Debt (62 page)

If one looks at the actual history, though, it quickly becomes clear that all of these new forms of money in no way undermined the assumption that money was founded on the “intrinsic” value of gold and silver: in fact, they reinforced it. What seems to have happened is that, once credit became unlatched from real relations of trust between individuals (whether merchants or villagers), it became apparent that money could, in effect, be produced simply by saying it was there; but that, when this is done in the amoral world of a competitive marketplace, it would almost inevitably lead to scams and confidence games of every sort—causing the guardians of the system to periodically panic, and seek new ways to latch the value of the various forms of paper back onto gold and silver.

This is the story normally told as “the origins of modern banking.” From our perspective, though, what it reveals is just how closely bound together war, bullion, and these new credit instruments were. One need only consider the paths
not
traveled. For instance: there was no intrinsic reason why a bill of exchange couldn’t be endorsed over to a third party, then become generally transferable—thus, in effect turning it into a form of paper money. This is how paper money first emerged in China. In Medieval Europe there were periodic movements in that direction, but for a variety of reasons, they did not go far.
⁷⁴
Alternately, bankers can produce money by issuing book credits for more than they have on cash reserve. This is considered the very essence of modern banking, and it can lead to the circulation of private bank notes.
⁷⁵
Some moves were made in this direction as well, especially in Italy, but it was a risky proposition, since there was always the danger of depositors panicking and making a run, and most Medieval governments threatened extremely harsh penalties on bankers unable to make restitution in such cases: as witnessed by the example of Francesch Castello, beheaded in front of his own bank in Barcelona in 1360.
⁷⁶

Where bankers effectively controlled Medieval governments, it proved safer and more profitable to manipulate the government’s own finances. The history of modern financial instruments, and the ultimate origins of paper money, really begin with the issuing of municipal bonds—a practice begun by the Venetian government in the twelfth century when, needing a quick infusion of income for military purposes, it levied a compulsory loan on its taxpaying citizens, for which it promised each of them five percent annual interest, and allowed the “bonds” or contracts to become negotiable, thus, creating a market in government debt. They [the Venetian government?] tended to be quite meticulous about interest payments, but since the bonds had no specific date of maturity, their market prices often fluctuated wildly with the city’s political and military fortunes, and so did resulting assessments of the likelihood that they would be able to be repaid. Similar practices quickly spread to the other Italian states and to northern European merchant enclaves as well: the United Provinces of Holland financed their long war of independence against the Hapsburgs (1568–1648) largely through a series of forced loans, though they floated numerous voluntary bond issues as well.
⁷⁷

Forcing taxpayers to make a loan is, in one sense, simply demanding that they pay their taxes early; but when the Venetian state first agreed to pay interest—and in legal terms, this was again
interesse
, a penalty for late payment—it was in principle penalizing itself for not immediately giving the money back. It’s easy to see how this might
raise all sorts of questions about the legal and moral relation between people and government. Ultimately, the commercial classes in those mercantile republics that pioneered these new forms of financing did end up seeing themselves as owning the government more than they saw themselves as being in its debt. Not only the commercial classes: by 1650, a majority of Dutch households held at least a little government debt.
⁷⁸
However, the true paradox only appears when one begins to “monetize” this debt—that is, to take government promises to pay and allow them to circulate as currency.

While already by the sixteenth century, merchants were using bills of exchange to settle debts, government debt bonds—
rentes, juros
, annuities—were the real credit money of the new age. It’s here that we have to look for the real origins of the “price revolution” that hammered once-independent townsfolk and villagers into the ground and opened the way for most of them to ultimately be reduced to wage laborers, working for those who had access to these higher forms of credit. Even in Seville, where the treasure fleets from the New World first touched port in the Old, bullion was not much used in day-to-day transactions. Most of it was taken directly to the warehouses of Genoese bankers operating from the port and stored for shipment east. But in the process, it became the basis for complex credit schemes whereby the value of the bullion was loaned to the emperor to fund military operations, in exchange for papers entitling the bearer to interest-bearing annuities from the government—papers that could in turn be traded as if they were money. By such means, bankers could almost endlessly multiply the actual value of gold and silver they held. Already in the 1570s, we hear of fairs in places like Medina del Campo, not far from Seville, that had become “veritable factories of certificates,” with transactions carried out exclusively through paper.
⁷⁹
Since whether the Spanish government would actually pay their debts, or how regularly, were always slightly uncertain, the bills would tend to circulate at a discount—especially as
juros
began circulating throughout the rest of Europe—causing continual inflation.
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It was only with the creation of the Bank of England in 1694 that one can speak of genuine paper money, since its banknotes were in no sense bonds. They were rooted, like all the others, in the king’s war debts. This can’t be emphasized enough. The fact that money was no longer a debt owed
to
the king, but a debt owed
by
the king, made it very different than what it had been before. In many ways it had become a mirror image of older forms of money.

The reader will recall that the Bank of England was created when a consortium of forty London and Edinburgh merchants—mostly already
creditors to the crown—offered King William III a £1.2 million loan to help finance his war against France. In doing so, they also convinced him to allow them in return to form a corporation with a monopoly on the issuance of banknotes—which were, in effect, promissory notes for the money the king now owed them. This was the first independent national central bank, and it became the clearinghouse for debts owed between smaller banks; the notes soon developed into the first European national paper currency. Yet the great public debate of the time, a debate about the very nature of money, was about not paper but metal. The 1690s were a time of crisis for British coinage. The value of silver had risen so high that new British coins (the mint had recently developed the “milled edge” familiar from coins nowadays, which made them clip-proof) were actually worth less than their silver content, with predictable results. Proper silver coins vanished; all that remained in circulation were the old clipped ones, and these were becoming increasingly scarce. Something had to be done. A war of pamphlets ensued, which came to a head in 1695, one year after the founding of the bank. Charles Davenant’s essay on credit, which I’ve already cited, was actually part of this particular pamphlet-war: he proposed that Britain move to a pure credit money based on public trust, and he was ignored. The Treasury proposed to call in the coinage and reissue it at a 20- to 25-percent lower weight, so as to bring it back below the market price for silver. Many who supported this position took explicitly Chartalist positions, insisting that silver has no intrinsic value anyway, and that money is simply a measure established by the state.
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The man who won the argument, however, was John Locke, the Liberal philosopher, at that time acting as advisor to Sir Isaac Newton, then Warden of the Mint. Locke insisted that one can no more make a small piece of silver worth more by relabeling it a “shilling” than one can make a short man taller by declaring there are now fifteen inches in a foot. Gold and silver had a value recognized by everyone on earth; the government stamp simply attested to the weight and purity of a coin, and—as he added in words veritably shivering with indignation—for governments to tamper with this for their own advantage was just as criminal as the coin-clippers themselves:

Therefore, he argued, the only recourse was to recall the currency and restrike it at exactly the same value that it had before.

This was done, and the results were disastrous. In the years immediately following, there was almost no coinage in circulation; prices and wages collapsed; there was hunger and unrest. Only the wealthy were insulated, since they were able to take advantage of the new credit money, trading back and forth portions of the king’s debt in the form of banknotes. The value of these notes, too, fluctuated a bit at first, but eventually stabilized once they were made redeemable in precious metals. For the rest, the situation only really improved once paper money, and, eventually, smaller-denomination currency, became more widely available. The reforms proceeded top-down, and very slowly, but they did proceed, and they gradually came to create the world where even ordinary, everyday transactions with butchers and bakers were carried out in polite, impersonal terms, with small change, and therefore it became possible to imagine everyday life itself as a matter of self-interested calculation.

It’s easy enough to see why Locke would adopt the position that he did. He was a scientific materialist. For him, “faith” in government—as in the quote above—was not the citizens’ belief that the government will keep its promises, but simply that it won’t lie to them; that it would, like a good scientist, give them accurate information, and who wanted to see human behavior as founded in natural laws that—like the laws of physics that Newton had so recently described—were higher than those of any mere government. The real question is why the British government agreed with him and resolutely stuck to this position despite all the immediate disasters. Soon afterward, in fact, Britain adopted the gold standard (in 1717) and the British Empire maintained it, and with it the notion that gold and silver
were
money, down to its final days.

True, Locke’s materialism also came to be broadly accepted—even to be the watchword of the age.
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Mainly, though, the reliance on gold and silver seemed to provide the only check on the dangers involved with the new forms of credit-money, which multiplied very quickly—especially once ordinary banks were allowed to create money too. It soon became apparent that financial speculation, unmoored from any legal or community constraints, was capable of producing results that seemed to verge on insanity. The Dutch Republic, which pioneered the development of stock markets, had already experienced this in the tulip mania of 1637—the first of a series of speculative “bubbles,” as they came to be known, in which future prices would first be bid through the ceiling by investors and then collapse. A whole series of
such bubbles hit the London markets in the 1690s, in almost every case built around a new joint-stock corporation formed, in imitation of the East India Company, around some prospective colonial venture. The famous South Sea Bubble in 1720—in which a newly formed trading company, granted a monopoly of trade with the Spanish colonies, bought up a considerable portion of the British national debt and saw its shares briefly skyrocket before collapsing in ignominy—was only the culmination. Its collapse was followed the next year by the collapse of John Law’s famous Banque Royale in France, another central-bank experiment—similar to the Bank of England—that grew so quickly that within a few years it had absorbed all the French colonial trading companies, and most of the French crown’s own debt, issuing its own paper money, before crashing into nothingness in 1721, sending its chief executive fleeing for his life. In each case, this was followed by legislation: in Britain, to forbid the creation of new joint-stock companies (other than for the building of turnpikes and canals), and in France, to eliminate paper money based in government debt entirely.

It’s unsurprising, then, that Newtonian economics (if we may call it that)—the assumption that one cannot simply create money, or even, really, tinker with it—came to be accepted by almost everyone. There had to be some solid, material foundation to all this, or the entire system would go insane. True, economists were to spend centuries arguing about what that foundation might be (was it really gold, or was it land, human labor, the utility or desirability of commodities in general?) but almost no one returned to anything like the Aristotelian view.