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The Melting Ice Cube Series - Part 2: A Brief History of Money

May 10, 2021

The Melting Ice Cube Series - Part 2: A Brief History of Money

Since this series is primarily concerned with the question "What is money?" it’s necessary that we at least have a general historical perspective of humanity’s relationship with money. What money have we used in the past, and how has it changed as humanity came into contact with successively superior forms of money?

We weren't always using rands and dollars. Money, just like technology, language and life itself, evolves. In fact, the most recent form of money, fiat, will only be 50 years old in 2021. More on this topic in a moment.

 

The traits of sound money 

Examples of primitive forms of money are numerous: shells, salt, glass beads, cattle, rare stones etc. These early forms of money were by no means perfect and lacked several of the characteristics of sound money as outlined below:

The hardness of money is its resistance to unpredictable supply increases and debasements of value. Fungibility requires that units are interchangeable and indistinguishable from one another. Portability is the ease with which monetary units can be transported and transmitted across distances. Durability entails the resistance of monetary units to rot, corrosion or deterioration of value. Divisibility is the ease at which monetary units can be subdivided or grouped. Security is the resistance to counterfeiting or forgery.

Of the traits listed above, hardness is the most essential. Historically, only truly scarce and hard-to-acquire items could function as a reliable form of money - scarcity was the critical element. This scarcity could be unlocked by expending tremendous amounts of human time and energy. In other words, it was a challenging process to come into the possession of this scarce item. The harder it is to create this money by expending time and energy, the harder the actual money is. That is why humanity eventually settled globally on gold as the superior form of money: it had an annual inflation rate that was closest to zero and satisfied the majority of the critical traits of money. Eventually, even silver was demonetised in most parts of the world as the supply could more easily be inflated by expending more energy. With gold, this was the hardest to do.

 

Money hacking and the birth of inflation

Terrible human tragedies have occurred in the past where different groups of people came into contact with others using relatively “softer” forms of money. Inevitably, one group's money could easily be "hacked" by the technologically superior group. 

For example, when Portuguese and other European traders came into contact with West Africans exchanging tiny glass beads on the Gold Coast, known as aggry beads, they realised that the West African people had no interest in their foreign money. The Portuguese, however, had access to Venetian glass-making technology which was lightyears ahead of the West Africans at the time. These traders went back to Europe, accumulated many cheap glass beads, and flooded the Gold Coast’s “scarce" money with cheap money. The aggry bead had been hacked. The Portuguese proceeded to trade everything of actual value - food, clothing, cattle, land and so on - for worthless glass beads. It was time and value theft on a monumental scale. The scarcity of West African money was corrupted, and a world of value was confiscated.

There are various other examples of this type of “money hack” occurring throughout history. Another interesting example of this happened on the island of Yap in Micronesia, where the Yapese’s precious Rai Stones could be quickly and cheaply created by an Irish-American captain and his crew who got shipwrecked on the shores of Yap.

Rai Stones on the Island of Yap

Rai Stones on the Island of Yap

Today, this same surreptitious form of theft is happening on a global scale that dwarfs these historical scenarios. The mechanism that makes this possible is commonly referred to as inflation, whereby more money is created and injected into the economy, supposedly to stimulate spending and economic growth. 

Inflation is taxation without representation - everyone who holds cash pays this tax - but since it’s not a direct payment, nobody notices or realises that their hard-earned value is slowly melting away. Historically, the rate of devaluation has been too gradual for us to feel the diminishing value and purchasing power of our money (much like the proverbial frogs in boiling water). Still, there is reason to believe that this is about to become increasingly evident in the years to come. 

 

What happened in 1971?

The reason that we’ve been able to uninhibitedly create money out of nothing for the past 50 years (as of 2021) is because of the following oft-forgotten moment in history:

In 1971, President Richard Nixon effectively abandoned the global gold standard. You can find the whole speech online, but here's the crucial snippet for context:

"In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation's currency is based on the strength of that nation's economy -- and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States."

- President Richard Nixon's address to the nation, 15 August 1971.

The Nixon Shock: birth of the global fiat monetary standard

Notice that word "temporarily"? Well, as it turned out, it was permanently. Thanks to the Bretton Woods Agreement, which was introduced after World War II, the dollar was backed by gold, and all other currencies were pegged to the dollar. Since Nixon suspended the convertibility of the dollar to gold, the tie to gold for the whole world was effectively broken. And so we entered into the age of fiat currency - the softest money we've ever had, controlled by governments and central banks (and by extension the wills and whims of those at the helm of these institutions).

Humanity’s money has changed and morphed throughout history based on relative scarcity and the technological capabilities of the time. Since our tie to gold was broken in 1971, money is no longer scarce. It is being created with no particular expenditure of time or energy at the discretion of global governments and central banks. It's all heading in one direction, sharing the inevitable fate of all fiat currencies throughout history: hyperinflation and ultimately, worthlessness. 

This form of money has profound implications on the state of society itself: rampant consumerism and short term preferences are a natural result of a form of money that incentivises immediate gratification (i.e. our collective time preference as society becomes higher and higher - we increasingly tend to neglect the longer-term consequences of our decisions in favour of the short-term). 

 

Where do we go from here?

The global fiat monetary experiment celebrates its 50th birthday in August 2021. Perhaps we should rather consider it the 50th anniversary of the gold standard being hacked. This seems more apt (and less celebratory).

Here is the main problem with having a select group of people able to control something as powerful as money itself: the temptation to breach the trust of the masses and abuse this power for personal gain is too great to resist. As the old adage goes: “Power tends to corrupt and absolute power corrupts absolutely”. 

In the next instalment of The Melting Ice Cube Series, we take a closer look at inflation from a numerical perspective and how seemingly small figures, compounded over time, melt the ice cube at an ever-increasing rate.


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