I O U Part 3: Banknotes and Virtualization
So we’ve established that, throughout the greater period of man’s history, metals and other precious goods were used to represent value, creating the concept of money and eventually the mass-production of minted coinage. Electrum, silver, copper and gold were all formed by weight, struck with the official mint, tested by touchstone and used in trade. Men and women walked with purses filled with coin, and wagons carried chests filled with a merchant’s riches. A coin was worth what it was made of, and for a while, the only true insurance that it carried value was its composition.
Yet somewhere in history, things changed: the business of transacting solely in coins and treating coins and metals as the only true representation of monetary value went out of style, and new systems of credit were implemented. At first, coins were valued for what they were: then, seigniorage was implemented, and coins were given a set value to justify their production.
Then the forerunner to the modern day banknote was implemented, and everything began changing. At first, these forerunners were bills issued by merchants and banks, carried as promissory notes, which upon presentation would earn the owner of the bill a certain discounted value in specie (money in coins). This began validating such promissory notes, giving each note a certain agreed upon value, and backing that value with the actual physical coin to be expected at the end of the transaction. Yet as time went on, physical coinage became cumbersome and the utilization of such promissory notes became a regular monetary custom. And over time, the value of the coin was no longer in its composition as a precious metal, or in its weight and usability in trade. Precious metals declined in monetary use, and money became a represented concept rather than a tangible, exchangeable and practically valuable resource. And where did it all begin?
It all began in China. In Ancient China, money was represented in copper coinage, struck into circular shape with a hole in the middle. This led to the custom of counting money by stringing a certain amount of coins together, assigning each string a certain value. Yet as trade flourished, carrying all that copper became difficult, as it unnecessarily weighed down a merchant and impaired his ability to sell.
Things became even more difficult in the 7th century Tang Dynasty, when richer merchants and wholesale buyers began transacting in large quantities of goods (and therefore paying each other in equivalently large quantities of heavy copper) – at this point, merchants began leaving their physical money with a trustworthy person, and began issuing paper notes as an equivalent for the transactions value. The notes could be presented to the merchant’s, say, “cashbearer”, and the equivalent of the note’s agreed upon value could be withdrawn in the form of actual coin.
The practice continued on for several centuries, but it wasn’t until the 10th century, during the Song Dynasty, when paper money actually began official circulation due to a shortage of copper for coin production. This paper money, called jiaozi, was issued to promise a later withdrawal set within a limited deadline, of a discounted amount of equivalent specie – yet it did not replace the value of copper coins, it simply represented that value in the face of a shortage.
Paper money was used by private shops and merchants as IOUs and promissory notes – until the central government took notice of its economic advantages and stepped in to create a monopoly in the issuance of jiaozi. By the 12th century, paper money made up something around 26 million strings of copper coin, and by the 1120s, the central government began producing its own, official paper money via woodblock printing.
However, to produce paper money, the government needed paper. Even before the official production of notes, however, paper tributes had been mandatory in Chinese villages – until their detrimental effects were noticed, and the tributes were lessened. To counter the slow in paper production and keep the printing of money fluent, the government created and put to work 4 large paper-producing factories in the cities of Huizhou, Chengdu, Anqi and Hangzhou.
The factories were incredibly large, employing over a thousand workers a day – yet the actual printing of money was planned only for a set number of geographical locations for a short time period of 3 years. It wasn’t until 1265 that geographical limitations began to disappear, and the Song Dynasty began producing paper money as an official national currency.
At this point, paper money was backed by its value in gold and silver, and official notes were issued with varying values – some equivalent only to a string of copper coins, others equivalent to up to a hundred of these. Notes were printed in six colors with varying designs, and certain fibers and fiber patterns were used to prevent counterfeiting.
This saw the advent of paper notes as a government-produced, asset-backed representation of monetary value, used officially in trade and exchange, distributed and printed as per government standard.
The trend caught on in the Mongol Empire, where Kublai Khan issued the production of Chao: paper money printed just as it was in the Song Dynasty. Eventually, however, the Mongol Empire ran out of specie to fund its presence in China, and began issuing Chao without time-based or area-based restrictions, and Chao quickly became the circulating currency within China and the Mongol Empire. It was this that caught the interest of Marco Polo, who upon returning from his travels described the Mongolian custom of utilizing paper as money. Venetian traders, impressed with the eastern methods of transferring monetary value into promissory notes, began issuing such notes to counter the same issue of the transport costs and impracticalities of owning physical coinage. At first, these notes were personally registered, but the 14th century saw the creation of “banknotes” – promissory notes issued by accountholders of certain banks to people who would then earn the right to withdraw an assigned amount of precious metals from said bank. Sometimes, due to the discounts on such notes, certain values would be made worthless, as the money earned from such transactions depended heavily on the distance between the issuing bank and bank at which the note was presented. Eventually the production of banknotes was restricted to the central banks of a certain country.
By then, banknotes were used all over Europe for ease of transaction and transport, and even by Italian merchants outside of Europe. Internationally, similar “bills of exchange” were used to represent a virtual, non-existent currency that held equal value to individual national currencies – this was the first monetary instrument to serve as credit.
By the 17th century, banknotes were printed in Sweden and France, although the former stopped production after running out of coins for exchange. Later that century, banknotes began circulation in the Thirteen Colonies of the United States, and by the early 18th century, each of the colonies issued their own official set of banknotes, with individual denominations and a permanent place in monetary circulation. After the American Revolution and the creation of the United States Constitution, the government transferred the ability to print banknotes to the First Bank of the United States, the country’s quasi-central bank, although the printing of government banknotes didn’t begin until 1862.
Beforehand, cotton bills of exchange were used as currency, although these weren’t official banknotes. It wasn’t until 1861 that the Confederate Congress allowed the production of paper currency (promissory notes bearing interest) due to a shortage in coins. Banknotes were popularized by government mandate in favor for precious metals in 1933, when President Roosevelt issued Executive Order 6012, banning the use and possession of gold and silver in place of currency. It wasn’t until later that the Federal Reserve stopped backing its currency with precious metals – a policy that introduced a new era I’ll discuss tomorrow.