Review: What really creates the value of money

LONDON (Reuters Breakingviews) - “I promise to pay the bearer on demand the sum of twenty pounds”. Curious British children sometimes ask their parents the meaning of this statement, printed on every 20 pound note. Befuddled elders can find the answer in the excellent “Making Money: Coin, Currency and the Coming of Capitalism” by Christine Desan.

A woman poses with a Bank of England twenty pound note bearing the image of Edward Elgar in Edinburgh, Scotland June 29, 2010. REUTERS/David Moir

The 2014 book covers English monetary history from Anglo-Saxon days to the beginning of modern times, with a conclusion that takes in some current issues. It turns out that the words on the bank note are the last remnants of a longstanding lie about paper money. The untruth is that currency is only worth as much as the gold or silver that it can buy.

“Making Money” traces the history of the actual relationship between these valuable commodities, the coins used, and monetary accounts kept in England. British paper money started as a claim on the loan account from the Bank of England to the government.

The shareholders of the BoE, which was a privately owned institution until 1946, worried that people would not accept the notes unless the government promised that they could be cashed in for gold coin. So like the father in the story of Rumpelstiltskin, who said his daughter could spin straw into gold, the BoE promised to turn paper money into precious metal.

But there was no little man to perform miracles on Threadneedle Street. There was just a polite fiction. The store of gold was always far too small to match the issue of notes. In 1797, when too many people actually asked for gold, the BoE arranged for parliament to free it from the commitment to convertibility.

The fiction of gold backing was restored in 1821, in what came to be known as the gold standard. The always-false promise of gold repayment was finally abandoned a little more than century later, leaving only the printed words to confuse attentive children.

The presence or absence of gold pseudo-backing has no effect on the value of notes. That’s because the value of money does not come from any tangible commodity. It is always created and protected by some public authority, because the money system is deeply embedded in society.

In other words, money is always and everywhere what Desan calls a governance project or a constitutional undertaking. A professor of law at Harvard University, she cites evidence from her own field and also from history and philosophy, with a bit of anthropology and sociology thrown in.

Governance comes with governments. While private banks create most of the money supply these days, the ultimate political authority still provides the ultimate guarantee of monetary value. No other person or organisation can persuade people to accept a token which “must deliver value immediately… for strangers as well as friends, for those without trust or further contact as well as those who can reciprocate at a later time”.

Desan shows how the English system gradually changed. For centuries, people paid the government some quantity of gold or silver to turn the rest of their specie into state-approved coins. By the beginning of the 18th century it was the government which paid interest on debts that were converted into paper money, and which allowed bank accounts to be denominated in the same currency. Unlike coins of precious metal, the supply of the new gold-free money expanded along with England’s commercial and industrial economy.

The journey from coins to accounts was marked by scandals, crises and depressions. Sometimes the government ignored or even abetted monetary excesses; sometimes it put disastrous limits on the supply of money.

The path might have been smoother if more people had understood earlier that money was essentially man-made. Then again, public trust in what was actually fiat money may have been enhanced by Bank of England’s sincere belief in the untruth that this backing existed. Desan calls the gap between the belief and the reality “deeply ironic”.

Though “Making Money” is a history, the past sheds light on some current questions: First, ridicule is the right response to suggestions that government-backed money could give way to gold or some private system using an electronic token. Money and states are too intimately entwined ever to be separated.

Second, the control of money is political rather than technical. A central bank’s monetary policy requires essentially political judgments between debtors who welcome unexpected inflation and creditors who gain from stable prices. And there are no technocratic answers to the question of who should suffer when the monetary system goes wrong.

Third, there is nothing natural or inevitable about letting profit-seeking private banks control the money supply. They only acquired this role through a historical accident, and they are excessively prone to economically damaging mood swings. Besides, financiers are probably the wrong group of people to entrust with a responsibility so central to the common good.

Finally, here’s some advice for BoE Governor Mark Carney. The next time you approve a new design for a banknote, get rid of the “promise to pay”. Parents will be grateful.


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