Mediums of Exchange and Financial Instruments
Money Makes the World Go Around
The cumulative manipulative power of commerce on the world is perhaps best illustrated by a song from the multiple-award-winning musical Cabaret that opened on Broadway in 1966, was made into a movie in 1972, and, after its revival on stage in 1987, garnered its second Tony award. Set in Berlin at the beginning of the Third Reich, the story follows the romance of an English cabaret performer and an American writer. Through its songs the audience witnesses the political changes taking place in Germany against the backdrop of the global economy of such a period. One of the memorable songs performed by the emcee, as joined by the female chorus line in international designated costumes with each nation’s currency clearly delineated, is usually referred to as The Money Song although its original title was Sitting Pretty. The lyrics by Fred Ebb tell a universal tale: “Money makes the world go around … of that we can be sure.”1
There is no other worldwide physical object nor shared language or political dogma as expressed in philosophy or religious beliefs that unites all the peoples of the globe like money. Money is a medium of valued exchange as accepted by societies for their trading activities. It acts as a respected intermediary that further supports the commercial imperative, always retaining its intrinsic value: a dollar is a dollar, but what it receives in return—products or services in the marketplace—fluctuates. The importance of creating a designated value conciliator changed, united, and propelled civilization forward. Under the traditional barter system, if one party only had an apple to trade, he had to find those who wanted an apple and hoped what they had he also desired. This arrangement deeply limited the trading process especially between parties who were not acquainted with the fruits of the labors of distant lands. My own son at age six understood the marvel of money as a flexible instrument to enable one to get what he or she really sought. When asked what he wanted for his birthday, he replied, “Don’t give me a present as it may not be what I want; give me money instead so I can go to the store and buy what I want.” The development of a medium of exchange provided freedom of choice, thereby liberalizing and expanding the trade process. It fueled early commercial venturing, allowing for greater integration of people into the system, and thereby propelled the development of civilization.
Whatever the current denominated local currency unit or the value assigned to historic bartered items, a fundamental understanding and appreciation of a medium of exchange to enable parties to transfer ownership between them permeates all cultures. Aphra Behn, author of the play The Rover (1677), best expressed such a concept with the line “Money speaks sense in a language all nations understand.”2 The development of such an exchange tool grew out of the basic need of all human beings to trade with each other. Whether money is defined as metal coinage or paper currency backed by a governmental obligation or expressed as the intrinsic value in gold, silver, or some other mutually recognized intermediary material of accepted denomination from wampum shells to bricks of salt, its conceptual use is universal and the principle exists in all societies.
Economic textbooks describe money according to its three basic functional or operational characteristics. First, it is of value unto itself when used as a standard of evaluation in asset or wealth determination. Second, it has value as a measured unit of account or counting in exchange transactions. Third, it has value as a medium of exchange with potential value determined by the things or services it can purchase in return, thereby carrying a variable value determinable through agreement based on an exchange event. Perhaps the oldest forms of money were physical things based on the fruits of one’s labor via agriculture and land use—the farming of grain and the herding of domesticated animals, predominantly cattle. Transactions based on such early physical embodiments of value were cumbersome or awkward to transport and difficult to accurately gauge before uniform weights and measures were introduced. Out of such a need the use of numerous other, more portable commodities as mediums of exchange, with their physical properties varying throughout history, was born. While precious metals—like gold, silver, and rare stone gems—are the most well known of the accepted value mediums, many others were used over mankind’s history in the exchange process. The Aztecs of Mesoamerica used chocolate as money. The cacao beans served as a way to calculate value and round out the exchange computation in a basic barter system. They even used quachtli (cotton cloaks), beads, shells, and copper bells to shape their commercial transactions.3 The use of ordinary commodities was also assigned a socially acceptable value of exchange in ancient times. The reliance on salt, due to its precious characteristic as a life-sustaining mineral, made it an intermediary denomination in China, North Africa, and the Mediterranean (see Chapter 5). During different periods, such necessary products to assist in life were granted value exchange status (e.g., rice to zappozats [decorated axes], eggs to nails). Rare and exotic items also took their places as intermediary value substitutes (e.g., amber, jade, ivory, shells [wampum, used by northeastern American Indians, and cowrie, a shell found off the coast of China]).
The first metal coins, made from an amalgam of gold and silver, by most archeological accounts, were invented in the Kingdom of Lydia around 560 BCE.4 The concept, sometimes referred to as representative money, was adopted in nearby civilizations (e.g., the Persians) and used in many of the early Greek states. The victory of Alexander the Great over the Persians provided the Greeks with a large amount of mined gold and silver along with the ability to mint more coins. His insistence on a standard exchange rate between gold and silver—a 10:1 ratio—sustained trading confidence in the newly introduced coinage system while enabling his administration to control important commercial activities thereby providing economic stability to war-ravaged territories. The Romans furthered the use of coins after years of relying on heavy, cumbersome bronze bars while the expansion of their empire unified vast conquered areas with a common medium of exchange, itself contributing to the intercontinental trading process, an essential element to Romans’ existence and maintenance of the empire. The engravings on ancient metal coins featured a variety of symbols and reliefs of emperors and kings. The Roman government even recorded messages, essentially propaganda, they wanted to get across to their citizens. The use of coins was an invention quickly implemented by many regimes in the ancient world as it provided a fair, predictable, and easily portable method of exchange as opposed to the old barter system that required the weighing or measurement—which was always questionable—of bulky and at times perishable intermediary commodities whose values fluctuated with market conditions.
Recently, scientists at McMaster University in Canada have found a method to use ancient coins to map trade routes and shed light on the early economic patterns as exemplified by commercial dealings in the Mediterranean region.5 Probing their metal content, researchers have discovered trace elements that allowed them to determine the geographic origins and in turn the circulation of these initial mediums of exchange. The wide territorial acceptance of these precious metal pieces containing gold, silver, bronze, and copper (along with adulterating elements of tin or lead, indicative of economic troubles) exemplify the early spread of merchant trade based on common values across and between civilizations—the roots of globalization.
Markings on ancient coins often depicted the faces of territorial rulers as insurance of recognized acceptance in their kingdoms, but such engravings primarily were used to promote the sovereigns’ public image. The true value of these early mediums of exchange was the inherent weight of the rare metal used in the forging process. An innovative change in the coinage-denominated value occurred during the reign of Cleopatra in Egypt.6 Coins struck during her reign had varying denominations inscribed on them, a quantified face value, thereby negating value based on the precious ore content. This revolution in the prescribed value of intermediary mediums of exchange served as a precursor to the introduction of paper money and began the movement away from prized metal determining the value of money to state-backed acceptable currency.
Fiat money or paper currency does not have an inherent value like commodities, gold, or silver coinage. Its declared worth or value is derived from its authorization by a sovereign government or kingdom as legal tender for payment of all debts to be declared acceptable for the settlement of both public and private debt in the territories under the rule of such institutions. The first use of paper money (also referred to as bank or promissory notes of exchange) was attributable to the Song dynasty in China back in the seventh century, which imprinted the image of the emperor. Banknotes appeared in Europe in the mid-1600s issued by Stockholms Banco. It should be noted that the use of fiat money was tied throughout history to a gold standard wherein such paper notes were technically convertible to preset quantities of gold; hence, backed by the holdings of the sovereign state of the physical precious metal. The Bretton Woods Conference in 1944 was history’s first example of a fully negotiated monetary order intended to govern currency relations among sovereign states. Signatory countries pegged their currencies to the U.S. dollar, which in turn was fixed to gold. However, in 1971, the United States revoked the U.S. dollar’s conversion to gold and many countries suspended their currency’s tie to the U.S. dollar. Since then. the principle of a government-backed legal tender has remained in practice.
This notion of representative money by governmental fiat has produced some very troublesome events. Ask yourself what would the currency in one’s bank account be worth if you could find no one to accept such government-marked paper in return for the receipt of goods or services? Millions of hardworking thrifty German consumers during the administration of the Weimar Republic of Germany in late 1923 found almost overnight that their life’s savings were worthless as a valued medium of exchange in the marketplace. It took 50 billion marks to purchase a postage stamp and 200 billion to buy a loaf of bread. Home owners quickly realized that it was cheaper to burn mark notes in their kitchen stoves than to use them to buy firewood. Hyperinflation (i.e., when prices increase rapidly and the nation’s currency loses its value) can result in some ridiculous face values of bank notes. At the height of inflation, U.S.$1 was equivalent to 4 trillion German marks. The Reichsbank during this period issued a denomination of 100 trillion marks, which was worth U.S.$25. Throughout history, the loss of trust in government-issued mediums of exchange caused chaos. Whether it be the Roman emperors debasing their metal coinage, the French revolutionary regime printing a flood of useless assignats, or the U.S. Continental Congress issuing money until the phrase “not worth a Continental” was born, the danger of reliance on what Lewis Lapham calls our “secular religion,”7 our spiritual-like reverence that places the public trust in such instruments, has always been a danger. This analogy is reflected in American currency with the words “In God We Trust” printed on dollar bills. Perhaps, such references echo the words of Voltaire, the French philosopher, who wrote that “When it is a question of money, everybody is of the same religion.” The need, however, for nations to erect a common unit of exchange often accompanied by a shared measurement system (mutually accepted weights and measures) has helped societies throughout history to unite their people and bring social order; hence, giving credence to the idea that money is akin to a civil religion, a unified belief system as Lapham refers to it.
Paper money, as evidence of value, has moved beyond the scope of a nationally recognized currency. Commercial bank money, checks, or bank drafts are acceptable documents in the exchange process today. Bonds, letters of credit, wire transfer authorizations, and credit or debit cards all evolved to enhance and make more efficient the trading imperative, propelling mankind and the evolution of civilization. However the word money is defined and its value or worth measured, it is key to the socialization process of mankind. As observed by Lapham, “Money ranks as one of the primary materials with which mankind builds the architecture of civilization.”8 While it is a tool for living, the Latin phrase radix malorum est cupiditas (greed is the root of all evil) reminds us that it is not money that causes trouble but rather the use of money in a votive ritual as a pagan ornament with no redeeming social value or, worse, its utilization in a socially destructive or harmful manner. Jack Weatherford paints a rather stunning portrait of money in society when he states,
Money constitutes the focal point of modern world culture. Money defines relationships among people, not just customer and merchant in the marketplace or employer and laborer in the workplace. Increasingly in modern society, money defines relationships between parent and child, among friends, between politicians and constituents, among neighbors, and between clergy and parishioners. Money forms the central institutions of the modern market and economy, and around it are grouped the ancillary institutions of kinship, religion, and politics. Money is the very language of commerce for the modern world.9
While Weatherford injects the term modern into his observation, the author would submit that money defined as a medium of socially acceptable value in the exchange process has been important throughout human history as an identifier and classifier, even a definitive measurement and structuring device in mankind’s relationship with his fellow man. An American colloquial term, “Keeping up with the Joneses,” signifies the desire to compare one’s lifestyle with neighbors. Its theme, however, is universal as wealth accumulation in many cultures is a social conditioning mechanism to convey status and respect. Whether it is the number of chickens in a yard, the size of a cattle herd, gold jewelry anointing one’s body, an expensive sports car in the driveway, or a platinum credit card, such material objects serve as the social symbolism of value attainment. On the other hand, an altruistic lifestyle that delivers peace, tranquility, and harmony is also to be envied but the former measurement device seems to permeate most societies.
The emergence of the commercial trade process in the world was the essential ingredient in the development and progression of societies or in some instances their demise. In the modern era, the system it created is known as globalization but the roots of its current format can be traced to the dawn of man on this earth and his interaction with his fellow men. The invention of money was an essential component to the basic exchange process. It eliminated the difficult barter system, which required the cumbersome transportation of physical objects offered for trade. It allowed for smoother and more efficient business transactions to be conducted.
Raise of Capital Instruments
While money in various forms was used as a medium of exchange in transactions, its intrinsic value as a thing unto itself allowed it to be used and exchanged as a capital asset and thereby fund commercial activities. The idea of loaning money has been recorded throughout time. It is evidenced in ancient stone and clay tablets describing such arrangements. Its use as a thing to be exchanged with payment back in the form of interest has been noted in religious texts with many doctrines attacking the concept as usury (an exorbitant rate of interest in excess of reasonably acceptable social conditions or the legal set rate). In the Hellenistic east, third century BC, commercial loans carried a legal interest rate of 24 percent and the practice was severely limited. In ancient Egypt and throughout the Middle East, the percentage was only 8 percent, as money was commonly viewed as an acceptable resource to fund long-distance trading expeditions. While around the world the use of money as a capital instrument varied, its real rise on the global stage as an influential financial tool was in the form of the government bond.
Government Bond
The development of the bond, a formal contract to repay a borrowed amount with interest at fixed intervals, was a step beyond the traditional singular relationship of debtors and their bank for a loan. It enabled the issuers to broaden their credit base to alternative sources of funds in the general public while at the same time created an instrument that unto itself could serve as a portable medium of exchange that was also of transferable value. Like money in its initial numerous physical forms from engraved tablets to forged metal to wampum, this new embellishment of trusted value was another step in the expansion of the economic system and the globalization of finance.
As originally used to raise funds for the independent city-states in northern Italy around 1200 CE, the government bond was primarily a financial tool to provide money to wage war and hence it is associated with hostile conflicts between royal houses. The idea of the issuance of bonds rose out of the need by regional and later national feudal kingdoms to go beyond the repugnant property tax system and institute a reward-like mechanism for its landed gentry whose support was required to maintain political allegiance and authorized control. While the bond was an investment vehicle as it paid periodic interest to the holder, in reality, its true value was literally a gambling chip—a bet placed on the outcome of its use. As the tides of war changed—battles won or lost—the value of the bond fluctuated, much like the present-day corporate bond or stock that moves in relationship to the quarterly success of the issuing company. It should be noted that the doctrine of the Catholic Church, a dominant force during the early period of the bond’s introduction, prohibited usury, the charging of interest on a loan. Such religious-based prohibition was circumvented by not calling such instruments a loan or mutuum. Instead, they were constructed in contracts of purchase as a census or as they have come to be known an annuity—funds deposited with another for a future stream of periodic payments. The bond fit this definition perfectly.
In the 1200s, the banking house of Rothschild added a new wrinkle to the bond instrument. By placing family members in branches throughout the great cities of Europe, an integrated financial banking network was established. Previously, the bond market was limited to the sovereign territory and currency of the issuing state with interest paid domestically. But with the power and prestige, and also the shared intelligence of the Rothschild family, pressure was bought on bond issuers to denominate their value in a pan-European acceptable currency—sterling. In the capacity of an underwriter, the Rothschild family acted as its own syndicate, buying an entire issue of bonds from the issuer and reselling them to investors. This allowed bonds to be sold across and between national territories with interest payments available locally. The portability and expanded universality of the bond market was established. Today the pioneering activities of the Rothschild bank allows for national governments to place their debt securities on a global scale.
Although bonds were originally used as capital financing instruments to raise funds for military preparedness and to wage war, such specific designations were not adopted by countries until the United States did in World War II. During World War I, they were referred to as Liberty Bonds; then around 1935 a more exacting name was introduced, calling them Defense Bonds. The designation was officially changed to War Bonds with issuance of the E series after the attack on Pearl Harbor on December 7, 1941. The government with private interests launched a massive national advertising campaign for their sale. From attention-grabbing posters to radio and movie commercials to public bond rallies with Hollywood celebrities, a strong emotional promotional program was launched.
Apart from governmental use, the bond also played a significant part in early commercial transactions as well as historically raising investment capital for private commercial investments. In ancient times, such instruments were in the form of surety bonds or third-party promissory notes. However, within the bond family, such financial instruments are issued by one on behalf of another, guaranteeing that if the principle does not fulfill the contractual obligation, then the one owed the commitment can look to the bond for satisfaction. The term surety bond, a document evidencing an enforceable monetary obligation under specific circumstances, works like an insurance policy, and hence the term is often used in such commercial situations today requiring an event to trigger payment of the bond. The idea is not new, however. Stone tablets have been discovered in archeological sites dating back to 2400 BCE in Mesopotamia (Iraq) during the Babylonian era. Scribed by professional artisans of the period, such pieces described the guaranteed reimbursement if the principal failed to make timely payment for grain. Attested by witnesses who impressed their seals onto the tablet, this functional debt instrument served as a binding legal agreement between all parties. Historians tell us that the concept of business insurance as an endeavor entered into on a regular commercial basis probably originated under the term bottomry, an orientation toward the safe movement of merchant cargo stored in the hull or bottom of the ship. Recorded evidence of merchants entering the field of insurance for seafaring carriers via payments of securitas (Latin for security as well as the name in Roman mythology for the goddess of security of the empire and a veiled reference to a surety bond) is found in commercial documents of 14th-century Italy due to the ocean trading endeavors of the Venetian and Genovese city-states. These instruments insured against acts of God and other perils encountered outside of the control of the ship’s captain and the crew; today the concept is acknowledged under force majeure clauses of contracts.
Perhaps the greatest use of the private commercial bond was by the Dutch East Indies Company (Vereenigde Oost-Indische Compagnie, or VOC). Their bond issuance in 1623 further propelled the company to global trading dominance. In 1669, it was the richest private company in the world with assets of 150 merchant ships, 40 war shipments to protect cargo from sea raiders, and a standing army of 10,000 to control and administer their land expeditions tied to Dutch colonial ambitions. More than 50,000 people worked for them making them the world’s largest private employer in the 17th century.
Joint Public Stock Company
As world exploration in the 15th century yielded new sea lanes to support the East Indian trading initiative, the tiny Dutch nation, by European standards, rose to prominence as a globally induced commercial party to challenge the Portuguese and Spanish dominance of global trade. (Note that, between 1580 and 1640, these two nations were joined under one ruling royal house.) Due to the numerous hazards in sailing halfway around the world and back again, merchants pooled such one-off ventures to spread the financial risk of the numerous individual entities. Such an investment principle was not new as tradesmen in ancient times formed commercial partnerships to fund singular land trading excursions to traverse the Middle East. The Dutch experience improved on such a historic concept by merging these companies into a solitary unit to formally create a nationally charted monopoly on this lucrative trade route. Originating in 1602, the VOC introduced a model on which modern public corporate entities are based even though it was a government-sponsored enterprise. Not only was their structure a template for future companies to administratively and operationally construct their activities and legal formation but it also opened this investment vehicle to a wider public audience to participate in while also creating a trading system for shareholders to exchange their certificates of ownership, the forerunner of the contemporary stock exchange.
Subscription to the offering was open to all residents of the nation provinces, thereby allowing the public in general to participate in what was historically an exclusive elitist wealth-creating mechanism. Such expansion of the opportunity also helped to unite the country’s citizens in pursuit of a national economic agenda with global implications. As with the trade partnerships under the agreement called naruqqum under the Assyrians and Babylonian kingdoms, as previously described, the company had a fixed period of operation (21 years), but shareholders could withdraw their investment after 10 years. Even the money needed to acquire an interest in the company could be paid in periodic installments via purchase warrants, a financial vehicle used in funding initial stock offerings today. The actual ownership instrument was called apartijen, also referred to as actien (which literally translates to a piece of the action), a veiled reference to the gambling nature of the entities’ ventured activities. No actual stock certificates were issued but a receipt for monies received was issued and the name of the shareholder was entered on the company’s ledger, thereby entitling them to dividends. Perhaps the most appealing and legally interesting principle established in the use of the stock offering was that of limited liability. A board of directors was established to control operations but within the tradition of hierarchical reverence in the society at such a time when these overseers were known as Lords. Initially, such Lords were appointed for life but later this term was limited to three years.
To act as a check and balance on the maintenance of the company’s accounts, the use of independent auditors was also introduced. One of the key aspects of this capital funding system was the principle of limited liability—stockholders only risked their investment and could not be held liable for debts or losses that exceeded the subscription price. Their potential loss was restricted. The initial trading expeditions of VOC to set up operations in foreign markets were no easy task, and with many new commercial entities the venture was not immediately successful. Nervous investors could not withdraw their funds notwithstanding the potential liquidation of the company, so their options were limited. Out of such a situation emerged a new concept, a financial paper marketplace for the exchange of shares in a company, the stock market. As the trades were only officially registered periodically, the idea of forward purchases or futures was also created. Another interesting economic principle that came out of the public stock offering was the use of shareholding values being considered a recognized tangible asset that could act as collateral against which loans could be procured. The effect of such recognition was the expansion of credit opportunities as previously hard assets, usually land, livestock, or warehoused merchandise, were the only accepted form of guaranteed security for a loan.
Although the Dutch East Indian Company was initially charted to pursue trading activities in the Far East, one of its best known expeditions targeted North America. In 1609, the Halve Maen (Half Moon) captained by Henry Hudson, attempting to find a northwest passage for the VOC to the East Indies, sailed into what is today the New York Harbor. The area he explored was first developed and administratively operated by private commercial concerns primarily interested in the lucrative beaver felt pelts prized in Europe for the manufacture of waterproof hats. The region was later designated a colony of the Dutch Republic as a provincial entity in 1624 and, two years later, Peter Minuit created a deed with the local Indian tribe for the island of Manhattan, which eventually became New York City.
Congruent with the establishment of the VOC was the English joint stock company that came to be known as the British East Indian Company, which was also formed to pursue trade with the East Indies but focused more specifically on the Indian subcontinent and China. While initially created by Elizabeth I in December 1600, a greater privileged position was granted to the company in 1708 when a rival firm caused the original one to be merged into a singular entity. While the trading activities of the firm grew, its regional influence morphed into a semigovernmental arm of the British Empire as it came to rule large areas of India, exercising military control and administrative functions and eventually moving away from its original commercial activities.
Like bonds, shareholdings expanded a new base of credit and monetary value that helped to revolutionize the economic systems of societies and helped to propel civilization forward. These financial instruments—like their predecessors, the coinage of money and paper currency—expanded the mediums of exchange. Such documentable, easily transferred portable stores of value dramatically altered the commercial landscape, contributed to the trading initiative, and were fundamental to mankind’s progression. Paraphrasing the ideas of Jacob Bronowski, Niall Ferguson said that “the accent of money (and all its revolutionary instruments) has been essential to the ascent of man.” Such “financial innovation has been an indispensable factor in man’s advancement …. The evolution of credit and debt was as important as any technological innovation in the rise of civilization.”10 The bond and the stock certificate can also be considered as social reengineering instruments.
Before the introduction of these instruments, wealth was defined by a prime tangible appreciable asset, land, which could itself generate increased value based on its ability to produce extracted or supported resources through agricultural crops, a natural sustenance for farm-bred and wild animals, as well as mining operations for precious metals. While gold and silver were certainly valuable, they mainly served as an intermediary measurement for the transfer of other assets. When used on their own as investment capital with a return received for their use, they had value unto themselves, like a physical asset. As with the ownership of land, bonds and stock could generate an ongoing return via interest and dividends as well as increase in value themselves. Their one great advantage over property is that they were portable transferable wealth—land could not be moved. One could now move his or her wealth around, creating a more mobile society. Working capital created a new aristocracy as opposed to the historic landed gentry. And as the general public began to participate in the marketplace for such securities, they began to accumulate wealth, a privilege traditionally associated with landownership. Society was presented with a vehicle that allowed for a new class of citizens to emerge to challenge the elite landlords of the past. The societal system that had previously created a large gap between the rich and the poor was presented with an initial building tool to bridge the chasm of economic and social separation. It should be noted that bonds and stocks were not the only mechanisms to have a social impact. The rise of a merchant class and valued craftsmen or artisans also propelled social change in medieval times but it was these groups that gravitated to the use of bonds and stocks more quickly than the average laborer or commoner; so it provided additional fuel for their social accent. Primarily devised to aid the commercial trading imperative, these financial instruments combined to help shape the course of global human affairs and contributed to the development of civilization on earth.