Wednesday, March 8, 2017

Good as Gold, III: The Cash Problem

Yesterday we noted that, while gold has certain advantages as a monetary standard, it also has a number of weaknesses.  Primary among these is the fact that the amount of gold in an economy has no direct tie or link to the level of productive activity.

Spanish treasure that didn't make it to Spain.
If gold flows in but production remains low, inflation results.  Consumers lose money by paying higher prices as their money declines in value.  This is what happened in Spain and the rest of Europe when vast quantities of gold and silver poured in from the New World.  Prices that had been stable for nearly 1,500 years suddenly jumped 400% or more in less than a century.
Inflation favors producers (just as deflation favors consumers), and ownership of the means of production began to become very concentrated as producers began enjoying income in the form of cash money that they had never seen before.  Always before cash transactions had been a rarity.
Land and technology had almost always been purchased on credit and the loan repaid “in-kind,” i.e., in goods and services over time instead of cash.  For example, a farm bought for “fifteen years’ purchase” sold for fifteen times the annual crop, which might take up to thirty years to repay.
It leaves out the Emperor, but you get the idea.
A knight or lord held land in return not for a cash rent, but by virtue of an annual delivery of foodstuffs or fiber, and a non-cumulative number of days’ service per year, usually forty.  A peasant or serf held land on condition that he deliver a percentage of his crop or other produce each year, and a certain number of days’ labor on the landlord’s projects.  This latter was called “robot labor” in Central Europe — now you know where the term comes from.
In such a system, there is no convenient way to accumulate savings, and very few people did so.  When money in the form of currency became more common, however (it was not really truly “common” until the latter half of the nineteenth century), it became possible to accumulate money savings.
But what do you do with money savings?  Put it in the bank?
The Medieval Money Market was no big deal.
No.  With one or two exceptions (such as the Bank of Amsterdam), the few banks that existed were usually not savings banks.  They were commercial banks that discounted bills of exchange and bought mortgages to facilitate commerce.  They did not accumulate savings for investment loans.
How about the stock market?
Really?  What “stock market”?  Most business enterprises were sole proprietorships or partnerships, not corporations.  There was no such thing as a “stock market.”
How about government bonds?
Surely you jest.  Until the end of the eighteenth century (and in most countries down to the present day), government bonds were the worst investment you could make.  Do you know why Medieval kings protected Jews in some cases?  Because Jews had wealth in the form of cash, and could usually be counted on to pay for protection by “loaning” the king money . . . and sometimes he even paid interest, and once in a blue moon actually repaid the principal.
So what do you do with all that new cash?  You buy land, of course.  And it was even easier to do because with the changeover to a cash economy, taxes were beginning to be demanded in the form of cash instead of in-kind payments and service.
The "New Men" had wealth and power.
At the same time, with kings and emperors desperate for cash, traditional feudal dues were changed to one-time cash payments, while serfs and peasants negotiated fixed cash rents instead of a share of produce.  Landowners got into debt, and had to sell to the “New Men” with cash in hand instead of to peasants or yeomen who would make an in-kind purchase over time out of profits.
When technology started advancing at a rapid rate, the New Men had the cash to finance it or to collateralize loans to create new money for investment — which really took off with the invention of central banking in the late seventeenth century.  Ownership of all forms of capital became even more concentrated.
 So what happened in the nineteenth century when cash economies started coming into their own to replace more traditional forms of money, e.g., contracts like bills of exchange and mortgages?
Currency crises, the business cycle, financial panics, economic downturns, — you name it, all things that had never before been heard of.  And why?
That’s what we’ll look at tomorrow.

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