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Why Money?Campbell R. Harvey

Duke University, NBER and

Investment Strategy Advisor, Man Group, plc

Revised February 20, 2017

Innovation and Cryptoventures

Campbell R. Harvey: 2017 2

Purposes

Purposes:Primary

• Unit of Account: A way to compare the value of various goods and services• Medium of Exchange: Allows for non‐barter transactions.

Secondary

• Store of Value: Allows value to be retained – even if partially – rather than complete decay (e.g. storing food).

• Transfer of Value: Ease of transfer of value and to defer value.

3Campbell R. Harvey: 2017

Characteristics

Traditional characteristics:• Durability: Withstand repeated use (coins, paper, gold)• Portability: You can carry around• Divisibility: Fractional units• Uniformity: Versions of the same currency have identical value• Limited Supply: Unlimited supply would mean zero value• Acceptability: “This is legal tender for all debts, public and private”• Stability: If unstable, people will look for alternatives


The Communist DreamThe Principles of Communism, 1847• “Finally, when all capital, all production, all exchange have been brought together in the hands of the nation, private property will disappear of its own accord, money will become superfluous, and production will so expand and man so change that society will be able to slough off whatever of its old economic habits may remain.”

5Campbell R. Harvey: 2017https://www.marxists.org/archive/marx/works/download/pdf/Manifesto.pdf

The Communist DreamA World without Money, 1975‐6• “The new people will resemble their hunting and gathering ancestors who trusted in a nature which supplied them freely and often abundantly with what they needed to live, and who had no worry for the morrow, over which in any case they had no control.”

• L'homme nouveau se rapprochera de son ancêtre chasseur collecteur qui faisait confiance à une nature fournissant gratuitement et souvent abondamment de quoi vivre, qui ne se souciait pas d'un lendemain sur lequel de toute façon il n'avait pas prise. L'homme de demain aura pour nature le monde qu'il aura façonné, l'abondance naîtra de ses propres mains. Il sera sûr de lui car il aura confiance en sa force et connaîtra ses limites. Il sera insouciant parce qu'il saura que demain lui appartient.

6Campbell R. Harvey: 2017http://www.reocities.com/demainlemonde/Un_monde_sans_argent.pdf

The Communist DreamBut…• Even North Korea uses money!


The Communist DreamFurther…• Hunter‐gather life style is no easy life style• “Five years ago, members of the Nukak‐Makuunexpectedly wandered out of the Amazonian rainforest at San José del Guaviare in Colombia. The Nukak were a tribe that time forgot, cut off from the rest of humanity until this sudden emergence. Subsisting solely on the monkeys they could hunt and the fruit they could gather, they had no concept of money. Revealingly, they had no concept of the future either. These days they live in a clearing near the city…. Asked if they miss the jungle, they laugh.”

8Campbell R. Harvey: 2017Niall Ferguson, The Ascent of Money

The History of MoneyNot just coins• 3300 BC Clay tokens in Mesopotamia• “In the Mesopotamian cities, there were 16 main types of tokens and dozens of sub categories for things like honey, trussed duck, sheep's milk, rope, garments, bread, textiles, furniture, mats, beds, perfume and metals.”

9Campbell R. Harvey: 2017http://factsanddetails.com/world/cat56/sub363/item1514.html

The History of MoneyNot just coins• 2800 BC Silver ring money in Mesopotamia• Others used tin, copper or bronze• Allowed for trade within a city and between cities

10Campbell R. Harvey: 2017http://factsanddetails.com/world/cat56/sub363/item1514.html

The History of MoneyNot just coins• 1650 BC Clay tablets in Mesopotamia• “Babylonian town of Sippar. A clay tablet found there was inscribed with this promise: At harvest time, someone named Amil‐mirrawould pay 330 measures of barley to whomever held that tablet.”

• First “promise to pay”

11Campbell R. Harvey: 2017Bitcoin: And the Future of Money, Jose Pagliery

The History of MoneyPaper money• Fiat money invented in China• ~600 AD China T’ang Dynasty “promises to pay” (hence the term promissory notes)

• First record of metallic reserves around 1000 AD, where reserves were 3/7ths of the face value.

12Campbell R. Harvey: 2017John F. Chown, A History of Money: from AD 800

The History of MoneyEurope• Roman coinage, the silver denarii, was used well after the fall of the Roman Empire.

• However, there was a shortage of silver in Europe. Why? because of deficits with southern Mediterranean and Near East.

• Alternatives to coins arose for small amounts (like squirrel skins and peppers)


The History of MoneyEurope• Discovery of silver in New World solved the shortage problem• 170 tons of silver heading to Castilian monarchy per year• Spanish pieces of eight used outside of Spain – so a global currency• Inflation resulted. In 100 years, the price of food increased 7X


The History of MoneyUSA• Federal Reserve Bank relatively new – set up in 1913• Until that period, essentially “free banking”• Over 30,000 banks in 1922 – many undercapitalized• 1933 deposit insurance introduced during Great Depression• Highly fragmented system; the first state to allow interstate banking ‐ 1976


The History of MoneyRise of Banking• Late 1300s the Medici established modern banking• Banking spread to northern Europe, Amsterdam Exchange Bank set up in 1609, resolved problems that merchants faced with multiple currencies. 100% reserve ratio. 100% commercial transactions.

• Swedish Riksbank 1656 did deposits as well as lending. Fractional reserves

• Bank of England 1694. Granted monopoly power. 1742 was able to issue promissory notes that did not bear interest. Designed to help government with financing.


The History of MoneyFractional reserves increase money• Money multiplier results because a deposit is not 100% held at a bank, some is lent out and the person that borrows, deposits at another institution, ….

• M0 (monetary base or high power money) = total liabilities of central bank (cash plus reserves of private sector banks at the central bank)

• M1 (narrow money) = cash in circulation + demand deposits


The History of MoneyGold or commodity‐based currency not necessarily a solution• Countries choose when to be on gold standard and when to abandon it• US is a good example• Illegal to hold gold from 1933 to 1971.


The History of MoneyUS in and out of gold standard


1

10

100

1,000

U.S. G

DP Deflator

Basically SilverAverage inflation rate:

‐0.1%/year

Basically GoldAverage inflation rate:

1.1%/year

Fiat Paper MoneyAverage inflation rate:

‐0.1%/year

True Gold StandardAverage inflation rate:

0.7%/year

Quasi‐Gold StandardAverage inflation rate:

3.2%/year

Fiat MoneyAverage inflation rate:

3.7%/year

Data source: U.S. GDP deflator from Johnson and Williamson (2011). “Currency regime” labels from Elwell (2011). See Erb and Harvey (2013).

The History of MoneyGold also subject to inflation• Just as discovery of new world gold led to high inflation, technological change will dramatically increase the supply of gold


The History of MoneyGold also subject to inflation• Just as discovery of new world gold led to high inflation, technological change will dramatically increase the supply of gold


Near‐earth asteroid Eros might have 125,000 mts (Science, 2009). That equals all gold ever mined on Earth.

The History of MoneyPure fiat currency is a bubble• US dollar, for example, has three features:

• Legal tender• Government can tax• Government can incarcerate you if you do not pay tax


The History of MoneyPure fiat currency is a bubble• Nevertheless, any fiat currency is a bubble – the currency only has value because people believe it is valuable

• There are plenty of historical examples of when faith was lost in a currency


The History of MoneyHyperinflations


Highest Highest HighestStart End Daily Start End Daily Start End Daily

Country Year Year Inflation Country Year Year Inflation Country Year Year Inflation

Angola 1994 1997 2.1% Danzig 1922 1923 11.4% Philippines 1944 1944 1.6%Argentina 1989 1990 3.7% Estonia 1992 1992 2.1% Poland 1923 1924 4.5%Armenia 1992 1992 1.9% France 1795 1796 4.8% Poland 1989 1990 1.9%Armenia 1993 1994 5.8% Georgia 1992 1992 3.7% Russia 1992 1992 4.2%Austria 1921 1922 2.8% Georgia 1993 1994 3.9% Soviet Union 1922 1924 3.9%Azerbaijan 1992 1994 2.6% Germany 1922 1923 20.9% Srpska 1992 1994 64.3%Belarus 1992 1992 3.2% Germany 1920 1920 1.5% Taiwan 1945 1945 5.5%Belarus 1994 1994 1.4% Greece 1941 1945 17.9% Taiwan 1947 1947 1.4%Bolivia 1984 1985 3.5% Hungary 1923 1924 2.3% Taiwan 1948 1949 2.5%Bosnia 1992 1993 4.9% Hungary 1945 1946 207.0% Tajikistan 1992 1993 3.7%Brazil 1989 1990 2.0% Kazakhstan 1992 1992 3.0% Tajikistan 1995 1995 1.7%Bulgaria 1991 1991 2.7% Kazakhstan 1993 1993 1.5% Turkmenistan 1992 1993 5.7%Bulgaria 1997 1997 4.2% Kyrgyzstan 1992 1992 3.2% Turkmenistan 1995 1996 1.6%Chile 1973 1973 2.1% Latvia 1992 1992 1.7% Ukraine 1992 1994 4.6%China 1943 1945 4.8% Lithuania 1992 1992 1.5% Uzbekistan 1992 1992 2.6%China 1947 1949 14.1% Moldova 1992 1993 4.2% Yugoslavia 1989 1989 1.6%Congo (Zaire) 1991 1992 2.6% Nicaragua 1986 1991 4.4% Yugoslavia 1992 1994 64.6%Congo (Zaire) 1993 1994 4.3% Peru 1988 1988 2.6% Zimbabwe 2007 2008 98.0%Congo (Zaire) 1998 1998 2.0% Peru 1990 1990 5.5%Note: Data from Hanke and Krus (2012), Bernholz (2006) and McGuire (2010). These sources use a definition fromCagan (1956) that says hyperinflation exists when a country's monthly inflation rate exceeds 50%.

November 2016, Venezuela becomes 57th entry

The History of MoneyCurrency does can exist without government• Gold is the traditional example – but gold has uses• Cigarettes used in POW camps as medium of exchange• Other examples include cowrie shells and peacock feathers

25Campbell R. Harvey: 2017 ChinaPapua New Guinea

The History of MoneyIraqi Swiss dinar• Iraqi Swiss dinar was the currency of Iraq until the first Gulf War in 1990 (plates made in Switzerland, printed in the UK)

• In 1991, Iraq was split in two with Saddam Hussein in the south the Kurds in the north

• Because of sanctions, could not import dinars so Saddam ordered the printing of a new currency

26Campbell R. Harvey: 2017http://people.ischool.berkeley.edu/~hal/people/hal/NYTimes/2004‐01‐15.html

The History of MoneyIraqi Swiss dinar• In May 1993, the Central Bank of Iraq announced that citizens had three weeks to exchange old 25 dinar notes for new ones


The History of MoneyIraqi Swiss dinar• However, old Swiss Dinar continued to be used in the north.• Saddam cranked the printing press to finance regime and soon the exchange rate was

300 Saddam dinars=1 Swiss dinar

28Campbell R. Harvey: 2017See Mervyn King, http://www.bankofengland.co.uk/archive/Documents/historicpubs/speeches/2004/speech208.pdf

The History of MoneyIraqi Swiss dinar• However, old Swiss Dinar continued to be used in the north.• Saddam cranked the printing press to finance regime and soon the exchange rate was

300 Saddam dinars=1 Swiss dinar


The History of MoneyIraqi Swiss dinar• Key insight is that Iraqi Swiss dinar had no official backing yet it was accepted as money – because people were willing to accept it as money.

• Interesting related story with the introduction of the Brazilian “unit of real value” in 1992 when inflation was running at 80% per month.


http://www.npr.org/sections/money/2010/10/04/130329523/how‐fake‐money‐saved‐brazil

Recap: History9000 BCE Barter• Market in Egypt exchanging goods, i.e. cows for sheep

31Campbell R. Harvey: 2017http://techcrunch.com/2016/01/21/barter‐to‐bitcoin‐a‐story‐of‐money‐and‐blockchain/#.yf9zg3w:id5P

Recap: History600 BCE Coins• In Lydia


Recap: History1290 Banknotes• Marco Polo introduces the idea to Europe (originates in China)


Recap: History1871 e‐Money• First Western Union money transfer


Recap: History1950 Credit Cards• First credit card is Diners Club


Recap: History1967 ATM• First ATM introduced in north London by Barclays Bank


Recap: History1983 Telephone Banking• Bank of Scotland introduced Homelink which is the first application of Internet banking


Recap: History1990 Internet Banking• Began to become widespread in the US


Recap: History1997 Contactless Payment• Mobil introduces Speedpass at gasoline stations


Recap: History2005 Chip and Pin• Introduced with credit cards


Recap: History2009 Bitcoin• Programmable money introduced


Recap: History2014 Apple Pay• 40% of US retailers have capability for contactless pay


Recap: History2017 Blockchain• All leading banks have blockchain initiatives


Future201? Back to Barter• Cross‐blockchain trading of objects• Billions of bilateral exchange rates• Still need some way to store your wealth• Open question of whether currency – as we know it, either in fiat or crypto, is necessary


Summary


The History of MoneyConclusion• All fiat currency is a bubble.• Bubbles need not burst – they can be rational and long living• All cryptocurrencies are bubbles.• If someone dismisses a cryptocurrency saying it is a bubble, it is likely they do not understand basic monetary economics.


The History of MoneyHighly recommended


Supplement: The History of Money


http://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf