MONEY IS AN INGENIOUS TOOL: IT LETS A MANICURIST BUY HALF A DOZEN DANISHES WITHOUT HAVING TO GIVE HER BAKER A PEDICURE. AND ITS ESSENCE CAN BE SUMMED UP IN ONE WORD: FAITH. BASICALLY, IT'S THE FAITH THAT YOU'LL BE ABLE TO EXCHANGE THE PAPER IN YOUR WALLET, OR THE NUMBERS THAT APPEAR ON YOUR ONLINE BANK ACCOUNT, FOR SOMETHING TO EAT, WEAR, OR LIVE IN.
But this notion is incomplete.
Money only deserves this name when it obeys two criteria:
1. It has to be something everybody wants.
2. It can't be something that is overly abundant. If it isn't scarce, it won't be worth anything. And if it's not worth anything, it's not money.
Think about something everybody always wants. Water, for instance. You can't live without it, so it fits criterion number 1 very well. Except it doesn't fit criterion number 2 – all you have to do is go to a riverbank, or to your kitchen sink, and get as much as you want. Way too abundant to serve as money.
Now think about food. That's different. Throughout much of the history of humanity, it fit both criteria perfectly. First of all, everybody enjoys food, of course. Second, it's never been easy to make it sprout out of the ground. And hunting for it – even tougher. Food has always been relatively scarce.
That's precisely why it was the first thing to be used as money. And not only before currency had been invented but even before the appearance of human beings. The chimpanzees are here to prove it. The males give females meat in exchange for sex. Well, it's not exactly a direct trade-off, a straightforward give and take. Sharing the results of the hunt with female monkeys is one of the ways that the males of the species try to win over their lady friends. This is a case of money, the oldest currency in the world, paying for the oldest service in the world.
And when humans appeared on earth, things didn't change much. What we call humanity began two million years ago. That was when a biped animal with a big brain, capable of wielding weapons and using fire, multiplied over the earth. This was Homo erectus, a human with monkey-like features that was to leave two descendants behind before disappearing into extinction. Some of the Homo erectus who left Africa – their native land – and went to live in the European cold evolved into Neanderthals. The ones who stayed in their birth place engendered the other species of big monkey: us, Homo sapiens.
This was 200,000 years ago. The fact that we're still around today is no big deal compared to the two million years that Homo erectus survived or even to the 400,000 years that the Neanderthal hung around. Even so, getting here wasn't easy. And it only happened for a reason: we learned to survive one of the biggest financial crises of all times. It occurred about 12,000 years back, well before money itself existed. That's right: money doesn't have to be involved for there to be an economic crisis. There are a number of ways of defining an economic crisis, but let's focus on the essential: a crisis happens when we can no longer produce everything we need to maintain our life style.
Shortly before this crisis got underway, we were in the midst of global warming. And that was awesome. It was the end of the last Ice Age, which had left half the world living at below-freezing temperatures for 100,000 years. Glaciers became rivers, white landscapes turned green, the number of animals grew... It was a paradise for large predators. And this was precisely our case: armed to our teeth with spears, slingshots, ivory knives, and a giant brain, we, Homo sapiens, took our place as the greatest predator that had ever lived. With things to hunt, we grew and multiplied freely. And now there were a lot more prey than during the Ice Age.
The abundance of plantlife helped too. Before, we had gathered any fruit and grain that we might stumble across every so often, and that was that. Now, with more fertile soil, human beings began to realize that they could plant something and eat it later, when game was sparse. Not that it was easy. We were still condemned to the same nomadic life as during the days of the glaciers. We would set up camp, hang around until the animals started thinning out, and then move on to try our luck elsewhere. But of course it wasn't pleasant to live under the constant threat of scarcity. We tried to use our heads to change things so we could put down roots in one place.
Back then, the meat and potatoes for some people – the ones living in the Middle East – was gazelle meat. They didn't kill just any old gazelle; they tried to kill only the males. Which made complete sense. In a herd of one hundred gazelles, half a dozen males would be enough to inseminate all the females. Then a whole new generation would be born, leaving the stock of food still nicely intact, even after a wholesale slaughter. Nobel Peace Prize in hunting for them.
There was only one problem: they forgot to figure in the theory of evolution. These people – who scientists today call Natufians – preferred the bigger males since they had more meat on them. Big mistake. That left only the puny ones to mate with the females – precisely the ones that'd be rejected under natural circumstances (females display this instinctive behavior because smaller males produce smaller and more vulnerable children). But that was OK: the females ended up sleeping with them anyway. Then along came the next generation, and the Natufians hunted the biggest of these. Leaving just the scrawniest ones alive. In a few generations, the result was a mini-gazelle that didn't have enough meat on it to feed the hordes of humans.
This is just one example of how our sophistication has worked against us. The fact is that the human species has driven other species to extinction – or almost there – in various parts of the world. But the real problem began later. Around 10,000 B.C., the planet's temperature hiccupped again. The climate got colder and drier, and stayed there for centuries. Plants and animals died. Our species had barely taken advantage of the end of the Ice Age and we were being frozen out once more. The solution? Use our heads again. How about, instead of allowing gazelles to reproduce freely, we held some captive in the village and made them have their offspring there? It'd also be a good idea to slaughter the smaller males first and let the big ones live long enough to reproduce as much as they wanted. That way each generation of gazelles would get bigger, right? And planting seeds? Why not try doing it on a large scale to guarantee all our necessities once and for all?
No need to say that nobody came up with these notions overnight. Yet ideas like this sprung up among different peoples, each in its own time. Owing to the major headache of global cooling, techniques that had been devised during times of plenty were refined. In overdrive. Planting seeds and trying to raise animals were no longer a matter of luxury (if they ever had been). Now, doing these things – or not doing them – was like choosing between living, or dying of hunger.
Humans were in for another surprise though: the lean years didn't last long, geologically speaking at least. Something like a millennium. After that, the climate improved again, producing land that was more fertile and leaving tons of animals grazing about. And now? Give up this thankless task of planting Guinea grass and watching cattle swing their tails, or instead go back to the more adventuresome days of the hunt? Not on your life.
By that point, raising seeds and animals had definitely proven more worthwhile. Agricultural techniques had evolved during rough times. And now that the climate was good, everybody had a green thumb. Opportunity met up with talent: for these folks, growing a garden was like charming food right out of the ground. Something magical. And raising animals? After generations of cross-breeding meatier creatures, they provided more calories than the hunt could ever yield – from this point of view, a domestic bull or a pig is just as artificial as a computer. After reproducing only the fattest of these creatures for millennia, the species differed greatly from their wild ancestors. They had been transformed into meat plants. If the same type of artificial selection were applied to people, babies would weigh over 200 pounds by age two – an unappetizing thought, but it was thanks to these animal husbandry techniques that we managed to get the food we needed to make it this far.
It was no different with plants. Wheat, barley, corn, and rice, the staples of our species, never existed in nature as we know them now. We have domesticated these plants just as much as cattle and swine, the fruit of genetic selection – that is, by reproducing only strains of plants that yield the best grain in an effort to grow more food in a smaller space. All by trial and error, culminating in resounding success.
Of course this didn't happen all at once. Each population developed farming and livestock-raising in its own way. Slow but sure. Yet things went much faster where land was fertile. One of these places was the region around the banks of the Tigris and Euphrates rivers (today, home to areas of Turkey, Iraq, and Syria). This was the main part of the Fertile Crescent, a region where growing seeds and raising animals exploded exponentially between 10,000 and 9,000 B.C. It was the New York City of its day. In one part of the Crescent folks were planting grapes and olives. Fifty miles downriver, someone else was raising pigs. Over that way, sheep and goats. Over this way, cattle. To the north, ranchers crossbred two species of wild wheat that had almost no nutritional value, obtaining bread wheat, the most important crop in history. "All that diversity in close proximity enabled them to quickly assemble a balanced package of humanity's basic needs: carbohydrates, protein, oil, milk, animal traction, fiber for clothing," says Jared Diamond, geographer and biologist at UCLA.
You know the rest of the story: now that people didn't need to spend the whole day hunting, humanity had spare time in which to create writing and mathematics, build cities, and so on. But this is a simplistic explanation. Our most valuable agricultural legacy is something else. Agriculture created money.
Clay money
The idyllic image of everyone blissfully growing things in their local community garden for the whole of society is a bit flawed. It has nothing to do with reality. What agriculture did was propel social inequality to unprecedented heights. In a tribe of hunters, the strongest men and the most astute leaders enjoyed advantages, but there was no way one fellow could be that much better off than another. These folks practically didn't stock food – they hunted by day, ate at night, and woke up to go hunting once more. They might actually accumulate a bit of wealth, in the form of better weapons – a priority when it came to divvying up food and women. Even nowadays, this happens in all hunting and gathering societies, like tribes in the Amazon or in Africa. Anthropologists have deduced that it was no different in the past. This degree of inequality might be horrific for the guy who ended up poorly armed, poorly loved, and poorly fed. Even so, everybody was pretty much in the same boat. If the hunt went well, everybody ate. If it didn't, everybody died. If you got more meat than the others, you might use it as money to pay for some favor, following the chimps' example. But the next day, you'd start all over from scratch. Unless it's possible to accumulate a reasonable amount of wealth, the idea of money is irrelevant.
Plantations changed this story. Whoever owned fertile land had power. He could eat, drink, and wear whatever he wanted. And he was able to produce much more than he needed. If you didn't have a patch of land, it was your tough luck. More and more land was snatched up by farms, and there was practically nothing to hunt in certain regions. So, what could you do? Trade labor for food. But this was a double-edged sword.
First, the down side: a big farmer could easily have a dozen slaves fermenting his wine, baking his bread, and building his stone mansion, all for a pittance. He just needed to maintain a well-fed army of security guards to prevent rioting, and all was right with the world.
Now, the up side: men who had been running all over chasing gazelles before were busy fermenting wine, baking bread, and building houses. For the first time in the pre-history of our planet, highly specialized branches of work evolved. And this proved so successful that we've never quit living like this, no matter what our form of government. Labor was exchanged for food? It was. All right then: food ended up playing the exact same role that money does today. If you were a better baker or house builder than the others, you tended to get a bigger chunk of surplus grain and meat from your boss, the land owner (a fellow who would eventually earn the name "king"). You might even end up with more food than you could eat. You'd have your own private surplus. Then if you wanted to have your own personal baker and to wear fur coats, you could trade a bit of your surplus for services and products like that. Whoever made a better fur coat could sell so many of them that he'd end up with a surplus as well. And it would never end. Just like it still hasn't ended.
You can imagine that it wasn't very practical to lug bags of food around to trade for other products. The Babylonians, a people who lived in the Fertile Crescent some 4,000 years ago, concocted a way around this. And while they were at it, they came up with two things you're even more familiar with: paper money and banks.
Well, it wasn't exactly paper money and not exactly banks. You would deposit your bags of grain in storage silos kept by the king (the banks) and in exchange you received a clay tablet inscribed with the quantity of goods you'd left there. These tablets were the paper money. "Paper money" because people began to pay for services and buy things with the tablets. It was money, pure and simple. If you had a ton of these tablets in your safe at home, you were rich. You could eat, drink, and wear whatever you wanted.
The wealthier folks in fact learned how to make their tablets earn more tablets without any effort at all: they loaned them out and charged interest. If you needed ten tablets to buy a cow, one of these ancient bankers would loan you the ten, so long as you paid him back with twelve tablets later on, using part of the profit you got from selling the milk supplied by your new Elsie.
It was a sophisticated set-up. They were already charging compound interest. Compound interest, just to remind you, is when you pay a rate of 1% a month and at the end of a year the total comes not to 12% but to 12.7%. And at the end of 20 years, it's not 240% (multiplying by the number of months in two decades) but 989%! Almost ten times the amount financed.
If you owe 100, the 1% is charged against the 100. The next month, it's 1% over 101. And so on. It doesn't seem like much, but after a while you've got a monster debt. Any similarity with what happens when you finance a car or buy an apartment is not a coincidence. Deep down, we never stopped being Babylonians.
Gold, silver, and tobacco
The Babylonian tablets may have been a brilliant idea, but it wasn't the one that endured. The problem was that the monetary reserve would go bad. Grain ultimately rots. Then the clay tablets were worthless. For money to really become money, it had to be something that lasted a long time and, on top of that, fulfilled the same two prerequisites as food: it had to be something relatively rare and something that everyone wanted.
Salt fit the bill. Here's where its intrinsic value lay: in a world without refrigerators, how could you preserve meat? By salting it. So demand for salt was almost as guaranteed as demand for food itself. It was also relatively rare, since extracting it from the sea or from mines is no simple process. Besides not rotting, it offered a fantastic advantage over grain: it was easy to transport. It was so natural for salt to play the role of money that this ended up happening in a number of cultures in antiquity. It worked so well that even today your boss pays you in salt – at least etymologically speaking. A "salary" was the remuneration Roman legionnaires received in the form of salt, and the word stuck. Leather, dried fish, the feathers from certain birds, pretty shells, booze. Almost anything that lots of people wanted and wasn't easy to get their hands on has at one time or another served as money. Even after money was invented. And even when and where it had already been dubbed "dollar."
In the U.S. state of Virginia, for example, tobacco was the most common currency from the time of this colony's foundation, in 1607, until 200 years later, when the United States was already a rich, established country. People used tobacco to buy things and pay their taxes. They even bought their wives with it. "It would have done a man's heart good to see the gallant young Virginians hastening to the waterside when a vessel arrived from London, each carrying a bundle of the best tobacco under his arm, and taking back with him a beautiful and virtuous young wife," wrote Reverend Parson Weems, a chronicler of those times. Robert Chalmers, a nineteenth-century economist, had this to say: "They must have been stalwart, as well as gallant, to hasten with a roll of tobacco weighing 100 to 150 pounds under the arm."
But exotic types of money only took hold in specific situations. This was the case in Virginia, where it wasn't worth the bother of trading merchandise for coin. Since people imported almost everything that wasn't tobacco, it was easier to pay directly with the product itself. Something else would become the great vehicle of trade: copper.
Since copper melts at a relatively low temperature (about 1,980ºF) and isn't all that rare, it was the first metal to replace stones and ivory in the making of weapons, around 5,000 B.C. These new arms were much more efficient than older ones, so whoever had copper had power. And if you didn't have a patch of land to call your own? You just rounded up a gang armed with swords and spears, and stole someone else's land. You needed to defend your glebe? You got your hands on some copper.
Copper was valuable in times of peace as well, in the form of caldrons and pots or of decorative objects. In fact, these uses were the most common. Humanity produced greater numbers of necklaces and earrings than of weapons. And keeps on producing them.
So here you had something that was hard to produce – for a good time, try mining copper from a mountain – and that everyone wanted. Badly. With an advantage over bags of grain, salt, or any other merchandise: it lasted much longer. You could amass as much copper as you wanted, and it would always be there, without going bad. If you were an ancient sovereign and traded grain from your kingdom for copper to fashion into swords and necklaces, there would be no risk of loss for you. When things got rough, you could melt down part of the metal, transform it into bars, and use them to buy goods from other kingdoms (the criminals in Brazil who steal copper from electrical cables to melt it and make new wires are basically doing the same thing). And so, go figure: owning copper became as secure as owning land. It was something that could be handed down through the generations.
So copper bars logically became the first universal currency, and when people started mixing copper with tin to form a stronger metal, one much better for forging weapons, this byproduct – bronze – became a currency as well.
But when we're talking about money, the rarity factor is more important than the utilitarian factor. Gold, for example, serves no purpose other than to show the whole world that you own something extremely rare, be it at home, on your wrist, or around your neck. So rare in fact that if you collected all the gold that has been mined in the history of humanity and formed it into one massive block, you'd have a cube less than 63 feet on a side. This is equal to the volume of a seven-story building, or 142,000 metric tons – the amount of iron ore mined by Vale every six hours.
Part of this gold has been lost – in shipwrecks, for instance – or was turned into something more useful than jewels, like industrial parts or circuitry components. Estimates are that 122,000 metric tons of gold continue circulating in the form of investments or jewels. In other words, any old Rolex might contain a tad of gold that was once part of a Roman coin and another bit from the gold tooth of a nineteenth-century miner, whose grave was violated by thieves in search of just such loot. Even the bullion that the U.S. Treasury keeps in its reserves may contain metal that was once part of Al Capone's gold watch.
Despite all this turnover, there has always been very little gold for the world economy to revolve around it, but this is exactly what happened. And what continues happening in a way. In 2010, a German company installed gold-bar vending machines at the Emirates Palace, a luxury hotel in Abu Dhabi, and also at the Frankfurt airport. They're like pop machines but instead of soda, they dispense bars that come in ten different weights, ranging from one gram to one ounce (31.1 grams). Not only has gold always been money; it's worth "more than money" since its value tends to rise above any inflation index. From 2005 to 2010 alone, the price of one gram of gold rose 190% in U.S. dollars.
We can still find ample evidence of the important role metals have played as money. Many of today's currencies bear names derived from these metals. The sterling pound, for example. Pound refers to the weight while sterling is an adjective that describes the purity of the silver. So a sterling pound is literally "sixteen ounces of top-grade silver."
Today, this much silver costs a good deal more than one sterling pound; it goes for about $75. But the age-old reference stays with us. Truly as old as the ages. A sterling pound – in the sense of sixteen ounces of pure silver – was the fine that a citizen of Eshnunna, a Mesopotamian kingdom 4,000 years ago, had to pay if he was found guilty of biting someone's nose. It was cheaper to hit someone in the face: one-sixth less in fact, or one shekel, in the language of the day. Not coincidentally, Israel's currency is now called the shekel (more precisely, the new shekel – inflation caused them to drop three zeros in 1986).
Another advantage with metal is that everything has a clear-cut price. An Egyptian financial document from 1,000 B.C., recording the purchase of an ox, provides a fine illustration of this. The animal was worth 50 debens (10 pounds) of copper. But the buyer only had 5 debens. So he made up the difference in foodstuff and clothing – as was the custom before the rise of metals – except that in the document these goods are quoted in copper debens as well: lard (30 debens), oil (5 debens), and another 10 debens in clothing to round it off to 45.
Everything had a value that was translated into a monetary unit. Just like we have U.S. dollars and Brazilian reals today, we had copper debens, right? Wrong. The biggest revolution hadn't taken place yet: the invention of counterfeit money. Precisely what you have in your wallet today.
The very first coin
It's hard to know if you're holding a 6- or 8-ounce package of sliced ham in your hands. If we're talking about cold cuts, 2 ounces doesn't make a whole lot of difference. But with gold, silver, or copper, it's a different story. So any financial transaction had to involve a scale. And that brought with it two problems. One: you couldn't always count on having a scale every time you went to buy something. Two: trickery was easy, as the seller could rig the scale to read low, so the client's metal weighed in at less than the client claimed; or, on the other hand, the consumer could show up with "dirty" metal, embedded with other, worthless ore.
What could be done? Find a way to prevent both types of cheating. And one kingdom managed to do this with one shot. It was Lydia, a city-state situated in what is now Turkey. Around 600 B.C., the government there decided to settle this issue by casting precious metals in the form of pepitas, whose weight and degree of purity were predetermined; furthermore, each coin was engraved, as a seal of authenticity. Well, some other kingdom might actually have been the pioneer, but the oldest coins found to date by archeologists come from there (when someone sticks you with a mountain of coins as change, now you know who to blame). In principle, it was the Lydians' idea. An idea that would change everything.
When money was food, you could plant it or raise it. When it was salt, you could filter sodium chloride out of seawater. When it was simple pieces of gold and silver, you could mine some more. But now there was a currency that was controlled by the government. This in itself boosted people's confidence when it came to doing business. If you don't need a scale or anything else, it's much easier to buy and sell. And the more business you do, the richer your country. It's a good deal all around.
Except the biggest role that coins played in the economy was different. Much more important. To understand how coins became the solution, we have to begin with the problem they presented.
Imagine a government that depends on gold and silver to mint its coins. Got it? So it has to mine gold and silver to make money. But if a mine becomes depleted, it'll take a good long while to find another and extract more precious metal. Meanwhile, the supply of coins on the market gradually dries up.
Of course. This happened because not all the coins stayed in the same place forever. If they were used to buy something from abroad, like a shipment of wine off some foreign merchant's vessel, the coins would land in another country, which is where they'd stay, circulating in the form of precious metal (since gold is gold everywhere).
When the supply of coins shrinks, so does the domestic economy. Obviously. People have less money in their pockets, so they buy less stuff. If people are buying less, producers get stuck with unsold crops, which go bad, and tailors make less clothing. In brief, the country gets poorer. What's more, anyone who's gone into debt will never be able to pay it back. Since there's less money circulating, the debtor can never pay off a debt that was acquired when money was abundant. But whoever loaned him the money isn't concerned about this sob story. He'll do whatever he has to to collect from the debtor. It's just around the corner from there to pandemonium.
To avert a catastrophe, the government mines more gold and silver, mints new coins, and injects virgin money into the economy. It's not hard to do. All the State has to do is buy things up – like overstocked agricultural produce, for example. Done. The government fills some pockets, the lucky ones start spending their new money in the market, and the next thing you know, the economy is up and running again. In a heartbeat, more currency than before is in circulation. This stimulates the production of wealth. Debtors can obtain money to clear their names. Everything goes back to normal.
But who's to guarantee that there'll always be a mine where more gold or silver can be gotten? Nobody. And the truth of the matter is that sooner or later, the mines ran out. The end had come. Either you, as a ruler, waged war with your neighboring country to plunder its gold and balance your accounts, or you watched and waited as your people slipped back into the Stone Age. But government-minted coins opened up a third possibility. A stroke of genius discovered by the Greeks in Athens.
Twenty years after the Lydians began minting their coins, a number of Greek city-states had already copied the idea and were making their own money. But in the most important of these city-states, Athens, they ran into a stumbling block. In the sixth century B.C., Athens was at the height of a financial crisis.
In principle, the problem wasn't money but a lack of organization. A part of the people in Athens had always made their living by planting wheat, while another part produced olive oil and wine. The region's soil, however, had never been good for producing grain. There was never enough. At first, it was a comfy situation for those who planted wheat. When something is scarce, it's more expensive. The law of supply and demand. Simple. But one man's problem was rooted in another man's luck. Oil and wheat producers traded with ranchers from the East (today's Russia). And the land there was something else: whatever the grain, if you planted it, it would grow. Since the comrades in the East had all the wheat they needed, the oil and wine producers in Athens exported a little of their oil and the coveted narcotic they produced in exchange for a lot of grain – and a little extra gold, of course. As a result, those who made their living off grain had no one to sell to. And society became stratified. The rich olive oil and wine producers were on top and the grain farmers below, battling credit card debt.
Really battling credit card debt. A farmer who can't sell his crop will have no capital so he can plant more and try his luck with the next harvest. So what does he do? Takes out a loan. From whom? From whomever has it to loan out. In other words, from the rich noble farmers on the other side. But this brings us to the old story we're all familiar with: the one on the top goes up, and the one on the bottom...drowns.
The noblemen set interest rates sky high. Cruel, but it made sense. Many wheat farmers wanted financing precisely so they could produce olive oil and wine and sell these delicacies to the old (and new) world on the international market. If the traditional producers were going to finance their future competitors, they were going to make them pay through the nose.
Except it was more than Athens could afford. The poor farmers' debts grew to the point where they simply were not payable. It became common to settle a debt by relinquishing part of your land. The folks on top took advantage of the situation. Anybody who owed volumes also had to give up their women and children as slaves. And that's what happened. But that was going too far. Slavery was part of life in the Greek world. Generally, however, people had foreign slaves, captured during war. For an Athenian who had been born free, nothing could be more degrading than becoming a slave.
It was a time bomb. The noblemen who ruled Athens started to fear a popular revolution. The mass of debtors – afraid their children would be doing forced labor for the wealthy and their wives would be sharing the latter's beds – might rise up against the State and put a tyrant on the throne. To save their necks, they appointed to power an aristocrat known for his extraordinary intelligence, in hopes that he could solve the problem: Solon.
Solon's first measure, enacted in 594 B.C., was to prohibit slavery as a way of settling debts. Solon in fact used public money to buy back the relatives of debtors who had been sold as slaves to other city-states. This calmed things down but the core of the problem was unresolved: sharp inequality and indebtedness. Poor farmers wanted their debts fully pardoned and they also wanted agrarian reform − a piece of the wine and olive land for themselves. But reversing the scales by taking from the rich what rightfully belonged to them would only shift the revolt to the other side, and the stability of the Athens government would remain at risk. Solon then decided to take a strictly economic approach to this dilemma.
Theoretically, he could use State money to buy what had been produced by the poor. And they would pay off their debts with this money. It wouldn't be a magic bullet, but it would get things back on track. The problem was that the State didn't have all this money. Neither the State, nor the silver mines where Athens got the raw material to mint its coins.
Solon opted to go down this road anyway. How? Using a method that might seem like some kind of scam but in point of fact was a brainwave as important to economics as the theory of gravity is to physics or the theory of evolution to biology. You might call it the theory of devaluation. Though it didn't even have time to be a theory as it was immediately put into practice.
Here's the crux of the idea: people believed in the government-minted coins precisely because the State guaranteed that they were made of pure gold or silver, right? Solon ignored this. If people trusted the minted coins, they didn't need to be completely pure. Whatever the State called money would be accepted as such. But how could more money be put on the market? Using counterfeit coins. Well, relatively counterfeit, to be precise. Solon began mixing cheaper metal in with the raw material in the coins so he could produce more money. So a silver coin contained only 73% of this ore. The rest was copper. If the lettering on the coin said it weighed 1 obolus (1.05 grams) of silver, or 1 drachma (6 oboluses), cool. It was a 1-obolus coin, and that was that. The amount of silver that it really contained didn't matter so much.
If the population didn't swallow Solon's economic plan, it would be the end of coins. And probably of Athens. But what happened was something no economic analyst back then (if there were any) would have bet on: it worked. Solon started using the copper-tainted drachmas to make government purchases, injecting money into the whole economy. With more money on the market, more people could buy things. Including wheat. And grain farmers had a motive for producing more. The new coins also served to finance new olive plantations and vineyards and to strengthen foreign trade. Those who had nothing left got back on their feet. And could finally pay their debts. Athens was stronger and richer than before, and Solon had paved the way for another measure of his: the creation of democracy.
All thanks to counterfeit money.
This story seems so illogical that it's hard to believe at first glance. But the biggest proof that it actually happened is right in your wallet. There are no silver coins in there. And your dollar bills are made of worthless paper. Even so, this paper can motivate you to work as many hours as an Athenian wheat farmer.
The imaginary currency you receive as your salary
We're just like the Greeks of sixth century B.C. We believe money is worth the value printed on it. A fifty-dollar bill is a fifty-dollar bill, case closed. The fact that the U.S. Treasury, which issues the currency, won't give you 50 grams of silver or even a sack of wheat if you present one of these notes at a teller's window doesn't matter in the least. What matters is that someone will be interested in selling you the amount of silver or wheat that $50 will buy. If fifty-dollar bills are in short supply for some reason, and silver miners and wheat producers are about to lose all their clients, the government will inject more fifty-dollar bills into the economy, before we slide back into the Stone Age.
This happens all the time. In late 1994, there were $5 billion worth of bills and coins circulating in Brazil. That's the total amount in people's wallets and in bank safes. By the turn of the century, the total was $11.35 billion. By February 2011, it was $70 billion.
And guess what: from 1994 to 2011, prices climbed an average of 300%. Four fold. What cost $50 before jumped to $200. It seems like a lot but this first impression fades when we realize that the supply of money grew fourteen fold.
In practical terms, the difference between the growth in the amount of money in circulation and rising prices shows how much the country's production grew. In 2011, every Brazilian could buy more than in 1994, even though everything cost more.
What happened here was the same thing that happened in Solon's Athens. With more money on the market, the production of goods and services grew. The extra money was a stimulus. With everyone producing more, everyone – at least on average – began eating better, trading in their car earlier, buying a home, and so on.
$70 billion in action
Quantity of money in circulation in Brazil:
Late 1994
Early 2011
$10,045,616,772.54
$140,033,212,605.30
Since Brazil created the real in 1994, the country's Gross Domestic Product (GDP) has quadrupled in dollars (because Brazil doesn't print U.S. dollars, it's the best measure of our growth). Imagine that someone gave you everything that Brazil produced in one year, as a present. Everything. Every barrel of oil, every car off the assembly line, every cheeseburger off the grill, and, on top of all that, every single bill that made its way into the cash register at every office supply store, car wash, hair stylist, and wherever else. In 1994, all this together tallied $550 billion. That was Brazil's GDP. By 2011, it had reached $2 trillion. Four times as much. Talk about pens, soap, and haircuts! The difference alone comes to three Belgiums (its GDP is $500 billion), or one India (GDP of $1.4 trillion). It's important to leave something clear here: the illusion that money has a value – whether it's made of impure silver or of toilet paper with a hologram on it – creates concrete things. And it's never been so easy to use new money to incentivize the production of wealth. If you take a good look, you'll see that money isn't even made of paper today. What really circulates are numbers on a computer screen. Images that don't even have paper money as a reserve. There were $70 billion in the form of bills and coins in early 2011, right? But the total amount of money in Brazil is much greater. If you add up all the deposits in checking accounts, savings accounts, securities, CDs, and so on, it'll come to $1.55 trillion.
All just as virtual as music on an MP3 player. Nothing but bytes. Yet this should come as no surprise to you. What's your salary? You probably only see it in the form of numbers on your internet banking site. The company you work for transfers numbers from its accounts to yours. You then use these numbers to pay off your credit card and to pay your monthly bills online, or let a software program do an automatic debit. Done. Money barely needs to show its face – and if this were to happen, there wouldn't be enough bills for everyone. Nonetheless, it's still money. And for a basic reason: these bytes are maintained as a scarce resource, as scarce as precious metal or bags of wheat.
It's almost as impossible to get into your bank's system and add zeros to your account as it would be to make gold or food out of nothing. Since the system is trustworthy, those virtual numbers are really hard to come by. You need to work for someone or open your own business, just like any Babylonian or member of the first agricultural societies in the Middle East.
And so a restaurant in Paris is more than happy to accept as payment for your bill a slice of the numbers you got by working in Brazil, since the bytes in the banking system are seen as a universal means of exchange. This medium is as well-accepted as copper bars and bags of wheat once were. If it were easy for everyone to get as many bytes as they wanted, the bytes wouldn't be money. They'd just be worthless bytes.
And so how does the government put new money on the market to make the economy go round? Paying for public works with new money, just like in antiquity – that's one way. But this isn't as relevant today, at a time when private enterprise spends more and employs more than the government. Now money has to be injected more directly, straight in the vein.
Have you ever gotten out of bed, gone to your online banking screen, and seen that the Fed had deposited $2,500 into your checking account? And then opened an email that read: "Dear sir, this is your quota of extra money that we are using to irrigate the economy. Spend it as you like. And make jobs while you're enjoying yourself! Signed: President of the Federal Reserve"? Yeah. Me neither. Nor has there been any news about government planes flying over cities tossing fifty-dollar bills into the air.
Yet the government does in fact toss bills into the air. Not literally, but it does. This is what happens when the Fed forces interest rates down. In Chapter 10, we'll see what tools the government uses to do this. But what matters for now is this: the effect of pushing down interest rates today is precisely the same as putting more coins on the market through public spending, as in the past. That's because interest rates are the price of money.
The notion of the "price of money" may seem redundant at first. And it is. Although you pay interest when you buy a plane ticket or a flat screen TV on the installment plan, or when you don't pay off your credit card bill every month, you usually don't pay for the money you need for your bread and butter. You simply go to work, receive your salary, and spend it. But the owner of the company where you work probably pays for his money all the time. It's common for large corporations to borrow money to cover daily expenses, like their payroll. If down the line the company makes much higher profits than its expenses plus interest, it's all good. Worth it.
So cutting interest rates irrigates the economy at both ends: consumption and production. With lower rates, consumption grows and companies spend less to produce consumer goods. One thing feeds another: the more that is produced, the cheaper its price; the cheaper the price, the more that is produced. If everything goes well, profits get fatter and wages go up. Boost wages, and consumption rises as well. Production climbs to meet new consumer demand. And the cycle begins all over. It's the gears of the economy turning.
The visible effect of this is that prices drop over time. Not prices in money. Because of a mechanism inherent to the economic model that took root all over the globe after World War II, prices always rise (we'll see how this happens in Chapter 9). But the number of days that you need to work to buy something declines – at least when the economy is growing. A civil engineer in Brazil who earned an average salary for his profession in 1989 had to work 17 months to buy a small sedan. Someone in the same profession today can buy a Toyota Corolla with 12 months' worth of paychecks. This is a national average; top-earning engineers can buy a car like that with two months worth of wages or less. Furthermore, the number of jobs paying high salaries has also risen since 1989. And expectations are that they will continue growing at an even faster rate through 2020. In 2010, 32,000 engineers graduated in Brazil. But estimates call for the oil and automobile industries alone to create 34,000 jobs for people with engineering degrees during this decade. We can already feel the effects of this shortage today: in 2010, an engineer left college to step into a job earning $30,000 a year – twice the figure for 2006. In areas where demand rose more, salaries of $200,000 are common, even among people with little experience.
Unless a country can be irrigated with new money, none of this would be possible. The problem is knowing the right dose, because if it rains too much money, you're up the creek. Sooner or later, people will lose their fundamental belief that money is worth money. While this faith may be big, it doesn't move mountains.
So much so that it is a faith that has died many times. The end of belief in the value of money destroyed the Roman Empire, served as Hitler's ladder, nearly dragged Brazil down from the third to the fourth world, and might be brooding again right now, anywhere. In the next chapter, the bottom of the pit.
[1] Science 278(5341):1243-4 (Nov. 14, 1997).
Milton Friedman, Free to Choose (New York: Harcourt Books, 1980), p. 251.
W.C. Butterman and Earle B. Amey III, "Mineral Commodity Products – Gold" (U.S. Department of the Interior/U.S. Geological Survey), available at http://pubs.usgs.gov/of/2002/of02-303/OFR_02-303.pdf.
Catherine Eagleton, Money, a History (Richmond Hill, Ontario: Firefly Book, 2007), p. 20.
Sarah B. Pomeroy, Ancient Greece: a Political, Social and Cultural History (Oxford: Oxford University Press, 1988), p. 165.
Charles Allan Fyffe, History of Greece (London: Spaight Press, 1988), p. 65.
[7] Veja, Nov. 11, 2009.