Problems of the 21st century problems cannot be solved with 20th century
solutions. Martin Hutchinson recently wrote an interesting and entertaining
article in which he suggested that we must go back to 1693 in order to find
solutions. He advocated not only a return to the gold standard, but also to a
system of "free banking", whereby private banks would create gold-backed credit
- without interference from Treasuries or central banks - in order to re-base
and re-boot our economy. (See
Back to 1693, Asia Times Online, November 24, 2011).
It was stirring stuff, and in my view he was right to suggest we look for
solutions prior to 1693, but not necessarily the ones he proposes. ...
The first economic paradigm - Economy 1.0, where buyers and sellers were
physically present in the market - was decentralized
but disconnected. The price of corn in one town's corn exchange would have been
different to that of the next town's corn exchange, never mind corn exchanges
in other regions or countries.
An intellectual battle is currently raging among economists, historians and
even anthropologists in relation to whether this Economy 1.0, which existed for
thousands of years, involved primitive forms of credit or whether it was based
upon barter transactions.
The answer is that both mechanisms were in use: firstly, units of currency -
objects of value - which were accepted in exchange because they were perceived
as a store of value which would be accepted in turn by others; secondly, credit
was routinely extended by sellers who created - in exchange for value provided
- obligations by counter-parties to provide something of value in exchange.
Currency - Forms of currency developed which were mutually
acceptable forms of value or money's worth, such as standard amounts of silver
and gold, but other forms of value have been generally accepted over the years
from cowrie shells to copper, and from cigarettes to salt (hence the word
Governments provided standardization, so that currency became understood as a
pricing reference or unit of account; and also quality control, in the case of
gold and other precious metals, by assaying, weighing, and minting coins as a
standard unit of currency.
Credit Instruments - The first form of credit instrument or IOU
was the tally stick. A tally stick was a wooden stick, marked with notches
which recorded the value of a transaction. It was split lengthways, and part of
it - the "stock" - was given to a creditor who had provided value in exchange.
The debtor retained the "counter-stock" or "foil", and undertook to provide
value in exchange when the stock was returned to him for redemption by whoever
held it - ie, the bearer.
order for "stock" to be generally acceptable in payment, it had to be issued by
a creditworthy counter-party. This would typically be a merchant of good
standing (hence merchant banker), or an institution like a temple which levied
tithes on the population, or a sovereign who levied and collected taxes.
The second economic paradigm, which evolved over a period of several hundred
years, is the present centralized but connected economy, where transactions
take place at a distance, through middlemen, ie intermediaries, who aim to make
transaction profit and put capital at risk to do so.
The development of regional, national and international trade was driven by the
growth of generally accepted and trusted currencies and documentary credits and
from the Middle Ages, the innovation of double entry book-keeping and
The second great innovation was the creation of the corporate body, which
enabled productive assets to be owned over generations, and was initially
developed by the church and by municipalities - such as London's City
Corporation. Such corporations eventually came to be created for commercial
purposes as an enterprise agreement between individuals with a view to profit.
The first of these "Joint Stock Companies" in which individuals shared risk
collectively - but not, as with partnerships, also individually - was the
British East India Company in 1600 - but the Dutch East India Company was the
first to issue "Stock" to raise investment. This was a credit instrument that
gave permanent rights of asset ownership and to the fruits of ownership, and
which was typically divided into "Shares" denominated in the national currency.
Private credit - There were essentially two sources of
documentary credits. Firstly, traders who deposited their bullion and coins on
"bancs" in goldsmiths' vaults for safe-keeping began to use the goldsmith's
receipt as currency instead of the gold itself. The goldsmiths - realizing that
the gold they held was rarely withdrawn - began to create additional receipts
and loan them for a period of time at interest. This essentially fraudulent
practice of private credit creation formed the basis of modern-day banking, and
was subject to a breakdown in confidence in the bank - "runs on the bank" - and
The second form of documentary credit was the issue of "bills of exchange" by
merchants, which began to be accepted by third parties through an endorsement
or assignment, often many times over, before the bill of exchange found its way
back to the issuer to be exchanged for value. Trust in the issuer was key.
These forms of credit enabled the flow of goods and services to take place,
oiling the wheels of commerce, and were essentially based upon the capacity of
people, individually and collectively to provide goods and services.
Public credit - The historic role of public credit has been
almost forgotten. From the 12th century onwards, the Exchequer of English
sovereigns would pledge the sovereign's credit - against value received -
through the issue of stock which was later returned by the eventual holder in
payment for taxes. The very phrase "rate of return" alludes to this long
forgotten practice of returning stock to the issuer for cancellation.
The important role of stock in UK public finances may be gauged by the fact
that by 1694, when the Bank of England was privately incorporated, more than 17
million pounds worth of government stock in the form of tally sticks were still
in circulation, at a time when the cost of running the government was 2 to 3
million pounds per year.
But by this time, the Exchequer had also - in order to finance public
expenditure, particularly military - begun to issue stock in documentary form.
Issue of interest-bearing perpetual annuities, also known as stock, met a need
for a "risk free" investment bearing a reasonable return. In order for interest
to be paid, registers of entitlements were usually kept, although some
documentary instruments carried coupons, which could be detached and presented
to collect payment of interest.
Privatization begins - The Bank of England was a private UK Joint
Stock Company incorporated by Royal Charter and it began to create and provide
credit on the basis of gold deposited with it. The Bank of England began to
finance the UK government by purchasing its interest-bearing stock and
annuities and indeed had a monopoly on this activity.
In 1705, the remarkable Scottish gambler and adventurer, John Law, proposed in
Scotland a form of money backed by land rentals, which came to nothing, but his
proposal contained some remarkable insights as to the nature of money and
credit. By 1716, Law had become the trusted adviser to the French prince
regent, and after many successful economic reforms in France as controller
general he created the Banque Generale.
The credit created by this private bank created the first modern-day bubble,
which was not directly in land value but in the shares of the French
Mississippi Company, which had a monopoly on trade in the French territories
which then formed almost a third of the modern US land-mass, right up to the
The collapse of the Mississippi Bubble ruined the French economy, and a very
similar bubble in shares of the South Sea Company, which collapsed in 1720, and
had been fueled by credit from the Bank of England, caused similar widespread
ruination in the UK.
Since that time, the "Twin Peaks" of finance capital - investment through Joint
Stock Companies and debt created by private banks - have driven the development
of the modern industrialized world, assisted by further innovations such as the
privilege of free limited liability for Joint Stock Company investors in 1855.
In the mid 19th century, a number of failures/bankruptcies of private Free
Banks - which had issued their own bank notes but were unable to provide gold
when these were presented for redemption - led to the Bank of England being
given a monopoly on bank note issuance, which at that time was a very
significant part of credit in circulation.
A sophisticated system of wholesale and retail banking has since evolved,
central to which is the relationship between the Treasury and the Central Bank,
and a vast pyramid of credit was built upon a tiny base of gold. In 1971, even
the technical ability to demand gold was dispensed with, and the present day
system of public and private financing and funding reached its final form, at
the heart of which is a Black Hole.
A very secret agent
The myth underpinning virtually all schools of economics is that the Treasury
has a banking relationship with the central bank. The pervasive belief is that
the central bank lends money to the Treasury and is therefore a creditor of the
This is a myth. The central bank is actually the fiscal agent of the Treasury,
and it creates credit on behalf of the Treasury either in note form or by
crediting clearing bank accounts with new fiat currency.
The truth of this is demonstrated in the United States by the fact that a few
million US Treasury Notes (credit issued by the US Treasury) still circulate
alongside Federal Reserve Notes (credit created by the Federal Reserve Bank)
and they spend exactly the same. US Treasury Notes are to all intents and
purposes modern day US paper stock, since they are accepted by the Treasury in
payment of taxes.