The History of Paper Money – Part 1: Origins of Exchange

history of paper money


Good day everyone, have we got something special to share with you! The following is the first in a series of 4 educational videos explaining the origins of paper money. If you don’t want to watch the video, you can read the story below. Enjoy.

How did humanity come to accept rectangular pieces of pulp trees as something to spend 8 to 10 hours a day working for? It’s a pretty insane story, this change from hard currency, like gold or silver is really a huge deal, and without it we couldn’t possibly have the massive industrial and post-industrial economies we know today. This change revolutionized how we do business and forever altered how governments were financed. Learning about this massive sea change and how we as a species thought about money, can help us reflect on our current historical shift from seeing paper as money to seeing bits, seeing digital 1’s and 0’s as money. But, before we can get to the exciting story of people trying to convince other people that paper was worth something. To understand why this is such a huge deal, we have to discuss a bit about how we thought about money before paper.

If we go way back to the beginning of society, we find trade. Before early humans even really settled down, there is evidence that when we met, we exchanged things we had made or things we’d found. But as soon as humans started to cultivate the earth and form societies, we started to specialize and that meant that we not only loved to trade, we had to. Now often when we think of trade we think of long-distance trade; we think of caravans loaded with exotic goods, but for our story we have to talk about local trade, because he is where we run into the problem of ‘coincidence of wants’ or rather we run into it everywhere. But if we fail to solve this problem at the local level, society breaks down and we can’t have the specialized trades we need to run anything beyond the smallest gathering of people.

So what is a coincidence of wants? It’s the basis on which trade can exist. Let’s say that I make shirts and you grow food, well if you want a shirt and I want food, awesome, we can trade. But if I don’t want your ‘stupid’ food or if you’re all full up on shirts, well we can’t trade, can we. That starts becoming a real problem for society if I want food, but you don’t want my shirts. Maybe I can find somebody with some third good that you do want, but that means that a lot of time is consumed by trading. If I can’t find some other good you want to trade for, well there’s going to be trouble. And this problem runs even deeper than we sometimes think about when you consider the lack of refrigeration and transportation.

Imagine, I’m a fisherman and your farmer and let’s say that we want to trade. Well there’s this problem, your harvest only comes in once a year. I can’t trade you for a harvest you don’t have yet and all of those extra fish I caught today are going to be pretty rotten by the time your harvest comes in. And why this may seem like a very specific example, trade for food was probably the most prevalent trade of the ancient world. So we need to find the third good that we both want that we can trade for. But wouldn’t it be convenient if there was some universal third good which everybody wanted and would trade for…so we didn’t have to do some long chain of bartering every time we wanted something.

Enter money – all money is, is a third good that doesn’t spoil and that we all agree has value. Thus becoming a unit of exchange, an intermediary good by which all other goods can be traded. And why we often think of coins made of precious metals for this purpose, the truth is a so long as it’s a durable enough and hard enough to procure, anything can serve as money. Tangents time; turns out we have used a lot of weird stuff as money over our history. For example; cattle have often served as money, I mean they are fairly durable, they last for years, they are practical and they’re reasonably scarce. When Europeans arrived in the Americas, alcohol often served as currency, you could literally drink your paycheck. Cigarettes have often become money of prisons and POW camps. Back in ancient China, money in the shape of tools and then knives became some of the first examples of precious metal money.

And my personal favorite; on the island of Yap, gigantic limestone doughnuts served as money. They are so huge that once they are brought to the island, no one even moved them; they just remember who owns which ones. In fact all of these stones had to be quarried off island because there is no naturally occurring limestone on Yap. And once when a crew was coming back from a quarrying expedition, a storm hit and sent their stone to the bottom of the ocean, but the crew survived and told everybody what had happened and the Islanders decided that it still counted. So to this day somebody owns that giant piece of stone money at the bottom of the sea. And even though it’s not really in use today, for hundreds of years that stone was used to buy and sell things even though no one had ever seen it, giving Yap, in some ways one of the most forward thinking monetary systems before the modern era.

If we want to talk about the King of them all, the form of money that has been used the longest and over the widest expense of the globe, we have to talk about one thing. Nope, not gold; although in fairness that’s what I would’ve guessed too. Nope, it’s the cowrie shell. It’s durable, impossible to counterfeit and without modern harvesting techniques it’s not so easy to acquire that inflation will run rampant.

Anyway tangent over, back on target; we have lots of different possible types of pre-modern money including the gold and silver coins that we so often think of when we think of money of the past, but all of these different types of money have one thing in common. They are what we call ‘commodity money’ because their value is in the commodity themselves. Even cowries were seen as rare and beautiful and can be used for jewelry and the like, and so were thought of as having intrinsic value, the same way we feel gold has an intrinsic value for its scarcity and its uses. Now that makes a lot of sense for a currency, it feels secure and reasonable, you can trust to the worth of that gold coin in your hand.

I mean after all if you’re used to trading one thing for another, why would you ever trade something valuable like a horse, for something worthless like a pile of paper, but for gold or for cowries, well that’s another story. But when your economy grows, this system starts showing some of its limits. For one thing, commodity money is heavy, if you’re doing massive deals it gets really hard to transport and it’s risky to transport across lawless lands.

Commodity money is also often subject to debasing, where somebody usually the person who should be responsible for making sure the currency maintains its value, ‘waters down the whiskey’ or takes a gold coin, melts it down and re-forges it with a bit less gold in it and passes it off as worth the same amount. But more than anything, when you get to gigantic economies, the very scarcity that makes commodity money seem to have value, becomes your enemy. Like let’s take gold and silver; what happens when your economy grows to the point where you just can’t get enough of it? We actually saw the effect of this in our episode on the opium wars, where so much English silver was ending up in China in exchange for tea, it was actually causing inflation and hampering basic economic transactions at home. This really comes into effect when we get to more modern government finance and the financing of war.

What happens to a nation when it has to make a sudden drastic uptick in its spending, but can’t get enough specie to cover its costs, even from those who are willing to lend. As I am sure we will see in future Extra History episodes, it plays havoc with an economy and even the ability to prosecute a war, and the reverse of this is true as well. Currencies based on scarcity are often subject to changes in the scarcity of the commodity on which they are based which can be trouble when somebody finds a lot more of your currency commodity.

When Spain started to import massive amounts of silver and gold from the Americas, all the precious metal-based currency in Europe started to suffer from inflation. After all, all those gold coins weren’t worth nearly as much since somebody had just dumped a huge new pile of gold on European shores. And as a government or even a financial sector, when someone digging up a new pile of minerals means that you can’t control your own fiscal policy, then that’s bad news. But those disadvantages are only easy to see if you’re head of state or working on the largest scale transactions. If you’re just some average person in the streets, when some well-to-do says that they want to take your grain in exchange for this nice slip of…is that paper? – well you would be forgiven for thinking that you smell a rat.

Join us next time as we finally delve into the origins of paper money and start to address this problem of people fearing to give up their outdated gold.

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