Loading summary
Transcript1 lines
- [00:00]
A
Foreign hi, I'm Andy Tempte and welcome to the Saturday Morning Muse. Start your weekend with musings that are designed to improve financial literacy around the world. Today is June 28, 2025. Last week we looked at the advent of government issued coinage through the lens of the Roman Empire. We learned that the modern words mint and money can both traced back to ancient Rome. Governments issued coins to increase trust and confidence in early monetary systems. But we also learned that when coins were debased by reducing the precious metals content of each coin, a loss of purchasing power and inflation were the likely outcomes. So today we're going to continue the conversation by talking about where paper currency originated. In previous episodes, we've illustrated that money represents a debt that is to be paid or honored. And our discussion of paper currency is going to lead us to the same conclusion. In fact, any discussion of paper currency must begin with the concept of the promissory note, which by definition is a debt or or a financing instrument. Now, we're going to take a quick detour and clarify this word instrument, because we're going to hear that word a lot as we move forward. A financial instrument, as opposed to a musical instrument, is any asset or contract that holds monetary value. Stocks, bonds, options, forward contracts, swaps, loan documents, mortgages, winter wheats, futures contracts. These are all examples of financial instruments and we will talk about all of them in future episodes. So back to the story. What is a promissory note? A promissory note is a legal document and a financial instrument in which one party, the issuer, promises to pay a predetermined amount of money to another party that the payee or the recipient. Promissory notes are also known as notes payable. If we think back to our lessons on early trade, traders would use promissory notes as a tool to receive the goods that they needed today in return for a promise to pay at a later date when the crops or goods that they produced would become available. In essence, promissory notes, like early coinage, solved the problems with the barter system. Specifically, the double coincidence of wants challenge, in which both traders had to have physical possession of the goods that they were trading at the time a trade occurred. Initially, promissory notes were traded between individual traders, but traders in both China and Mediterranean nations started trading promissory notes as an early form of paper currency. So let's look at this through a simple example. We're going to start with two traders. Suppose that trader A has wheat, but trader B's fruit won't come in until Next year, Trader B would like to buy wheat from Trader A and issues a promissory note to Trader A in return for wheat. The promissory note states that a specific amount of fruit will be delivered to the bearer of the note, whoever holds it. So Trader B now has the wheat that she needs, and Trader A has a piece of leather or parchment which is dried animal skin. This is before we had paper that states that whoever shows up at Trader B's doorstep with the promissory note when it is due will receive a predetermined quantity of fruit. Now, let's suppose that Trader A needs cotton to make clothes. They don't have wheat to trade anymore because they already traded it to Trader B. But they do have the promissory note they received from Trader B that will pay a predetermined quantity of fruit at a specific date in the future. Trader C has cotton for sale and Trader A proposes that Trader C give him cotton in return for the promissory note denominated in fruit. Trader C agrees and provides cotton in return for the promissory note. Now, Trader C can do one of two things. They can either hold onto the promissory note until its due date and collect the fruit from Trader B, or Trader C can find another trading partner, Trader D, who will accept the promissory note in return for goods or services that they have for sale. And you can go on and on and on. Note that just like the coinage that we've discussed, the promissory note represents a debt to be paid. Trader B must deliver the predetermined quantity of fruit at the specified delivery date to whoever presents it the bearer. Of equal importance is that the promissory note is flowing through our hypothetical economy and has supported me multiple transactions. Remember the phrase velocity of money? Well, the rate of flow or the number of times our fruit based promissory note is used in future transactions. Well, that's an indicator of economic activity in our hypothetical economy. Just as one coin can support many transactions, one promissory note can also support multiple transactions. Hopefully it's becoming clear that early promissory notes were examples of the first paper currency. Now, paper didn't exist for a while, so folks used parchment. They literally wrote on pieces of dried animal skin. In fact, during the Chinese Tang dynasty, which ran from 618 AD to 907 AD, promissory notes were referred to as flying cash. The first global bankers, which were the Knights Templar, issued promissory notes to European pilgrims who were making their way to the Holy Land. Pilgrims would Make a deposit of valuables with the Templars in Europe in return for a promissory note that was issued by the Templars that could be redeemed upon arrival in the Middle east for goods of equal value to the deposit of valuables that they had made prior to their departure. So we're going to talk a lot about the Templars later. The first government sponsored paper money was issued by the Song Dynasty in China in the 11th century when they ran out of copper for minting coins. The bearer of these promissory notes could redeem this paper money for coinage on a future date, which represents the start of paper money that was backed by a fixed quantity of a precious metal. And we will see that then throughout history from the Song Dynasty forward. And we could go on and on with examples of the issuance of both government backed or banked backed paper currency. In a future episode, we'll talk a lot more about the Knights Templar as the first global bankers and discuss the history of banking. However, as we get to the back end of this episode, I'd like to ensure that the main lessons today are understood. 1. The first examples of what we might think of as paper money were issued in private transactions in the form of promissory notes between traders. That's point one. Point two. Like coinage, paper money has velocity and flows through an economy. The Tang Dynasty use of the term flying cash is an apt descriptor and captures beautifully the notion of velocity and flow. Point number three. While early coins had some level of precious metals value built into them, meaning that they had what's known as intrinsic or fundamental value based on gold or silver content. Paper currency has no intrinsic value and is backed or supported by a promise that either the government or a bank, like the Knights Templar, the issuer would provide the bearer or holder of paper money with a predetermined quantity of a predetermined precious metal or something else that everyone agrees has value, like fruit. In our simple example, number four, like coinage, paper currency can be debased by the issuer if the issuer reduces the amount of precious metal that they will provide to the bearer or holder on demand. As we saw last week, debasement typically leads to inflation holding all else the same. So as we wrap up today's discussion, what's the modern lesson? Well, in 1971, the United States eliminated what was known as the gold standard, where the US Dollar was convertible on demand to a specific amount of gold. So since 1971, the currency that you have in your pocket is called fiat money. That is not backed by a physical commodity like gold, silver or fruit, but is instead backed solely by the government decree and as an extension, the confidence that citizens and the global public has in the issuing country, the United states. Prior to 1971, under the Bretton woods system that we talked about a few weeks ago, 35 US dollars was convertible into one ounce of gold. Today, $35 is convertible into whatever we believe equals $35 in value. And $35 in paper currency can be used to affect that transaction because we trust in the full faith and credit of the United States government, the issuer of that money. But what if that trust breaks down? We're going to tackle that question in a future episode. For now, I wish you grace, dignity and compassion. My name is Andy Tempte. This is the Saturday Morning Muse. You can find the show on all the major streaming services as well as out on YouTube. Please like, subscribe, rate and most importantly, share this public educational good with your friends, your colleagues, your neighbors, and maybe even a family member. The show was produced by Nicholas Tempte, and we'll see you next time on the Saturday Morning Museum.