The history of paper money, banking, the gold standard, and fiat money in 10 minutes

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Knowing a little about the history of money is important in understanding the significance of a breakthrough like Bitcoin. In his previous article, Marquez Comelab wrote about the early forms of money like cows, rice, and shells, among many others, to the more durable and portable gold and silver coins. In this article, Marquez takes you through a condensed history of how paper money invented in China over a thousand years ago, combined with the development and use of banking, accelerated the evolution of the monetary and financial system we have today.

After the Lydians—an ancient civilization between 1200 BC to 546 BC— introduced standardized coins between 640 and 630 BCE, commerce became easier, quicker, and more efficient than ever. It spurred several hundred years of commercial explosion that reverberated worldwide. As trade became more popular and individual transactions increased in value, using coins posed a problem: large amounts of coins were too heavy and not secure to move around because they attracted thieves and bandits.

Paper money

Halfway around the world from the Greeks and Romans were the Chinese, who shared the same problem of coins becoming burdensome to carry around. But after the Chinese invented paper (200 BCE and 105 CE), they figured out that, before traveling, merchants could deposit their coins with a trusted person who gave them a slip of paper (a receipt) that recorded how much money was deposited. When the merchants returned, they presented the receipt to the trusted person and got their coins back.

In the 7th century, Chinese merchants started issuing what we would call promissory notes in the form of these receipts of deposits to transact with each other¹. Instead of exchanging coins, they were exchanging pieces of paper. The Chinese government realized the economic advantages of printing paper money, and they became the first in the world to print fiat currency in 1120.

How the Chinese used paper as money was reported in Europe by travelers such as William of Rubruck and the merchant Marco Polo who wrote about it in his book, “The Travels of Marco Polo”:

“All these pieces of paper are, issued with as much solemnity and authority as if they were of pure gold or silver… and indeed everybody takes them readily, for wheresoever a person may go throughout the Great Kaan’s dominions he shall find these pieces of paper current, and shall be able to transact all sales and purchases of goods by means of them just as well as if they were coins of pure gold.”

As the news and reports of the use of paper money arrived in Europe, the first banks were already established.

The origins of banking: The Templar Knights and the Italian banking families

The development of banking began in the 12th century by a group of religious knights known as the “Military Order of the Knights of the Temple of Solomon,” otherwise known as the Templars. Their Order was founded in 1118². Their purpose was to fight for the Catholic Church against Muslims and other Infidels in Jerusalem. It is somewhat ironic that these devoutly religious and fierce warriors turned out to be the first bankers in the world. How did this happen?

After the Christians captured Jerusalem from Muslim conquerors in 1099, Christians made pilgrimages to various sacred sites in the Holy Land. Many of these Christians were preyed upon by bandits and highwaymen who ambushed and slaughtered them³. For this reason, the Poor Knights of Christ and the Temple of Solomon was established. Their obligation was to protect these Christian pilgrims as they traveled to the Holy Land⁴.

The Templars were primarily recruited from “the younger sons of nobility, who inherited no titles or riches” and “pledged themselves to a life of devotion to the church”⁵. Their Order began with humble beginnings. Even their emblem was of two knights riding on a single horse to emphasize the Order’s poverty⁶. However, because of the popular support of the Crusades throughout Christendom (the Christian world), the Order began to accumulate assets relatively quickly.

The Pope allowed them to keep whatever they seized from the Muslims in the areas they captured during the Crusades. Further, they received gifts such as the one given by King Henry II of England in 1170. The donation was enough to support 200 knights for a year, with an extra 15,000 marks for each Templar. Over the years, they began acquiring more land and real estate designated to support the Crusades.

In his book, “The History of Money,” Jack Weatherford explains, “Because the Templars owned some of the mightiest castles in the world and because they constituted one of the fiercest fighting forces of the time, their castles served as ideal places in which to deposit money and other valuables. The fierce and respected Templars also offered an ideal means of transporting such valuables over long distances, and even across the Mediterranean, since they exercised responsibility for safety on highways and in the shipping lanes.”⁷ 

Eventually, the Templars’ castles became full-servicing banks as they began administering funds gathered to finance the Crusades, supervised mortgages, and even made loans to kings and other nobility. The Templars expanded their operations throughout Christendom, becoming the world’s first multinational corporation⁸, employing 7,000 people, with 870 castles and houses across Europe and the Mediterranean⁹. They built a truly international financial institution that lasted for about 200 years until 1312 when Pope Clement V officially abolished the Order¹⁰.

During the 14th and 15th centuries, in the north Italian cities of Pisa, Florence, Venice, Verona and Genoa, families like the Bardi, Peruzzi and the Medici began to offer the same services as the Templars did. Unlike the Templars, however, they provided their services not just to nobility but to everyone. It also did not matter if you were a Jew, Muslim, Christian, or Pagan. They did not confine themselves to doing business in churches either. Instead, they went where the ordinary people were. In fact, the very word “bank” comes from the Italian word “banco,” which means “table” or “bench,” because these families attended fairs and marketplaces, where they set up tables or large benches on which they could exchange money, make loans, arrange payments, and other services. People looked for these “tables”/“banks” to do “banking.” 

Banknotes

With the invention of paper, the Templars and the Italian banking families brought about the common use of agreements written on paper we now call promissory notes. These notes initially helped people travel without physically carrying large amounts of gold and silver. 

Let’s say you needed to travel from Paris to Flanders because you wanted to buy a farm there. You needed to pay the owner gold coins. Instead of travelling with precious coins and risk being robbed, you deposited them to a banker in Paris. The banker in Paris issued you a note confirming you deposited a certain number of coins with him. Once you got to Flanders, you went to a local banker there. You presented him the note that the depositor in Paris had given you. The depositor in Flanders would then provide you with the equivalent number of coins you deposited in Paris.

The notes initially specified the person’s name who could claim the valuables deposited in banks. But in mid-17th Century London, goldsmith bankers stopped specifying the person’s name who could claim deposited gold. Instead, they allowed the bearer—whoever was holding the note—to claim whatever amount of gold was written on the note¹¹.

Eventually, people realized that exchanging these notes as currencies for goods or services was more convenient. It bypassed the need for buyers to withdraw gold and give it to sellers, who then had to deposit the gold with their bankers. This is how the early promissory notes effectively became paper currencies in Europe. The first bank to initiate the permanent issue of banknotes was the Bank of England. In 1844, the Bank of England was established to be the very first modern central bank. At the start, it was only allowed to issue new banknotes with new gold to back it up or when it was backed by government debt.

The Gold standard and fiat money

The idea that the value of money is tied to the value of gold is referred to as the Gold Standard. The Gold Standard has been the basis of international monetary systems since 1870. It was further adopted, encouraged, and entrenched globally by the Bretton Woods System agreed on by most countries after the war in 1944. Nations agreed that the value of their currencies was stated in terms of the U.S. dollar, and U.S. dollars could be exchanged for gold.

In 1971 however, nations began dropping out of the Bretton Woods system. By 1973, it was officially over. The value of a nation’s currency was no longer backed by how much gold that nation had in its vaults. Instead of national currencies being valued by how much they were worth in U.S. dollars, and by implication, how much gold they could be exchanged for, the values of currencies were expressed in terms of their exchange rates with other currencies. We refer to these types of money as fiat money. The word “fiat” comes from Latin, meaning “let it be done.” It is called this because a government declares that it is money. 

Many people presume that we are still using the Gold Standard and believe that the value of their money is being backed by their nation’s wealth, like gold bars under the protection of their national treasuries. But our modern-day fiat money is no longer backed by a commodity like gold or silver. Unlike gold or silver coins that could be valued by the amount of precious metal they contained, fiat money has no intrinsic value. Further, beyond its use as a medium of exchange, fiat money has no other use apart from probably a harsh-textured replacement for toilet paper. Fiat money is not as useful, valuable, or helpful as the commodities our ancestors once used for money. Cows produced milk, and bulls helped tilled farms. And where agricultural products were used as money, people could still eat the rice and barley in their storage when they got hungry. Eating the coins and paper money in your wallet today definitely does not provide the same sustenance. 

Summary and contemplation

This article went through a concise, digestible history of money. We started from when standardized coins were introduced by the Lydian civilization (640 and 630 BCE). Then the Chinese invented paper (2nd century), and later paper money (7th century). They demonstrated how mere paper could be accepted for goods and services to the Europeans (13th century), who had just introduced banking to the world (12th century). With the combination of paper money and banking, our monetary and financial systems evolved rapidly to the form we see today.

The use of money is ubiquitous in the modern world, and to know its story is important to understand our lives and the world we are creating. It is not easy to disassociate money from the institutions that form the systems built to control it. We have all grown up in a world where money is produced, directed, and managed by institutions involving central banks, banks, and governments, all costing billions of dollars to operate and maintain—costs that are eventually passed on to us as consumers or as taxpayers. But does controlling money have to be so complex? Does it have to be so costly? 

Money is demystified by condensing the history of money and banking and how they began and evolved. Money is something our ancestors developed and evolved into exchanging goods and services they wanted and needed for themselves and their families. And if you think about it, this is what still matters. If we can therefore reimagine a form and a system of money that simplifies the process and reduces the costs of exchanging things of value, and make it easier and faster for anyone to transact all over the world, shouldn’t we utilize it?

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References:

[1] Ebrey; Walthall; Palais (2006). East Asia: A Cultural, Social, and Political History. Boston: Houghton Mifflin Company. ISBN 978-0-6181-3384-0.

[2] Jack Weatherford, The History of Money (New York: Three Rivers Press, 1997), p95

[3] Burman, Edward (1990). The Templars: Knights of God. Rochester: Destiny Books. ISBN 978-0-89281-221-9.

[4] Burman, Edward (1990). The Templars: Knights of God. Rochester: Destiny Books. ISBN 978-0-89281-221-9.

[5] Jack Weatherford, The History of Money (New York: Three Rivers Press, 1997), p95

[6] Read, Piers (2001). The Templars. New York: Da Capo Press. ISBN 978-0-306-81071-8.

[7] Jack Weatherford, The History of Money (New York: Three Rivers Press, 1997), p97

[8] Ralls, Karen (2007). Knights Templar Encyclopedia. Career Press. p. 28. ISBN 978-1-56414-926-8.

[9] Jack Weatherford, The History of Money (New York: Three Rivers Press, 1997), p98.

[10] Tragically, after about 200 years of service, the biggest international financial institution at the time, came to its end, when the indebted French monarchy under King Philip IV, in desperate need of money, began a seven-year campaign to annihilate the Templars and ransack their wealth to solve his financial problems.

[11] Faure AP (6 April 2013). “Money Creation: Genesis 2: Goldsmith-Bankers and Bank Notes”. Social Science Research Network. SSRN 2244977.