The Modern Period
Fiduciary Money and Convertibility
In itself, the idea of using materials other than gold or silver in the Western
monetary tradition is by no means new. In the fourth century BC the Greek
philosopher Plato advocated the use of a base-metal coinage for his ideal city,
the value of which would be established by law for use in domestic trade only.
In eighteenth-century Europe base-metal coinage began to be
produced in large quantities as fiduciary money (money whose value depends on
trust rather than on the value of the material from which it is made), and was
subsequently complemented by the extensive use of paper money in Europe and America.
Originally both these types of token money derived their value from an
implicit or explicit undertaking that they could be exchanged or converted into
precious-metal currency, whether gold or silver, which formed the basis of
the gold standard. Such forms of currency, particularly banknotes, came to play
such an important role that governments were simply unable, on an increasing
number of occasions, to offer to convert it back to gold on demand. It was the
combination of the pressure caused by a shortage of money coupled with the
growing intellectual discipline of economic and monetary rationalism that
eventually led to the end of the gold standard as the cornerstone of monetary policy in the Western world.
The use of paper money increased greatly in this period. For a long time
previously bills of exchange had provided a means of payment and credit without
the actual transfer of precious metal. But the advent of banknotes and other
promissory notes created a situation in which this facility became available to a
much wider public and on a much greater scale. Government and individuals
realized their potential as a means of increasing the money supply, since they
allowed more credit to be created by enabling a depositor to make a loan to a
creditor without any increase in the amount of precious metal available. The
total value of notes issued by a bank often exceeded the value of the amount
of gold or silver it held in reserves, but this did not matter provided all the
depositors and creditors of a particular bank did not try to convert their paper
into precious metal at the same time. If they did, then the bank would either
collapse or need to be protected by the temporary suspension of cash
payments. This is what happened in Britain during the Napoleonic Wars: in
1797, to preserve the Bank of England's rapidly falling gold reserves, the
Privy Council ordered the Bank Directors to 'forbear issuing any Cash in
Payment until the Sense of Parliament can be taken', and the resulting
'Restriction Period' was to last until 1821. Despite such real and potential
problems, issues of paper effectively enabled a great increase to
take place in the amount of credit in the economy. On the other hand, the difficulties of restricting
such a growth of credit in the face of the temptation it offered to
individuals and governments to over issue provoked a large number of financial crises.
|