Historic Background

In many respects, it is useful to have some initial outline of the history of money against which we might compare trends in today’s globalised economy. From this historical perspective, we might recognise that the earliest ‘economies’ operated on a simple barter system, which was problematic in the sense that it restricted the number of possible transactions because it was difficult to  equate the value of an item against another or to offer any immediate compensation for any difference in value. As such, there was an understandable need to replace barter with a more flexible system that supported the idea of a transaction in many more forms, such that the item exchanged, i.e. money, had both an intrinsic value and the following flexible properties:

  • Portability
  • Durability
  • Divisibility
  • Equivalence

The replacement of the barter system with a more flexible money system was initially based on precious metals, i.e. gold and silver, which had a recognised intrinsic value due to limited supplies, was relatively portable and durable, which could be made into divisible units, e.g. coinage, based on weight and purity.  As such, any two gold or silver coins of known weight and purity could be considered as equivalent units of money.

So how did this economic development affect history?

While the history of Greek civilisation can be traced back as far as 3000-2000 BCE, the golden age of this civilisation between 500-300 BCE is often linked to the introduction of coinage money around 600 BCE, which then allowed the development of trade between neighbouring city-states to expand and prosper. However, this expansion also led to increasing military conflicts that incurred the economic cost of supporting an ever expanding army. During the period 400-300 BCE, the city-state of Athens became involved in what would ultimately prove to be a disastrous series of wars against the city-state of Sparta. While there were possibly multiple reasons for the eventual downfall of the Athenian city-state, some have ventured to explain this downfall in terms of an economic failure to manage its  monetary currency. As suggested, the initial rise of the Athenian city-state can, in part, be linked to the economic prosperity generated by the introduction of gold and silver coinage, i.e. money, that helped to fuel increased trade, although the subsequent lengthy wars with Sparta would lead to problems. First, the large military armies had to be paid in gold and silver coins, such that money flowed out of the city when these armies were on numerous campaigns in distant regions. Second, and possibly more important, Athens would eventually lose access to its gold and silver mines on which its monetary system was now dependent. As a net result of these problems, the Athenian economy became subject to deflationary pressures, such that its tax revenues could no longer meet all its expenditure, i.e. it was running a deficit. In order to address the immediate deficit crisis, Athens started to debase its coinage money by mixing gold with copper, such that the intrinsic value of its money was devalued. In essence, Athens started to ‘print’ money, such that the idea of money with intrinsic value started to transition into a currency without intrinsic value and the government of Athens started to accumulate debt as the deficit between its tax revenue and state expenditure kept increasing. As a result of its economic declined, Athens eventually fell to Sparta in 404 BCE, which was in-turn subsequently subsumed into the Roman Empire around 146 BCE.

But what has this got to do with modern economics?

Initially the population of Athens may not have realised that some of the coinage in circulation did not have the same  intrinsic value in gold or silver. However, over time, the population started to realise the deception and, as a result, began to horde the gold and silver coinage and only spent the debase copper coinage. As such, we might see the idea of an exchange rate being developed in the form of ‘N’ copper coins needed to buy just 1 gold or silver coin. In this case, the intrinsic value of money in the form of gold or silver had been debased to a promissory currency IOU without any intrinsic value. While this might be seen as ancient history, it is a story often repeated in which the rise of an empire was initially based on a ‘quality’ money system only to be debased into a ‘quantity’ currency system. In this context, we may start to see parallels in history to what is now happening in many present-day Western economies, which author Mike Maloney has described in terms of the ‘7 stages of empire, although we shall qualify the term ‘empire’ to the rise and fall of some nation-state economy:

  1. The economy of our nation-state example is initially founded on a quality money system, which is backed up by an equivalent value in gold or silver, although other valuable resources are not ruled out as long as they are durable to market downturns over long periods of time.

  2. As the economy of a nation-state grows it also takes on more economic costs in order to support its ever expanding social and cultural expenditure, which may initially be met by increased taxation.

  3. However, as this nation-state continues to grow in political influences, there is a perceived necessity to protect and underpin this influence with an ever expanding military expenditure.

  4. Invariably this military expansion results in costly wars that ultimately starts to outpace any reasonable taxation revenues that can be extracted from the economy, i.e. deficits accumulate into mounting debt.

  5. However, in order to maintain the increasing military expenditure without an obvious increase in taxation, quality money starts to become a quantity currency by adopting the idea of a promissory currency IOU that can conceptually be increased without limit.

  6. Financial institutions, but not necessarily individuals, are quick to realise the growing risk of holding too much promissory currency that has no obvious intrinsic value, which then leads to a loss of confidence in the economy of the nation-state.

  7. Finally, this loss of confidence can ultimately become wholesale panic away from holding the promissory currency towards assets that are perceived to have longer term stability with intrinsic value that is both portable and durable, e.g. gold, silver, diamonds etc.

While there are many examples of economic collapse, which basically follow the outline above, it is possibly more useful to jump ahead to the beginning of the 20th century in order to highlight the effects that two world wars would have on the modern idea of money, based on gold, and the expansion of fiat currencies within a globalised economy. However, before doing this, the next discussion will simply provide a basic outline of the development of various gold standards.