The Business Master (4th Edition)

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A BRIEF HISTORY OF MONEY -- AND WHY THE HISTORY MATTERS TO YOU The evolution of money has been a long and often difficult process as societies searched for ways to develop reliable and lasting systems of commerce and finance. Over the course of history, money has changed its physical appearance as people refined its shapes and sizes into convenient and practical forms. At the same time, money's nature has changed. From the days of the Roman gold aureus to the original U. S. silver dollar, money's intrinsic worth -- meaning its precious metal content -- was a paramount measure of its value. Today, money's value is measured not by its material worth but by what it can buy -- its purchasing power. The long and colorful history of money began when people in ancient civilizations learned they could trade for things they needed, rather than produce them. However, trade was often complicated, with people not able to compare the value of different goods. And, finding an appropriate trading partner was difficult -- for example, a fisherman couldn't get wheat from a farmer who didn't want fish, and a candle maker couldn't get bread from a baker who didn't need candles. People learned to use prized ornaments or agricultural products as standards by which the values of different things could be compared. From time to time, beads, shells, rocks, fish, hooks, grain and cattle were used as money. Most types of early money were made from metal because it was durable and easy to carry. About 2,500 B.C. the Egyptians produced one of the first types of metal money in the form of rings. The Chinese used gold cubes about 400 years later. The first metal coins were struck in Lydia (now western Turkey) in about 700 B.C. Made from an alloy of gold and silver called electrum, the coins -- known as "staters" -- were actually bean-shaped pellets stamped by the government with their weight and purity. Because these coins were made of precious metal, they had "intrinsic" value, meaning that they had value in and of themselves, apart from their official designation as money. The ancient Greeks also minted coins, which replaced the handfuls of iron spits that they had been using. In fact, the word "drachma" -- which is the base unit of currency in Greece today -- is a derivative of the Greek word for handful. A number of numismatic innovations are credited to the Greeks, among them the first coin with designs on both sides; the first series of coins issued in different denominations; the first coin with a human representation -- the goddess Athena -- and the first commemorative coin, celebrating a military victory. Greek coins were also the first "international" currency, being widely used in trade throughout the Mediterranean. Another major development was in about 300 B.C. when the Romans issued their first coin -- the "as," which was made of bronze. Traditionally, 100 of these were equal to one cow. In later years, Julius Caesar authorized the minting of the gold "aureus," which became one of the most widely used coins in the ancient world for more than 300 years. Smaller denominations of Roman coins that did not contain gold or silver were struck with "sc," the seal of the Roman Senate, to bolster their acceptability. While these smaller denomination coins had no value in and of themselves, they were widely accepted because of the prestige of the gold aureus. This was one of the first successful examples of the circulation of "fiat" currency -- currency that is valuable because of its purchasing power rather than because of its precious metal content. This early attempt at using fiat currency failed in the fourth century when the Romans began issuing ever- increasing amounts of fiat coins to compensate for insufficient quantities of gold needed to mint the aureus, which was in demand throughout the empire. Huge budget deficits in the Roman government and a loss of confidence in coins caused catastrophic inflation that eventually destroyed the Roman monetary system. Ironically, it was during the post-Roman era that the Roman "solidus" became the most enduring coin in history, circulating throughout Europe and the Near East for more than 700 years. The solidus owes its incredible longevity to its largely unchanged appearance and gold content over time, which helped to maintain public confidence in the coin. While coins remained the primary medium of exchange for centuries, during the Crusades people sought alternatives as travel become more common. The precursor to European paper money was born in the form of "letters of credit" -- promissory notes between two parties that generally could not be cashed by anyone else. The use of these letters was aimed at thwarting highway bandits who wanted coins, not paper, which was impossible for them to cash. The Europeans were not the first people to discover the advantages of using paper money. Its ancient ancestor can be traced back to about 2,500 B.C. to the clay tablets on which the Babylonians wrote bills and receipts. The Tang Dynasty in China issued the first known paper money in 650, and the earliest piece of currency that exists today -- a Chinese 10-kuan note -- dates back to this time. Centuries later, in 1273, Marco Polo reported that the Mongol Emperor Kublai Khan issued mulberry bark paper notes in China bearing his seal and the signature of his treasurers. Marco Polo described the monetary system: "All these pieces of paper are issued with as much solemnity and authority as if they were pure gold and silver...and the Khan causes every year to be made such a vast quantity of this money, which costs him nothing, that it must be equal in amount to all the treasure in the world." With an overabundance of fiat currency in circulation, it is not surprising to learn that the Mongol-imposed monetary system suffered terrible inflation; eventually the Mongols left China. A major step in the development of paper money took place in 1661 when the Stockholm Banco of Sweden issued the first bank notes, which were private obligations of the bank and could be redeemed there in gold or silver by the bearer. Because redemption in precious metals was guaranteed, many people had enough confidence in the value of the notes to exchange them for goods and services. However, Swedish merchants feared that the notes would be bought up by foreigners who would redeem them and eventually deplete Sweden's gold and silver reserves. The issue lasted only one year. In the 17th century, colonists settling in North America brought coins with them, but most of these were quickly returned to Europe to pay for goods that were not produced in the colonies. This led to a shortage of coins, so Indian wampum -- beads of polished shells strung in strands -- was widely used as money throughout the colonies. However, when settlers learned to counterfeit wampum, it lost its value. In addition to wampum, the colonists also used as money those items that were staples of the local economies because they were always in demand. For example, in Virginia it was tobacco, and in Massachusetts it was grain and fish. Nails and bullets frequently were used for small change. After trade between the colonies and the West Indies developed, Spanish eight-reales coins circulated widely. These coins, known as "pieces of eight." were used until 1857. They were frequently cut to make change: Half a coin was "four bits" and a quarter section was "two bits" -- a slang expression for the modern American quarter. The first coin struck in the colonies was the pine tree shilling -- which bore a picture of a pine tree -- in a Boston mint in 1652. All issues of the coin, even those struck in later years, claim that no additional coins had been minted since 1652, in case the British Crown decided to enforce its ban on the colonists producing their own coins. Despite the efforts of the colonists, the British shut down the mint in 1686. During the 18th century, again contrary to British wishes, hundreds of different types of paper notes were printed throughout the colonies. Those notes, issued before the American Revolution, usually were denominated in pounds and shillings and made reference to the Crown of England for credibility. Some colonies issued too many bills, however, and their value quickly sank to small fractions of their face amount, making trade between colonies difficult. Despite the depreciation, these bills helped offset economic slumps caused by a scarcity of metallic money in an expanding economy. Before the start of the American Revolution, the Continental Congress, facing huge expenses without adequate taxing power, authorized a limited issue of currency in 1775 -- the first paper currency issued by what was to become the United States. These notes, called continentals, were printed from plates engraved by Paul Revere to read "The United Colonies" and sometimes even depicted colonial minutemen. They had no backing in gold or silver and could be redeemed only if and when the colonies became independent. In January, 1776, the Continental Congress made it treason for people not to accept continentals or to discourage their circulation in any way. In 1777, after the Declaration of Independence, the first notes bearing "The United State" were issued. However, because people were reluctant to accept paper money, well-known revolutionary figures were asked to sign the notes to give them credibility. For about a year and a half, continentals changed hands at close to face value, but this stability was short-lived. People hoarded goods and coins during the war, which caused inflation. As a result, continentals became basically worthless. As George Washington commented: "A wagon-load of money will scarcely purchase a wagon-load of provisions." The currency's vanishing value led to the expression for worthlessness that remains today -- "not worth a continental." The failure of continentals produced a deep mistrust of paper money throughout the colonies. However, the brief period when continentals circulated successfully was significant because it marked the first time that the worth of U.S. currency lay in its purchasing power, as it does today, and not in its intrinsic value. After the failure of continentals, more than 70 years passed before the federal government would issue paper money again. However, until then, state-chartered banks made up for the lack of a national currency by issuing their own paper notes, which were obligations of individual banks. These state-bank notes became the dominant form of currency used between the time of the American Revolution and the Civil War. Each bank designed its own notes, so they differed in size, color, and appearance. By 1860, an estimated 8,000 different state-banks were circulating what were sometimes called "wildcat" or "broken" bank notes in denominations from $1 to $13. The nickname wildcat came about because some of the less reputable banks were located in low-population areas and were said to attract more wildcats than customers. People also called the notes broken bank notes because of the frequency with which some of the banks failed, or went broke. Because these notes had varying degrees of acceptability and were not always redeemable in gold or silver on demand, they often circulated at substantial discounts from face value. These conditions made counterfeiting relatively easy and bogus notes abounded. In 1861, in an effort to finance the Civil War, the federal government issued the first paper money since continentals. The demand notes of 1861 were popularly called "greenbacks" because of the color on their reverse side. In 1862, Congress issued $150 million of legal tender notes, more commonly known as United States notes, and retired the greenbacks. These new notes were the first that were made legal tender for all debts, except import duties and interest on the public debt. Confidence in U. S. notes began to decline when the Treasury stopped redeeming them in coins during the Civil War to save gold and silver. However, redemption resumed in 1879. Even though U. S. notes were generally accepted, most paper currency circulating between the Civil War and the First World War consisted of national bank notes. This currency, uniform in size and general appearance, was issued by thousands of banks across the country. The federal government granted charters to these banks under the National Bank Acts of 1863 and 1864, allowing the banks to issue notes using U. S. government securities as backing. From 1863 to 1877, the notes were printed privately, but in 1877, the Bureau of Engraving and Printing -- a division of the U. S. Department of the Treasury -- assumed responsibility for printing all notes. During the late 19th century, the U. S. government increased its reserve of precious metals by offering certificates in exchange for deposits of gold and silver. In the late 1950s, rising world demand for silver as an industrial metal began pushing up its price. To avoid the possibility that the value of silver in coins might exceed the face value, the Treasury began selling silver from its stockpile in the open market to keep the price of silver low. However, demand continued to be high and soon threatened the Treasury's silver inventory, so Congress took steps to reduce the amount of silver in American coins. In 1964, the silver content of half dollars was reduced from 90 percent to 40 percent and, in 1970, was eliminated entirely. Silver also was eliminated from quarters and dimes in 1965. The elimination of silver from all U. S. coins completed the transition of American currency from money of intrinsic value to fiat money, the value of which lies in its wide acceptability and purchasing power. In 1971 the United States made a decision that marked the beginning of the end of the international system of fixed exchange rates. America closed its "gold window". Foreign central banks were thus prevented from converting their holdings of dollars into gold at the official price. For the first time in history, the world's principal currencies were shorn of all links to the value of any real commodity. Henceforth the value of money - that is, the stability of prices - was entirely at the discretion of governments. Before long, inflation was raging almost everywhere. Governments throughout history have tampered with the link between currencies and underlying measures of value. Whenever wars or other emergencies required it, they have become monetary cheats -- fiddling with the convertibility of their currencies and at times suspending it altogether, raising revenue either by depreciating their coins (explicitly reducing their weight) or debasing them (secretly reducing the proportion of precious metal). Since ancient times, whenever private mints found that the fees (or seignorage) for weighing, certifying and coining their customers' precious metal was earning them a nice profit, governments began to monopolize the business for themselves. That way, they found, the currency could be more conveniently debased whenever their battles for territory demanded extra money. This technology of expropriation (monetary policy, as it is now known) took its greatest leap forward with the advent of fiat currency. Governments printed intrinsically worthless bits of paper, called them legal tender, and required their subjects on pain of imprisonment to give them goods and labor in exchange. For governments, the idea was understandably attractive. They surrounded the process with the mystique of sovereignty to make the confidence trick more plausible. In many countries counterfeiting was not merely fraud but treason. Similarly, in the present debate over European monetary union, it is said that the creation of a European central bank would be an attack on the sovereignty of the member states. Viewed in a historical perspective, that warrants a hollow laugh: the sovereignty in question is the right of a government to steal from its citizens. The only check on these otherwise excellent opportunities for theft was the promise to redeem paper money for an asset of intrinsic value, such as gold. For a long time that was a serious inconvenience, because until around the middle of this century people thought the promise ought to be kept. By 1971 it had already been badly undermined; the closing of the gold window finished the job. The power of the state took another large and possibly irreversible step forward. The world will not return to the gold standard. As history has shown, modern governments are now big enough to rig the gold market, or the market for any other single commodity, without much trouble. The dropping of the gold standard by governments means that they have now lost interest in manipulating the price of gold, since it no longer has a relation to their currencies. This is important to investors in gold, which now takes on a private significance as a hedge of value. The history of money has been given here at length for a very important reason. It is important to not only have a feeling that something is wrong, and that United States currency and investments are at risk, but to understand fully the reasons why this is so. It is very important to realize that these patterns of history constantly repeat, and have done so for centuries. The current political rhetoric of a new administration in Washington cannot change the inevitable course of history, nor can it reverse the downhill slide that is well under way. All governments and a fiat monies have their problems, but some are better than others, and looking at the comparative strengths and values is important to preserving your wealth. The Swiss franc is more than a paper currency -- it is backed by gold -- the only currency left in the world that still is backed by gold. Swiss law requires a minimum 40% gold reserve for the Swiss franc, and the actual reserves are about 56%. But this is very misleading, because the gold is carried on the Swiss central bank's books at the old "official" purchase price of US$42 per ounce. So with the current prices of gold, the gold backing per Swiss franc is actually many, many times its face value. No other currency is in this position. To protect wealth properly, an investor must act on his own, know why he is doing so, and not drift along waiting for a political solution that history has shown is impossible.