What the history of money tells you about crypto’s future

The future of money, in other words, is attracting attention. What of its past? In a new paper, Adam Brzezinski of the London School of Economics, Nuno Palma of the University of Manchester and François Velde of the Chicago branch of the Federal Reserve urge readers also to pay close attention to money’s long history. It is capable of “delightful surprises”, they point out. It also contains some parallels to the supposed novelties of today.

Central-bank digital currencies, for example, could give members of the public an account at the central bank. That sounds new. Butas several economists have noted, it is also a return to the past. The Bank of England used to take deposits from the public: in 1855 a Regent Street hatter is recorded to have opened an account at the bank’s handsome new branch in Mayfair. And in 1900 the Bank of Spain held over half the country’s current accounts.

The study of history may also disappoint crypto enthusiasts who wish to liberate money from government control. Monetary policy—the manipulation of money by the state—is almost as old as money itself. Even when coins were made out of gold or silver, governments fiddled with their weight and purity. The value of coins often departed from the preciousness of their materials. Indeed, governments sometimes diluted the silver content of smaller, more practical coins to prevent shortages.

Until the 19th century, the value of coins was rarely inscribed on their face. They had no “face value” in this literal sense, as Mr Brzezinski and co-authors point out. This allowed for a separation between two functions of money that are now seamlessly joined. Coins served as a medium of exchange, the thing people swapped for the stuff they bought. Yet they did not serve as the unit of account, the thing in which everything else is priced. Often the unit of account was an old coin that had since disappeared from circulation; “ghost money”, in the words of Carlo Cipolla, a historian.

Such separation allowed the French court to carry out a grand monetary-policy experiment in the 1720s. In an effort to lower prices—what you might call an Inflation Reduction Act—the king’s council decided, without warning, that coins would be worth less than before. From 1723 to 1724, it cut their value by 45%. The policy resembles the kind of thought experiment beloved of economic theorists. David Hume, for example, once imagined what would happen if £5 was “slipt” into the pockets of every man in Britain, doubling the money in the kingdom. Would this miracle make everyone twice as rich? He assumed that it would only increase the price of everything “without further consequence”. The French in 1724 likewise expected prices to fall quickly.

They were wrong. “Everyone is so accustomed to sell dearly that no one can bring themselves to lower their prices,” one observer reported. “By a barely conceivable madness it seems that everyone in concert insists on doing the opposite of what common sense and reason dictate.” It took almost four years for prices to fall back into line. In the interim, France suffered an industrial recession: the number of looms in operation fell by about 30%.

The French decision was reckless, rather than random. It was imposed on an economy that suffered from inflation. It was not therefore a clean test of the effects of monetary shocks. Unfortunately, it is hard to conduct randomised trials of monetary policy.

History does nevertheless throw up “natural” experiments. In an earlier paper, Mr Brzezinski, Mr Palma and two co-authors exploited one source of variation in the money supply of early modern Spain: disasters at sea. Ships carrying treasure to Spain from the Americas would sometimes encounter hurricanes, privateers or the British navy. In 42 incidents from 1531 to 1810, they lost some or all of the precious metals that Spanish merchants had expected to receive. The losses averaged 4% of Spain’s money stock. Drawing on a variety of sources, including tax records and tallies of sheep, the authors showed the damage these losses inflicted on Spain’s economy. Credit became scarce, making it hard for merchants to buy supplies for weavers, and consumer prices were slow to adjust. A loss of 1% of the money stock could reduce real output by about 1% in the subsequent year. Sheep-flock sizes fell by 7%.

Paper, the barbarous relic

To the modern eye it seems strange to allow the money supply to be such a hostage to fortune. Why should it shrink when ships sink? Why should it expand when fresh deposits of silver are discovered? Even in the 18th century, some visionaries thought money should break its link to metals. The most prominent example is John Law, a Scottish banker and chancer who somehow persuaded France to shake up its monetary arrangements in 1716.

Law was ahead of his time—his experiment with fiat paper currency ended in disastrous inflation. In the future, money may need to change form again. It may shed all physical manifestations, as coins and notes become obsolete; the bank deposit may be replaced by a claim on the monetary authority itself. But some economists worry that such a transition also poses risks, making bank runs, or even runs out of currency into physical assets, easier. Although the forms money takes may be new, its effects will rarely be neutral. And as Mr Brzezinski and co-authors point out, itis cheaper to learn from the mistakes of the past than to make instructive mistakes in the present.

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