Foreign debt crises

 Economies and governments can accumulate debt to external creditors, meaning creditors from other parts of the world. External financing for productive investments can expand opportunities for economic development and accelerate economic growth. Just as households and businesses can sink too deeply into debt, countries and individual economies can accumulate debt to the point that external debt obligations cannot be met. Measures of indebtedness compare the amount of debt with income. A household with a moderate amount of debt can double its debt if its income doubles and remain only moderately in debt. If a country’s gross domestic product (GDP) doubles, it can double its external debt without increasing its debt burden. A country that is able to meet its external debt obligations is said to be able to “service” its debt.

Analysis of an individual country’s debt to the rest of the world takes on a macroeconomic perspective because it involves converting one currency into another currency. In addition to an individual borrower’s ability to repay, in the case of foreign borrowing there are aggregate credit conditions that must be met by the whole economy. Exceeding aggregate credit limitations can lead to sharp adjustments in domestic interest rates or exchange rates. Often a foreign debt is denominated in a foreign currency. In that case, a country must be able earn enough foreign currency in exports and capital inflows to service the debt. If a country’s debt is denominated in its own currency, it still needs to service its debt without upsetting exchange rates. A country can in effect default on its external or foreign debt by suspending convertibility of its domestic currency into foreign currencies. If a country is unable to earn sufficient foreign currency from exports and capital inflows to service its foreign debt, it can increase capital inflows by increasing domestic interest rates. These higher interest rates will be a burden on the economy and can force an economy into recession.

The debt that a sovereign government owes to external creditors is called “sovereign debt.” When a government defaults on obligations to external creditors, it is called a “sovereign debt crisis.” Russia, Ecuador, and Argentina furnish examples of outright debt default. Ukraine, Pakistan, and Uruguay avoided outright default through debt restructuring. Mexico, Brazil, and Turkey averted default with the help of large-scale support from the International Monetary Fund. Some debtor governments are more cooperative than others in resolving default situations. Uncooperative governments can harm the ability of private domestic corporations to access international debt markets. Risk of foreign debt default or restructuring appears to be lowest when total external debt as a percent of GDP is less than 49.7 percent, short-term debt as a percent of foreign currency holdings is less than 130 percent, public external debt is less than 214 percent of fiscal revenue, and the exchange rate not over appreciated above 48 percent (Manasse and Roubini, 2005, p. 40).

Economists have developed indicators to measure a degree of a country’s indebtedness. For poor, debt-laden countries, some type of debt restructuring is likely to occur when net present value of debt exceeds 200 percent of exports. For other, nonindustrial countries, it appears that the risk of debt exposure starts to rise when external debt as a percent of GDP rises above 40 percent (Daseking, December 2002). Countries can sustain higher debt ratios if exports are growing rapidly, or if exports represent a large proportion of GDP, or if a large share of external debt is denominated in domestic currency.

The United States is a debtor nation, but its debt ratios are well below the threshold levels that signal a possible foreign debt crisis. Given the role of the U.S. dollar as a world currency, it is not clear if the same debt–ratio threshold levels apply to the United States. The rise of foreign debt in the United States is worrisome to some observers. Easy access to foreign credit sometimes allows countries to delay painful but inevitable reforms.

Fur Money

Not surprisingly, the most northern and coldest countries of the world have made use of furs as a medium of exchange and store of value, particularly among the societies that advanced beyond the barter stage.

The most highly developed system of fur currency existed in medieval Russia, where the word for money was kuna, stemming from the skin of the marten (kunitza). The marten is a close relative of the sable, and its soft, thick, valuable fur is called sable. The use of fur currency stretched as far back as the eighth century a.d. The grand dukes of Moscow furnished furs to pay traveling expenses of ambassadors sent to foreign countries. Russian law codes from the eleventh and twelfth centuries suggest a fixed ratio between fur currency and silver coins. These codes made fines payable either in 5 metal kuna or two skins.

At first skins had to be complete to be acceptable in trade, including snouts and paws. As the demand for money expanded with trade, snouts, claws, and ears functioned as money. Eventually one-inch circles of skin with a government stamp met the need for a medium of exchange. These one-inch stamped circles may have been convertible in whole skins at a government depot, but the evidence is scanty.

Squirrel skins and hare skins also circulated as money, at least in certain areas. The smallest of the early Russian coins, the polushka, got its name from hare-skin currency. Ushka was the Russian word for “hare skin,” and pol meant half, suggesting it took two polushka coins to equal one hare skin.

The kuna monetary standard endured in Russia until late in the Middle Ages, lasting until 1409 in Pskov and until 1411 in Novgorod. Merchants of the Hanseatic League in Novgorod accepted Russian fur currency as an instrument of trade.

As Russia phased out its fur currency in favor of metallic currency, the northern colonies of the New World discovered the value of furs as a form of money. In 1673 the Council of Quebec decreed that bearskins be accepted in payments. On 17 September 1674 the same council defined moose skins as acceptable money, declaring that “no one is entitled to refuse them in payment of debt.” The records of the Hudson Bay Company show that furs continued to serve as money until the mid-nineteenth century. The company would sell a rifle to an Indian for a stack of beaver skins that reached as high as the rifle was tall. Twenty beaver skins bought a horse at Fort Saskatchewan in 1854, and one beaver skin a scalping knife. The various trading posts of the Hudson Bay Company counted their sales in terms of the number of beaver skins they collected, converting the values of other skins to beaver equivalents at a fixed ratio. Other skins have also served as money. The district of the Yukon used the skin of a mature land otter as a unit of value before beaver skins took over.

Furs shares many of the characteristics of other commodities that societies have recognized as money. Like precious metals and shells, furs sometimes met ornamental needs. Beaver skins also had religious significance for some Indian tribes. Also, furs resembled livestock in supplying the practical needs of survival in northern societies often besieged by harsh winters. These characteristics, combined with durability and ease of transportation, made furs a workable currency in remote areas where metallic currency was in short supply.

French Revolution Hyperinflation

The famous English economist John Maynard Keynes, commenting upon an observation of Lenin, wrote:

Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction. And does it in a manner which no one man in a million is able to diagnose.

(Keynes, 1920)

No doubt Lenin and Keynes were familiar with the role of inflation during the French Revolution.

In October 1789 the French National Assembly found itself in a desperate situation. Tax revenue fell far short of expenses, and the government survived day by day with advances from the Bank of Discount, a bank that largely loaned funds to the government. The bank declared itself out of funds, and the assembly needed resources to complete the Revolution. The assembly met the financial crises with two important and interrelated measures. It confiscated church lands and it created an “extraordinary treasury” charged with raising 400 million livres by selling assignats, which were certificates of indebtedness bearing 5 percent interest. The government announced its intention to sell the church property and take assignats in payment. The church property in effect served as collateral for the assignats.

The assignats met with less than a hearty reception because it was not clear which lands would be sold to creditors. In August 1790 the assembly turned assignats into bank notes and added an extra 800 million livres to the issue. The decree specified that the total number of assignats in circulation should never exceed 1,200 million livres. The new assignats bore no interest and could be acquired by anyone, whereas the first issue was available only to creditors of the government. Instead of just liquidating the national debt, the government took to issuing assignats to pay for deficit spending.

By mid-1792 the inflation horse was definitely out of the barn; prices rose 33 to 50 percent while wages lagged far behind. In January 1793 a mob stormed stores in Paris and in February a scarcity of soap sparked further riots. Mobs also obstructed grain shipments. In 1794 the government implemented a system of price controls known as the Law of the Maximum. People who refused to accept assignats in payment or accepted them (or paid them) at a loss, could be fined 3,000 livres and imprisoned six months for the first offense. The fine and imprisonment could be doubled for the second offense. Speculation in specie and assignats could bring six years’ imprisonment, and forestalling was punishable by death. A forestaller was a person who withheld necessary commodities from circulation. Nevertheless, farmers and manufactures hoarded goods, and the specter of famine rose up for the spring. In December 1794 the government abandoned price controls, prices soared, and assignats fell to less than 3 percent of their face value.

The Convention, the governing body at that stage of the Revolution, acknowledged the fall of the assignats in June 1795. The nominal value of each successive issue was reduced according to a scale of proportions. In July of the same year the Convention ordered in-kind payments for half of the land tax and rents. Peasants stopped bringing produce to market to avoid accepting assignats. Speculation became rampant while inflation ruined creditors and savers. As prices outpaced wages and workers suffered, speculative profits created a new class of ostentatious rich who stood in stark contrast to the destitution of the lower classes. Prices outpaced wages and workers suffered. Inflation reached its peak as the Directory took power. Each day saw prices rise hourly, and each night paper money came off the press for issuance the following day. Paper money issues doubled in four months, for a total of 39 billion livres in assignats.

In February 1796 the Directory discontinued the assignats. It tried an issue of land warrants, which were good for the purchase of national property at an estimated price without competitive bidding. The sale would be to the first taker. The public had lost faith in paper money, however, and in July 1796 the government decided to return to specie. Inflation continued to ravage the economy until the advent of Napoleon in 1799. Apparently, his wars brought in more than they cost and his government improved the efficiency of taxation, ending the government’s need to promiscuously print paper money.

Since the experience of the French Revolution, hyperinflation has been associated with revolutionary change. It played a role in the rise of Hitler to power in Germany, the Communist Revolution in China, and the Bolshevik Revolution in Russia. The American Revolution also had a hyperinflationary episode.

French Franc

The French franc is the monetary unit of account in France, just as the U.S. dollar is the monetary unit of account in the United States. It was the first decimalized currency system in Europe, except for Russia.

French francs were first coined in 1803. Before the decimalized franc was introduced, the French currency system was based upon the Carolingian system, in which 1 livre equaled 20 sols, which in turn equaled 240 deniers. In 1793 the French revolutionary government decided to replace the Carolingian system with a decimal system. In 1795 the livre was replaced with a franc equaling 100 centimes. These changes meant little amidst revolutionary chaos, but Napoleon’s government began striking francs based on the new system in 1803.

The French Monetary Law of 1803 put the franc on a bimetallic system with the silver to gold ratio, per unit of weight, equal to 15 1/2 to 1. Coin pieces of 5 francs and less were struck in silver, and gold coins came in denominations of 20 francs and 40 francs. One franc equaled 5 grams of silver. The smallest denomination coin authorized by the act was a quarter franc. During the wars of the French Revolution and Napoleon France imposed its new currency system on conquered states. In 1798 France reorganized the freshly conquered Switzerland as the Helvetian Republic with a unified currency system in which 1 Swiss franc equaled 10 batzen, which in turn equaled 100 rappen. With the downfall of Napoleon the Swiss threw off their imported currency system, but in 1850 they readopted the French system voluntarily. The Netherlands had also seen the French system imposed from without, but abandoned it in 1814. When Belgium won its independence from the Dutch in 1830 the Belgians reestablished the French system. Italy adopted the French system in 1861, but named its money of account the lira rather than the franc. One lira equaled 1 franc. Under different names, the French system became the basis of currencies in Greece, Spain, Rumania, Bulgaria, and Finland. Although the British pound sterling dominated international trade in the nineteenth century, the French franc was the most influential currency in Western Europe.

By the beginning of the nineteenth century, France had acquired a horror of inflation from two firsthand experiences. The hyperinflation of the French Revolution was still a fresh memory, further bolstering French resolve to maintain the stability and integrity of the franc. The French maintained the metallic content of the franc for 125 years. During the Napoleonic Wars the franc experienced milder fluctuations than the pound sterling, perhaps because Napoleon’s war indemnities helped supply the gold and silver to maintain the franc’s parity. France suspended convertibility of the franc in the Revolution of 1848 and during the Franco-Prussian War of 1870–1871. Following the Revolution of 1848 convertibility was resumed in 1850 and during the whole episode the franc had only depreciated mildly. After the Franco-Prussian War France was burdened with heavy war reparations and the political situation was clouded by the episode of the Paris Commune, which put Paris under the control of working-class revolutionaries. Nevertheless the franc fluctuated only within a narrow range, and convertibility was resumed in 1878.

In 1865 France, Italy, Switzerland, and Belgium formed the Latin Monetary Union, which fought to preserve a unified, bimetallic monetary system in the face of the growing prestige of England’s gold standard. Declining silver prices made the bimetallic standard untenable, and France abandoned silver in 1873. By 1878 France was officially on the gold standard.

Under the gold standard the franc lost a bit of its reputation for soundness. The French authorities were hesitant to allow an outflow of gold, and insisted upon their right to pay out badly worn 10-franc gold coins and 5-franc silver coins. All European countries effectively suspended the gold standard during World War I, but the franc emerged from the war weaker than the pound sterling and suffered speculative attacks. In 1926 the franc stabilized at about one-fifth prewar parity. From 1927 until 1931 the franc was undervalued and the pound sterling overvalued, putting an end to speculative attacks on the franc. With the onset of the Great Depression, England, Japan, and the United States devalued their currencies, leaving the franc overvalued. The Gold Bloc countries, mainly consisting of members of the old Latin Monetary Union, clung to the gold standard and France, the leading member, remained on the gold standard until 1936. After World War II the franc went through a series of official devaluations under the Bretton Woods fixed-exchange regime, the last occurring in 1968.

During the post–World War II era, the West German mark rose to become the preeminent European currency, partly because West Germany, compared to England and France, kept inflation subdued. In the 1990s France tamed its inflation and the German mark was buffeted by the turmoil of merging the two Germanys. As a consequence the French franc regained some lost ground as one of the leading European currencies. In May 1998 members of the European Union announced plans to launch a European currency, called the euro, to replace the individual national currencies, including the French franc and the German mark.

Free Silver Movement

The free silver movement was a populist movement in the United States during the last quarter of the nineteenth century. “Free silver” meant that silver could be brought to the mint and struck into coins without a seigniorage charge; that is, without taking any of the precious metal to pay mint expenses. Also, the amount of silver that could be brought to the mint was to be unlimited. Before 1873 anyone who brought 3.7125 grains of silver to the mint could receive a legal-tender silver dollar, and the campaign for free silver fought for a return of these conditions.

Between the mid-1830s and 1873 the market price of silver exceeded the mint price of $1.29 cents per ounce; therefore, very little silver found its way to the mint. Silver dollars had largely disappeared from circulation when Congress enacted the Coinage Act of 1873, an act that made no provision for the coinage of silver, and put the United States on an unofficial gold standard. Proponents of free silver later condemned the act as the “Crime of ’73.”

The deletion of the silver dollar drew little attention at the time, but the United States was already in the clutches of a deflationary downswing that would last three decades. From 1870 until 1896 prices plunged 50 percent, a deflationary wave that hit hard at farmers in the West and South, where debt incidence stood at high levels. These groups quite rightly saw that a return to free and unlimited coinage of silver would raise the domestic money stock, raise prices, and reduce their debt burden. Much of the populist flavor of the free silver movement came from the hopes it lifted among large numbers of low-income farmers.

Silver prices felt an added deflationary force because the world was rushing toward a gold standard that left little role for silver as a monetary metal. Major silver discoveries in the American West further depressed the market for silver. From 1850 until 1872 the market price of an ounce of silver stood above $1.32, clearly above the mint price, but the price had slipped to $1.24 by 1874, and from there it tumbled to $0.65 by 1895. Silver-mining interests in the United States saw free silver as a way of increasing the demand for silver, and putting a floor under silver prices. They would have been delighted to sell silver to the Treasury for $1.29.

The free silver proponents achieved limited success in Congress. On 28 February 1878 Congress enacted, over a presidential veto, the Bland-Allison Act, which required the Treasury to coin between $2 million and $5 million worth of silver per month. The bill had begun as a free silver bill but had been amended to restrict the amount of silver the Treasury purchased. In 1890 the Sherman Silver Act required the Treasury to purchase $4 million of silver per month, and issue silver certificates. The Sherman Silver Act was blamed for sparking a crisis of confidence in the American Europeans began withdrawing gold from the United States. President Cleveland, a staunch advocate of the gold standard, prompted Congress to repeal the silver purchase provisions of the Sherman Silver Act.

The silver controversy loomed as a major issue in the presidential election of 1896, coinciding with the nadir of the 30-year deflationary wave. William Jennings Bryan won the Democratic nomination after his famous “Cross of Gold” speech, denouncing the gold standard, and defining himself as the free silver candidate. Bryan lost the election and in 1900 the United States went squarely on the gold standard.

Free Banking

Free banking was a trend toward a highly decentralized monetary system that originated in Scotland and in the early nineteenth century, appeared on a modest scale in England, and developed on a wider scale in the United States, beginning in 1838 and ending with the National Banking Act in 1864.

Before the era of free banking, bank charters were granted for political favors, regarded as matters of political patronage. Rising inflation from 1834 to 1837, followed by a money panic and a rash of bank failures, elevated public concern about privilege and political corruption in the banking system. New York acted first with the Free Banking Act of 1838. This act allowed any person or group of persons to obtain a bank charter who could meet capitalization criteria requiring that bank notes be 100 percent backed with mortgages and state bonds, plus an extra 12.5 percent in gold and silver specie. The reserves of gold and silver specie enabled bank customers to count on redemption of bank notes in gold and silver, and when banks failed the state sold the mortgages and state bonds to compensate bank customers.

About 18 states adopted free banking laws similar to the New York act. They usually allowed anyone, without political connections, to deposit suitable financial securities with a state banking authority, receive a bank charter, and make loans and discount bills by issuing their own bank notes.

Free banking was not the only solution to the crisis of confidence in banks. In 1845 the fledgling state of Texas completely outlawed banks in its first constitution, and by 1857 four other states had enacted similar legislation.

The success of the free banking system depended on a delicate balance of state regulation and freedom of enterprise. A certain amount of chaos ensued. Bank notes circulated from defunct banks, and

Franklin Benjamin

Franklin, Benjamin

(1706–1790)

In addition to filling the roles of diplomat, newspaper publisher, inventor, scientist, and signer of the Declaration of Independence, Benjamin Franklin, perhaps the most American of the American revolutionaries, was a tireless advocate of paper money in the American colonies. As early as 1729 he wrote a pamphlet, A Modest Enquiry into the Nature and Necessity of a Paper Currency, and continued to advance proposals for paper money as an answer to economic ills that afflicted the colonies. Perhaps the same practical turn of mind that led Franklin to invent the lightning rod, bifocal glasses, and the Franklin stove also led him to take up the currency problems of the colonies, and seek answers in paper money schemes. By the time of Franklin’s death, and owing partly to his efforts, North America had experimented with more paper money issues than any other part of the world up to that time. Even today the United States 100-dollar bill bears an engraved portrait of Benjamin Franklin, symbolizing his long association with paper money in the United States.

The young Franklin apprenticed himself to the trade of printer, and in later years was publisher of the Pennsylvania Gazette. Franklin’s pamphlet on paper currency helped secure approval of a proposal continuing the issuance of paper money in Pennsylvania, paving the way for Franklin to receive the task of printing the paper money, which he described as “a very profitable job, and a great help to me.” Franklin’s involvement in the printing business may have favorably disposed him toward paper money.

The Colony of Pennsylvania had created a land bank that issued paper money as loans against real estate and precious metal plate. In 1765 British government officials asked for proposals to raise revenue from the American colonies in the least objectionable way. Parliament enacted the infamous Stamp Act to help service wartime debt and pay part of the expense of defending the colonies. Franklin argued forcibly with the British government for his “paper money scheme,” which would generate income from loans and at the same time supply the American colonies with a continental currency. Franklin wanted the English government to establish a loan office that would make loans secured by real estate. The interest-paying loans would be taken out as paper money issued under the authority of the British government, infusing the American colonies with much-needed money and raising revenue for the British government. According to Franklin, an annual interest rate would act as a general tax, but not “an unpleasing one.” This paper money would have been legal tender for public debts, including repayment of loans to the land bank. If England had adopted Franklin’s plan rather than the Stamp Act, perhaps history would have taken a different turn.

Franklin was noted for conservative philosophy in financial matters, and famous for sayings such as “A penny saved is a penny earned,” and “Early to bed and early to rise makes a man healthy, wealthy, and wise,” and “God helps them that help themselves.” That Franklin’s philosophy of thrift, honesty, and commerce could embrace the concept of paper money should have been taken as unerring signal that paper money was the wave of the future. Nevertheless, history has held up many examples showing that the abuses of paper money are

Fort Knox

Fort Knox, a United States Army post, is the location of the largest United States gold bullion depository. Located about 31 miles southwest of Louisville, Kentucky, Fort Knox began as a post for army maneuvers in 1918 and was called Camp Knox. Its name was changed to Fort Knox in 1933. The post covers about 110,000 acres and is home to 57,000 residents. In addition to guarding the gold bullion depository, Fort Knox is famous for training armored divisions in the United States Army. Construction of the Fort Knox Bullion Depository was finished in 1936. Because of the security surrounding the depository, which lies in the middle of the military base, Fort Knox has become a universal symbol of an impregnable store of wealth. No tourists are allowed on the military base.

Early in the Great Depression of the 1930s the United States nationalized privately owned gold, and devalued the dollar from $20.67 per ounce of gold to $35 per ounce of gold. The rise in the price of gold triggered an inflow of gold into the United States, and by 1939 the United States had swept into its vaults over half of the world’s gold stock. The United States Treasury built the new gold depository at Fort Knox to help store its newly acquired gold treasure.

The Fort Knox Bullion Depository is a granite building constructed from 16,000 cubic feet of granite, 4,200 cubic yards of concrete, and 750 tons of steel for reinforcement. The legend United States Depository, engraved in gold, adorns a marble-lined entry, along with the gold seal of the Treasury Department.

Today the depository holds approximately 4,600 tons of pure gold with a market value of approximately $58 billion. The gold is stored in bars of 1,000 ounces each. Because gold does not deteriorate, gold in the vaults of Fort Knox could be hundreds of years old, probably including gold seized from the Aztecs and the Incas. Some of the gold that flowed into the United States from France in the 1930s was still in the wrappings that held the gold when the Jefferson administration had sent the gold to France to pay for the Louisiana Purchase. The United States government maintains smaller gold caches at West Point and in Denver.

The world’s largest hoard of gold is not stored at Fort Knox. The Federal Reserve Bank of New York maintains an air-conditioned vault about 80 feet below street level in the bedrock of Manhattan Island, New York. This Federal Reserve vault holds about 11,000 tons of gold at a market value of about $176 billion, accounting for about a third of the gold reserves in Western economies. The gold mostly belongs to foreign governments and foreign central banks that store the gold in New York as a matter of convenience. Some of this gold was shipped over on the eve of World War II for security, but much of it European governments purchased from the United States during the 1950s and 1960s, but kept in the United States to spare shipping costs. In 1971 the United States stopped redeeming dollars presented by foreign governments into gold.

Forestall System

The Forestall system of Louisiana banking regulation, established in the middle of a depression in 1842, was one of the most successful and influential systems of state banking regulations, establishing principles that became standard in banking regulation.

The Panic of 1837 had thrown the United States economy into a deep depression that lasted until 1843. The depression was sparked by President Andrew Jackson’s Specie Circular, requiring that only gold and silver specie (coinage) be used to pay for land purchased from the government. The Specie Circular put the brakes on a land boom. Banks across the United States, including Louisiana, suspended payments, meaning they could no longer redeem their bank notes with specie. At that time each bank issued its own bank notes, in contrast to the current practice of issuing checking accounts. Louisiana boasted of nine commercial banks when the Forestall system was put in place. All nine banks had suspended payments.

Among the detailed regulations of the Forestall system was the requirement that customers’ deposits could be loaned out only for 90 days. The capital contributed by bank owners was exempt from this limitation. These short-term loans could not be renewed, and the law required that banks publish the names of borrowers requesting renewals.

The Forestall system also forced banks to maintain specie reserves equal to 30 percent of their bank-note and deposit liabilities. The remaining 70 percent had to be backed by short-term commercial loans.

Amidst the Panic of 1857 an epidemic of payment suspensions spread through the United States. Thanks to the Forestall system, however, Louisiana banks were among the few banks that continued to make specie payments. Other state legislatures, noting the panic-proof resilience of the Louisiana banks, began to insist upon cash reserves. The reserve policy of Louisiana banks enabled them to continue to make remittances to their New York correspondents long after the Civil War had started.

The success of the Forestall system created a predilection for cash reserves in American banking regulation that remains an important element of national banking regulation today. Commercial banks in the United States are required to hold reserves either in the form of vault cash or deposits at a Federal Reserve Bank. Deposits at another financial institution, government bonds, or other forms of seemingly safe assets are not acceptable as legal reserves. The Federal Reserves System usually requires commercial banks to hold reserves that range between 10 to 20 percent of demand deposits.

Foreign Exchange Markets

Foreign exchange markets are markets in which national currencies are bought and sold with other national currencies. In a foreign exchange market U.S. dollars may purchase British pounds, German marks, French francs, Japanese yen, etc.

Prices of foreign currency are expressed as exchange rates, the rate at which one currency can be converted into another currency. On 12 March 1997 it took $1.59 to purchase a British pound in foreign exchange markets, or, alternatively 0.6256 British pounds could purchase one U.S. dollar. Exchange rates are reported daily in large metropolitan newspapers and financial papers such as the Wall Street Journal.

Foreign exchange markets are as old as coinage itself. In the ancient world religious temples were a popular site of foreign exchange markets because the sacredness of the grounds acted to safeguard treasuries of coin. The modern term bank evolved from the moneychangers’ “bench” of the Middle Ages. Today modern communication and computers have made possible a worldwide integrated foreign exchange market where trades are conducted electronically 24 hours a day during the business week. The big players in the foreign exchange markets are the large commercial banks with foreign branches.

Under the current international monetary system, foreign exchange markets are highly competitive and exchange rates can change daily. (Between 1946 and 1971 the world was on a fixed exchange rate system, and exchange rates were pegged at certain levels by governments.) A supply of U.S. dollars is created in foreign exchange markets when Americans buy goods, or make investments, in foreign countries where dollars are not accepted. A demand for U.S. dollars is created in foreign exchange markets when the rest of the world wants to buy American goods, or make American investments, which require payment in dollars. Exchange rates fluctuate to balance supply and demand, clearing the market for U.S. dollars as foreign exchange. Markets for other currencies emerge in a similar fashion.

Exchange rates can exert strong influences on domestic economies. If the market value of the dollar appreciates relative to the Japanese yen—meaning it takes fewer dollars to purchase a yen—Japanese goods become cheaper to American consumers, increasing the importation of Japanese goods and reducing demand for domestic goods in competition with Japanese goods. If the market value of the dollar depreciates relative to the Japanese yen—meaning it takes more dollars to purchase a yen—Japanese goods become more expensive to American consumers, diminishing the importation of Japanese goods and making domestic goods more competitive. In summary, a depreciation of the dollar increases the demand for American-made goods, and an appreciation of the dollar decreases the demand for American-made goods.

Foreign exchange rates are quoted in spot rates and forward rates. The spot rate is the rate at which foreign currency can be purchased for delivery within two business days. A forward rate is the rate at which a foreign currency can be purchased for delivery after a length of time, such as 90 days. A forward market enables an American importer to strike a deal to import French goods and purchase French francs to pay for the goods when they arrive at some date in the future, protecting the importer from fluctuations in exchange that could make the goods much more expensive than expected.

Unless the world adopts a common currency, foreign exchange markets will remain a vital part of the international trade framework, the connecting link that allows trade between countries with different currencies. On 1 January 1999 Europe launched the euro, a European currency that will eventually replace German marks, French francs, Swiss francs, and other European currencies, and will abolish the need for foreign exchange markets to establish rates for the convertibility of one European currency into another. If the world follows the path of economic integration followed in Europe, then a world currency could become a reality some day. On the upside a world currency would remove the risk and uncertainty of exchange rate fluctuations that can disturb the flow of international trade, and promote trade between the regions of the world. On the downside a world currency would preclude the use of localized monetary policies to help specific areas. Currently, the Japanese economy is stagnant and the Bank of Japan is free to expand the Japanese money supply to stimulate the economy. If the world was on a worldwide currency system, and Japan was the only country suffering stagnation, world monetary authorities could not expand the money supply worldwide just to help Japan—and besides, increasing the money supply worldwide might not help Japan anyway.

Forced Savings

Forced savings refers to the use of money creation and inflation to divert resources into the production and acquisition of capital goods. A government that prints up money, as opposed to levying taxes or selling bonds, to pay for the construction of a hydroelectric generation facility is pursuing a policy of forced savings. Less-developed countries, particularly in Latin America, turned to forced savings policies in the post–World War II era as a means of financing economic development. At least some of the inflation in Latin America has its roots in economic development strategies based on forced savings.

The mechanics of forced savings operates through the medium of inflation. The government prints up money to purchase capital goods, attracting resources into the production of capital goods at the expense of consumer goods. Consumer goods production falls relative to demand, and consumer goods prices increase, reducing the amount of consumer goods that households can afford. This forced reduction in consumer goods acquisition translates as forced savings. Consumers still spend the same amount of money, it just does not stretch as far as it did before inflation. Thus the consumers do not come out with any more savings, but society does, because society is extracting resources for the production of capital goods. The forced reduction in consumer goods production is the key to forced savings.

Savings always involve a reduction in current acquisition of consumer goods. Ordinarily, households elect to divert a share of income away from consumption expenditures, and set that share of income aside as savings. Financial institutions and stock and bond markets channel these savings into businesses that need financing to purchase capital goods. Savings are always at the expense of consumption expenditures, but normally savings are a voluntary choice of households. Societies must save, that is, depress current consumption, in order to make resources available for the production of capital goods.

Economists and policy makers have advanced several arguments in favor of forced savings as an attractive vehicle for financing economic development. First, vast portions of the populations of less-developed countries live at the margin of subsistence, too poor to voluntarily engage in much saving. Second, many less-developed countries do not have the financial institutions necessary to mobilize the small savings of individual households. Third, wars have shown that governments can print up money to finance major public undertakings without destroying economic systems. The same effort that goes into financing a war can theoretically be tapped to finance industrialization.

Notwithstanding arguments favoring forced savings, the anti-inflation bias in current economic thinking emphasizes the downside of any policy that can only be activated with inflation. There has been no evidence of a correlation between inflation and growth, and many countries, such as Britain and the United States, experienced rapid economic development in the nineteenth century without inflation. Also inflation disrupts society and the burden of inflation is not evenly shared. Unionized workers can often strike and gain wage increases that compensate for inflation and some businesses may receive government aid that compensates for inflation. Other groups in society, those on fixed incomes or living on past savings, are likely to bear the bulk of the inflation burden. Inflation encourages households to invest voluntary savings in hedges against inflation such as land, buildings, jewelry, gold, silver, or stocks of grocery and household necessities. Investment in hedges against inflation diverts voluntary savings away from the purchase of capital goods such as factories, machinery, etc. After inflation has become expected, creditors extort high interest rates as inflation protection, further discouraging risk-bearing entrepreneurs from accessing sources of borrowed funds.

In countries that insist upon printing up money to finance government expenditures, forced savings strategies may make more sense than the acquisition of military goods, or the construction of lavish government buildings and monuments. Nevertheless, forced savings, because of its inflationary effects, entails major complications for the efficient operation of the economy, and seems to hold little charm for contemporary policy makers.

Food Stamps

Food stamps are coupons redeemable in food at grocery stores. The government allots food stamps to low-income families to assure that minimal nutritional needs are met. Because they are redeemable in food, food stamps have circulated as money in ghetto areas. Although the food stamp program is a federal program, supervised by the United States Department of Agriculture, the process of identifying qualified families and issuing food stamps is left to the individual state governments.

The first food stamp program grew out of the contradictions of the Great Depression of the 1930s in which agricultural surpluses mocked the problems of rising unemployment, hunger, destitution, and falling farm incomes. The government’s initial response of destroying agricultural commodities seemed unreasonable in light of growing poverty and hunger. The first food stamp program began in 1939 and continued until 1943 when the wartime boom had solved the unemployment problem, and agricultural surpluses were no longer accumulating.

The food stamp program was revived in the 1960s, partly because President Kennedy, when campaigning in West Virginia, had observed schoolchildren taking home leftovers from school lunches. Various pilot programs were put into operation until Congress enacted the Food Stamp Program Act of 1964. Later in the 1960s and early 1970s Congress increased the benefits and eased the eligibility requirements. At first food stamp recipients had to pay for the stamps, but in the 1970s the stamps became free.

To qualify for food stamps families must fall below certain income levels, after allowances are made for housing costs, childcare, etc. The lower a family’s income, the more food stamps the family can receive.

In the 1970s and early 1980s food stamps became a sort of second-class currency in low-income neighborhoods. Although food stamps could legally be used only to purchase food, some merchants fudged and sold alcohol and other grocery store items for food stamps. On the streets food stamps are traded for cash, but at steep discounts. Individuals traded food stamps for cash and used the cash to purchase items that could not be purchased with food stamps.

Partly because of the fraudulent use of food stamps, the federal government during the Reagan years cut back on food stamp expenditures. The program remained in place, however, and the 1990s saw many states implement electronic benefit transfer programs that substituted a debit card for coupons. The use of the cards requires identification, rendering the transfer of food stamp benefits to parties other than the cardholder almost impossible. By 2002 all states are expected to have electronic benefit transfers.

Given that food items such as livestock, rice, corn, and many others have historically emerged as mediums of exchange, it should not be surprising that coupons redeemable in food should began to wear the aspect of money and circulate accordingly. Presumably, food stamp money will disappear in time because it involves an illegal use of food stamps, and the government will work to improve its regulation of the program.

Florentine Florin

The Florentine florin was the first European gold coin to achieve the status of an international currency after the disappearance of European gold coinage in the eighth century. Florence first issued the florin in 1252. It weighed 3.53 grams or 72 grains of fine gold and took its name from the fleur-de-lis, the iris flower whose image adorned one side of the florin. The florin preceded the era of milled coins with corrugated edges that protected coins against the clippers. To circumvent the clippers, florins circulated in leather bags sealed by the mint. The seal was intended to vouch for the integrity of the coins inside. Thus anyone who wished to clip coins had also to be able to counterfeit the seal.

The florin did not burst upon the world without European rivals. Genoa also commenced gold coinage in 1252, but Genoa’s coins never commanded the international stature of the florin. Frederick II of Sicily may have struck gold coins a few years earlier than Florence, but his coinage was a descendant of Moslem and Byzantine coinage, despite its popularity in Europe.

Originally Florence struck the florin as a gold pound, equal to 20 soldi or shillings, or 240 deniers,or pennies. The Florentine version of the Carolingian system soon broke down amidst fluctuating exchange rates between gold and silver, and an imaginary money of account developed based upon a pound affiorino, in which 20 florins equaled 29 affiorinos. A separate silver standard evolved that set the value of the silver pound equal to 20 silver soldi, or 240 silver deniers. Market forces overrode government efforts to establish official exchange ratios between gold and silver such as existed with the European bimetallic system in the nineteenth century.

From the outset Florence groomed the florin to play the part of an international currency. Florentine law provided that only international merchants of the Calimala Guild, the moneychangers, the cloth and silk manufacturers, the grocers, and furriers, could keep books and conduct business in florins. Silver currency was used in retail trade, payment of wages, and small transactions. Wholesale prices were often quoted in florins, while retail prices were quoted in silver currency.

San Antonino (1389–1459), archbishop of Florence, complained of the government debasing the silver currency used by the lower classes, while maintaining the purity of the gold currency used by the wealthier classes. The employer-controlled government of Florence could effectively reduce real wages by debasing silver coins used to pay wages while maintaining the purity of gold florins in which wholesale goods were priced. Separate gold and silver standards, with separate prices, exposed one segment of the population to the ravages of inflation through debasement, while another segment remained untouched by inflation. From 1252 until the beginning of the fifteenth century, the florin rose in value 700 percent relative to silver coinage, largely reflecting debasement of silver.

In the second half of the thirteenth century and the first part of the fourteenth century the Florentine florin rose to become the equivalent of the modern-day dollar in international trade. As often happens in currencies, the florin was unable to dodge the pitfalls of success. Foreign governments minted florin imitations from lighter metal, and at the beginning of the fifteenth century Florence minted florins of a lighter weight. The florin may have owed part of its success to the strength and expansion of the Florentine economy. During the fifteenth century the Venetian ducat displaced the Florentine florin as the international currency par excellence.

Fleetwood, William

William Fleetwood, Royal Chaplain in England during the late seventeenth century, preached a sermon, the Sermon against Clipping, in the Guildhall chapel on 16 December 1694. Clipping was a means of debasing coins by removing precious metal from around their edges. Perfectly round coins with a ribbed edge, called a milled edge, were introduced to prevent clippers from robbing domestic currency of its precious metal content. Before the development of the milled edge, governments constantly struggled with the problem of clipped coins, often enacting legislation governing the use of clipped coins.

Fleetwood took the text for his sermon from Genesis 23:16, a passage in which Abraham paid for land to bury his dead:

Abraham agreed with Ephron; and Abraham weighed out for Ephron the silver which he had named in the hearing of the Hittites, four hundred shekels of silver, according to the weights current among merchants.

Before plunging into the hellfire and damnation portion of his sermon, Fleetwood gave a reasoned treatment of monetary theory, citing the importance that money be portable, durable, and beautiful. According to Fleetwood, in the days of Abraham, silver:

was valued both by Buyer and Seller according to its weight but because it was too troublesome, and took up too much time, to carry Scales Men found it convenient to have a stamp or Mark set upon every piece, to signify its weight and value. Yet something was still needed to secure the truth of Payments: Men might be fraudulent and false.

(Chown, 1994)

Fleetwood proceeded to denounce the sin and evil of clipping, arguing that the failure of the clipper to identify or see a specific victim of his sin did not absolve him of moral responsibility. He exclaimed that the convicted “can be sorry for their great misfortune, but they know not how to repent the sense of these offenses affects them little or nothing” (Chown, 1994).

He told of the punishment in past times for the crime of clipping, such as severing the right hand. In past times some “who were found to Adulterate the King’s Coin, were so punished as if the Laws intended to prevent Adultery itself” (Chown, 1994). He noted that in his own time society had become merciful, letting clippers off with a modern execution, “a short and easy death.”

In the following year Parliament again legislated against clipping and counterfeiting, prompting one observer to say, “But did this prohibition, tho by Act of Parliament, cure the evil? Alas no. The forbidden Fruit, was of too luscious a relish to be so easily relinquished. It was not in the power of any paper spell to stop the spreading Gangrene” (Chown, 1994).

Despite the pessimism expressed in the above passage, the government was already laying plans to replace all coinage in circulation with milled-edge coins. The milled-edge coins effectively discouraged the clipper by making the effects of clipping very noticeable.

Fishhooks

Fishhooks have served as money in the Maldives Islands, the islands of Micronesia, mountainous regions of the West African country of Cameroon, and portions of Nigeria.

The Maldives Islands, located southwest of the southern tip of India, were famous as a hunting ground for cowries, seashells that circulated widely as money in Asia and Africa. Cowries were the islands’ main export, and were used as local currency. In the 1800s, however, the main currency was a corrupted silver fishhook called the larin. The king of the Maldives issued larins, and put an official stamp on them, making them a state currency. For small change larins were divided into pieces, but a divided larin was worth only one-twelfth of a whole larin. The use of larins as currency seems to have gotten its start in the city of Larr in southern Persia.

In the Gilbert Islands in the west central Pacific Ocean, fishhooks circulated as money and were reported to be highly valuable. Pearl shells were cut into the shape of fishhooks, and were called fishhook money. Seashells strung on cords, sperm whale teeth, and discs of coconut also acted as currency on these islands.

In the mountains of Cameroon, called the Cameroons by the British in the nineteenth century, fishhooks served as a medium of exchange, along with cowries, soap, and gunpowder. Cameroon is on the west coast of equatorial Africa. Cowries were the chief medium of exchange in the Cameroons, while wives, goats, and bead necklaces acted as a store of value. Fishhook currency could also be found in parts of Nigeria.

Fishhook money fits into the category of nail money in Scotland, or needle money in India. Fishhooks are small and durable, easily stored and transported, serve a necessary need, and are restricted in supply because they can be produced only with labor. The logistics of storing and exchanging fishhooks is simple, and the restricted supply relative to demand preserves the value of fishhooks. Though of a small size, fishhooks are highly productive tools. The combination of smallness and utility contributes to their value as money.

First Bank of the United States

The First Bank of the United States (1791–1811) met the needs of a central bank in the early years of the Republic. It helped regulate the issuance of bank notes by state banks and acted as the bank of the United States government. The First Bank received its charter from the national government in 1791 when President George Washington signed the bill authorizing its incorporation.

The First Bank of the United States was a brainchild of Alexander Hamilton, who saw such a bank as a means of raising short-term capital for the government and handling bills of exchange needed for making payments to foreign holders of the national debt. Hamilton patterned the First Bank after the Bank of England, and got many of his ideas from the role the Bank of England played in the English economy and government finances. He also promoted the bank as a means of increasing the circulation of bank notes, which was needed at that time because of a shortage of specie.

Hamilton’s Report on a National Bank went to Congress in December 1790. The proposal drew fire from critics concerned that the bank was a monopoly sanctioned by Congress. As the debate on this issue waned, constitutional questions arose that were to haunt the bank for the duration of its existence. The Constitutional Convention of 1787 had chosen not to give Congress the power to grant charters of incorporation and the Constitution itself was silent on the subject.

The bill for the bank’s charter passed by a two-to-one vote in the House and by a majority vote in the Senate, but Washington balked at signing it, partly at the urging of such luminaries as Thomas Jefferson. Washington signed the bill chartering the bank after Hamilton wrote a very able paper in its defense. The First Bank made Philadelphia its headquarters and, over Hamilton’s opposition, set up branches, one as far away as New Orleans.

The charter authorized a capital stock of $10 million. The U.S. government purchased one-fifth of the stock, paid for by a loan from the First Bank, and the remaining four-fifths was opened for public subscription. The bank was fully capitalized within an hour after shares became available to the public. Public subscribers could pay one-fourth in specie and four-fifths in government obligations and foreigners eventually held much of the stock. The charter prohibited the bank from trading in anything besides bills of exchange, gold and silver bullion, and goods held as security for defaulted loans. The total debt of the First Bank could not exceed its capital and money held on deposit. The bank needed congressional approval before it could make loans in excess of $100,000 to the U.S. government, any state government, or to purchase any of the public debt.

Commercial loans accounted for most of the bank’s lending, and the bank served some of the functions of a central bank. At that time bank loans were paid out in bank notes, convertible into specie on demand. The bank held other commercial banks accountable by presenting to them their bank notes for redemption in specie. The First Bank’s role in controlling the issuance of bank notes won the support of the large commercial banks. The bank particularly helped control the overissuance of bank notes by country banks, often the source of inflationary pressures.

When the charter for the First Bank came up for renewal in 1811, it failed by one vote in the House. Constitutional issues and foreign ownership cost the First Bank much of its support in Congress. The vote in the Senate was a tie, and the vice president broke it by voting against the First Bank.

Congress soon missed the First Bank and in 1816 Congress chartered the Second Bank of the United States, but that bank lost its charter in 1832. The Federal Reserve System, established in 1913, was the first central bank in the United States to establish itself in the confidence of the voters.

Federal Reserve System

The Federal Reserve System is the central banking system for the United States, established by the Federal Reserve Act of 1913. Most countries have only one central bank, such as the Bank of England, or Germany’s Bundesbank. The Federal Reserve System makes up a system of 12 regional central banks. Central banks are bankers’ banks, holding deposits of commercial banks, making loans to commercial banks, and serving as lenders of last resort to commercial banks in an economic downturn. The Federal Reserve System also acts as a bank for the United States government, and has a monopoly on the issue of bank notes, called Federal Reserve Notes. The term reserve in the title refers to the role central banks play in determining the liquidity of commercial banks. The Federal Reserve System regulates the money supply, interest rates, and credit conditions in the United States.

The United States was slow to adopt the concept of central banks as systems of monetary control. The early years of the Republic saw the creation of the First Bank of the United States in 1791, but Congress failed to renew its charter in 1811. Congress chartered the Second Bank of the United States in 1816, but President Jackson vetoed the renewal of its charter in 1832. These two banks, similar in structure, were early experiments in central banking, but were unpopular. The United States government’s control over the management and policies of these banks was limited to the voting rights of a minority stockholder. Fear of East Coast domination of the banking industry helped undermine support for the Second Bank of the United States.

The decentralized and unregulated banking system of the latter 1880s constantly buffeted the country with money panics and financial crises, leading public officials to see the necessity for overcoming the political objections to a central bank. Political objections came from several angles, including government officials who felt that the banking industry could not be trusted to regulate itself, and leaders in banking who felt that elected politicians lacked the necessary knowledge to regulate banking and were often irresponsible in financial matters. In addition to the distrust between leading bankers and elected politicians, there was distrust between regions of the country. Many regions presumed that a central bank would be located in New York City, subjecting the country to Wall Street domination. These contending forces helped shape the Federal Reserve Act of 1913 that created the Federal Reserve System.

To diffuse the fear of Wall Street domination of banking the Federal Reserve Act created a system of 12 regional central banks. The Federal Reserve Bank of New York is the most important for policy purposes, but there are Federal Reserve Banks in Boston, Philadelphia, Atlanta, Cleveland, St. Louis, Kansas City (Mo.), Richmond, Dallas, San Francisco, Chicago, and Minneapolis.

Like the First and Second Bank of the United States, the Federal Reserve Banks are privately owned. Private ownership helped appease the banking community’s arguments that knowledgeable bankers can best regulate the banking industry. Commercial banks in each district that are members of the Federal Reserve System own the stock in the regional Federal Reserve Bank. The Federal Reserve Act requires all banks with national charters to be members of the Federal Reserve System.

The final authority for monetary policy lies with the Board of Governors of the Federal Reserve System. The president of the United States makes appointments to this seven-member board, subject to the approval of the Senate. The seven board members serve 14-year terms that are staggered so that one member’s term expires every other year. This constant rotation on the board dilutes the power of any one president to bias the board politically. One of the board members acts as chairman of the Board of Governors, and the president—with the approval of the Senate—appoints that person. The chairman serves a four-year term that is renewable. Congress organized the Board of Governors to be independent of either the banking industry or the elected politicians.

Despite the trend toward deregulation in banking, Congress has not limited the authority of the Federal Reserve System, except in certain areas such as fixing interest rates on savings accounts. The Depository Institution Deregulation and Monetary Control Act of 1980 gave the Federal Reserve System the authority to set reserve requirements for state-chartered banks in addition to its existing authority to set reserve requirements for national chartered banks. (The reserve requirement is the percent of money deposited in checking and savings accounts that a bank has to retain in the form of vault cash and deposits at Federal Reserve Banks.)

Because the Federal Reserve System’s governing board is composed of unelected officials who are somewhat immune to political pressure, the Federal Reserve System often bears the brunt of the responsibility for combating inflation in the United States. Anti-inflation policies are often accompanied by high unemployment, rendering these policies unpopular with elected officials, who like to earn credit for reducing unemployment rather than increasing it. Therefore the elected officials often defer to the unelected officials that compose the Board of Governors the responsibility for slowing down the economy and taming inflation.

Amid the U.S. financial crisis in 2008, the Federal Reserve put aside, at least temporarily, its concern about inflation and broadened its role as a lender of last resort. Customarily, only depository institutions enjoyed the privilege of borrowing funds at the discount window of the Federal Reserves. Even banks in financial difficulty could borrow as long as they put up good collateral. In the rescue of investment bank Bear Stearns, the Federal Reserve accepted as collateral securities backed by subprime mortgages of unknown risk and market value. The Federal Reserve agreed to grant loans against the mortgage-backed securities as part of a deal for JPMorgan Chase & Co. to purchase Bear Stearns. The Federal Reserve justified its action of the grounds that the failure of Bear Stearns put the entire financial system at risk. The Federal Reserve also gave other investment banks and primary dealers in U.S. government securities the same access to discount window lending that is ordinarily reserved for depository commercial banks.

See also: Bank of England, Bank of France, Central Bank, Deutsche Bundesbank, First Bank of the United States, Second Bank of the United States

References

Board of Governors of the Federal Reserve System. 1984. The Federal Reserve System: Purposes and Functions.

Broz, J. Lawrence. 1997. The International Origins of the Federal Reserve System.

Greider, William. 1987. Secrets of the Temple: How the Federal Reserve System Runs the Country.

Timberlake, Richard Henry. 1978. The Origins of Central Banking in the United States.

Feather Money of Santa Cruz

The use of feather money survived on the Santa Cruz Islands, a group of islands in the southwestern Pacific Ocean, into the post–World War II era. The red feathers of this money came either from the parrot Trichoglossus massena, or from a red-scarlet honey-eater named Mzomela cardinalis. The feathers were integrated into striplike coils of fiber extending 15 feet in length and 2 to 3 feet in width. The outer side of these coils was blanketed with overlapping rows of red feathers.

The feather money owed its high monetary value to the labor-intensive effort required to produce it. Capturing the birds was no small task, and each bird furnished only a few of the feathers suitable for the purpose of making a coil. Each coil was made by hand, further adding to the labor invested in each unit of money. The attachment of wooden emblems and charms partially accounted for the value of each feather coil. The production of a coil of feather money took 500 to 600 man-hours.

The feather money was too valuable to be useful for an everyday medium of exchange, but it was much in demand as a store of value. It was stored away with great care in a secure place that was dry and warm in order to preserve the color and elasticity of the coils. Wealthy individuals stored their feather money in huts built specifically for that purpose. The coils lost value as their feathers wore off.

The islanders paid fines, ransoms, and blood money in feather money. When a Bishop Patterson was murdered in 1871 on nearby Reef Islands, his murderer paid a fine of four coils of feather money, which was about the same amount that was needed to purchase an oceangoing canoe. A bride brought 10 coils or more, depending upon her beauty and habits of industry.

The trouble that went into the production of feather money helped keep the supply down, making the feather money scarce and valuable. Feathers probably became acceptable for money because of their beauty, which made them highly esteemed, and because significant prestige became attached to the their ownership. Gold and silver may have started as money for similar reasons. As Australian money began to invade the Santa Cruz Islands as a medium of exchange, the price of feather money in Australian money steadily rose, showing the hold of the feather money on the minds of the islanders. The attraction of feather money appears to have been purely aesthetic, independent of religious significance or physiological need.

Faust

A theme of the dangers, temptations, and blessings of paper money made its way into Part Two of Faust, one of the most famous epic poems in history. Faust came from the pen of Johann Wolfgang von Goethe (1749–1832), a many-sided scientist, statesman, and literary figure whose works can be found on any list of the greatest books in the history of mankind. Line 317 of Faust reads “Man errs as long as he doth strive,” a thought particularly pertinent to a history of paper money that is filled with errors made by societies striving to do too much with too few resources.

Part Two of Faust was finished in 1832. A historical figure, Dr. Johann Faustus, furnished the main subject of Goethe’s poem. The real Faust, living in the sixteenth century, practiced medicine, studied astrology, and conducted experiments in alchemy. The goal of alchemy was to find a method for transforming base metals into gold. Faustus was thought to be a magician and according to legend had dealings with the devil. The story of Faustus passed down to Goethe was probably much more mythical and legendary than historical.

Goethe’s Faust is a restless striving soul disappointed with the brevity of beauty and the never-ending search for elusive truth. He offers to sell his soul to the devil on condition that the devil show him a pleasure that brings lasting satisfaction, one that he would not tire of, but would want to “Tarry a while, you are so fair.” Second only to Faust in Goethe’s play is the devil, Mephistopheles.

In Part One Faust seduces a young maiden, gets her pregnant, kills her brother, and abandons her. None of the pleasures in Part One are able to calm Faust’s striving and enable him to feel fulfilled.

In Act 1 of Part Two, Faust and Mephistopheles visit the emperor of the Holy Roman Empire. They catch the emperor amidst a budget crisis with the pay of soldiers and servants in arrears, and moneylenders demanding payment on debts. Mephistopheles holds out the promise of the alchemist’s dream, the secret to making gold that is as simple as printing paper money. The paper money is secured because “In veins of mountains, walls far underground, gold coined and uncoined can be found.” The emperor, on learning the bills have been paid and seeing joy on so many faces, has to be reminded that the night before he authorized the issuance of paper money. The treasurer tells him that the night before:

The chancellor came and spoke in words that ran:

• “A lofty festal joy do for thyself attain:
• Thy people’s weal—A few strokes of the pen!”
• These you did make, ten thousand fold last night
• Conjurers multiplied what you did write;
• And that straightway the good might come to all,
• We stamped at once the series, large and small;
• Tens, twenties, thirties, hundreds, all are there.
• You cannot think how glad the people were.
• Behold you city, one half dead, decaying,
• Now full of life and joy, and swarming and playing!

  The notes bore the emperor’s signature, and on each note could be read:

  • To all whom it concerns, let it be known:
  • Who hath this note, a thousand crowns doth own.
  • As certain pledge thereof shall stand
  • Vast buried treasure in the emperor’s land,
  • Provision has been made that ample treasure,
  • Raised straightway, shall redeem the notes at pleasure.
  • (Goethe, 1952)

  Faust puts the money to good use, digging canals, draining marshes, building factories and new farms. At first the money spreads happiness, but sins are committed in the name of progress. New government functionaries appear on the scene with names such as Quick-loot and Getquick, and soon the emperor faces a rebellion.

  At the end Faust’s pleasure at his good works seems to have met his requirement for a pleasure that never grows stale. As the devil takes his soul, angels redeem Faust, saying redemption is possible for those who never cease striving.

  Goethe correctly anticipated the era of paper money. Before the nineteenth century virtually every experiment with inconvertible paper money had ended with disaster. Inconvertible paper money is money that cannot be converted into precious metals at a fixed rate. A century after Goethe wrote Part Two of Faust, most of the countries of the world adopted inconvertible paper standards