the contacts with strangers. If there were any savings, it would be stored stocks of supplies, put away by the group-elders for future consumption.$

So, what happened next? People gathered together in larger groups, attempted bigger joint projects, like building a wall for defense, a temple for worship, or canals for irrigation. As the group grew larger, it became more difficult to assure that everyone would do his fair share of this duties, and of other duties like guarding the town, or keeping records of duties performed. So, the third step was – the introduction of government.

But one of the first task of government was to assure accountability – that everyone did his fair share of the common duties. So they needed a unit of account – to record the amount of duties every resident had performed. So they could either try to establish a central register – or they could find another way of control. The superior method, so it seemed, was to issue tokens of account, that were handed over to those who had performed services, as a proof for their services. And to assure that people would perform duties in exchange for those tokens, the government would periodically re-collect the tokens from the residents, therefore introducing taxation.

Now, not everyone liked to perform those duties, but everyone had to get tax-tokens. So people with special skills agreed to give up some of their products in exchange for those tokens. Those (citizens) who exchanged tokens for goods and services could thus receive more tokens by performing more government duties, and thus buy things. So the tax-tokens had not only become a unit of account, but also a means of exchange, that is – token-money. As people desired more money to facilitate trade, government found it easy to hire people to perform government duties – so the token-money issuance exceeded taxation, or, the government did run a deficit. This left enough money in the hands of the private sector to allow for circulation, and some even used money as a store of value, that is, they saved money instead of storing goods for future consumption. So, we already have a full-blown fiat-money economy, except there are no banks.

But why, then, did metallic money ever see the light of day? Well, there are a few drawbacks of pure token-money, all related to the relative ease of it’s creation.
First: government could get used to the possibility to easily command goods and services by just creating more tokens – and as long as this was easily accepted, they might sometimes have neglected to tax enough – hence inflation showed up – and thus, people became less inclined to accept the government issues tokens.
Second: as no rare raw materials were needed to produce tokens, other people with skill in some crafts could produce tokens that were indistinguishable from government tokens, without much cost. So counterfeiting could become a serious issue.
And Third: Many places initially stayed out of the control of governments, so while there would be things to trade, and desire to get stuff not self produced, and therefore a demand for a means of circulation / this places didn’t need money for taxation, and non-metallic tokens weren’t that durable, so they wouldn’t collect and save them for future taxation – and so the issues one and two further reduced the demand for such money from people outside the control of government.

Thus, minting coins from rare metals, mostly silver, and for higher denominations even the much rarer gold, solved some of those issues. As the cost of producing the coins was high, this severely limited the ability of the government to issue additional money, and therefore to create inflation trough deficit spending. And second, it made the work of counterfeiters more difficult as well, because if the metallic content of their coins was much lower, it would be noticed – and if it was as high as in government money, the margin of profit was not really worth the effort. Thus, money became relatively rare, but durable, and thus it was often also accepted as means of exchange (and store of value) outside the realms of government.

OTOH, the rareness of the (now) precious metals reduced the availability of money, and therefore economic growth was severely hindered, as well as the ability of governments to react to changing needs and desires. Some reverted to paper money – China several times – other governments debased coinage (using cheaper metals instead of gold and silver) – both giving room for renewed inflation. Many, mostly local governments, couldn’t raise taxes in coin, and therefore returned to requiring direct goods and services from their subjects, as collecting tithes and drafted labor.

Only after the discovery of the Americas, with large Silver (and some Gold) deposits, did the amount of available coinage sharply increase. This did lead to some inflation, but also promoted economic growth, and facilitated trade, as standard coins, like the Spanish Dollar, became used and accepted in many places around the world. Trade and economic development were further facilitated trough the widespread development of banks, and the availability of bank credit.

During the 19th century, with fast increasing international trade and rapid industrialization, the volatility in the exchange rate between Silver and Gold (due to the different quantities of each metal that became available for minting in any period of time) seemed problematic for countries using a bi-metallic system. Therefore, major industrial countries, first the United Kingdom, but in the last third of the century, most leading powers, introduced the Gold Standard, that is a peg of their currency to a fixed amount of gold. The Gold Standard did, however, severely limit the capacity of money growth, leading to recurrent depressions and deflation. Not uncommon as well were bank runs, leading to the collapse of private banks, that in some countries were allowed to issue their own banknotes (still (officially) backed by gold). To reduce the risk of bank failures, all countries finally abolished the right of private banks to issue banknotes, and established this as a monopoly function of a Central Bank.

During WW I, governments found it inacceptable to be constraint in War expenditure trough the limit in Gold Money – so all countries sooner or later abandoned convertibility in to gold during the war, introducing fiat currency (again). After WW I, many countries tried to return to the gold standard, but this constraints were one of the main reasons for the Great Depression.

During the recovery from the Great Depression, and during and after WW II, all leading currencies were in fact based on a fiat system, although as part of the Bretton Woods system most countries introduced fixed rates to the US$. But this was not a real return to the Gold-Standard, because most countries wouldn’t dare to demand the Gold in exchange for Dollars (due to the clear dominance of the US within the western world after WW II) – and US citizens couldn’t exchange their Dollars, so domestically the US was still of the Gold Standard. As trade imbalances created problems for many countries, frequent devaluations – that is a default on the promise to convert other Central Bank’s currency at a fixed rate in to Dollars happened. So, while the Bretton Woods System was nominally a hybrid system, most countries issued more money, and could therefore afford to deficit spend.

The post-gold-standard attempt of many CB’s to restrict the money supply as part of ‘inflation targeting’ bears the danger that – similar to the time of early metallic money – or to the time just before the Great Depression – money could come in to short supply. This would especially be the case, if leading nations would actually fall for the fallacy of a balanced budget – or would even try to repay all debt by running a surplus. Back to the stone-age – or at least to the middle ages – seems to be the rallying cry of the austerity freaks.