Money makes this World Go Round

The institutions guiding capitalism know little why trade cycles inflict tragedies on people they are supposed to benefit

Bhupender Yadav Bengaluru

Two obvious facts stare us in the face. Despite the global financial slowdown, persisting since 2008, capitalism is here to stay. Second, capitalism will be made to survive without grace and on stilts. The stilts could be either monetary policies or the fiscal policy of moderate taxes carried out by governments. It could be a mix of the two, peppered with Keynesian ideas for growth and employment. Or there could be some other policy innovation to ease capitalism out of its on-going ordeal.

Currently, it seems economists are bothered about how money runs the world. So, in deference to economic thinking, we will start by talking about the power of money. And then discuss the policy-turned-ideology called monetarism.

Money, like God, has been invented because it is needed. Even the most primitive economy needed money as a unit of account. The American populist, William Jennings Bryan, popularised the term ‘money power’ in the 19th century. He said, “Money power preys upon the nation in times of peace and conspires against it in times of adversity. It is more despotic than monarchy, more insolent than autocracy, more bureaucratic than bureaucracy. It denounces, as public enemies, all who question its methods, or throw light upon its crimes. It can only be overthrown by the awakened conscience of the nation.”

Between the time of its invention and the 19th century, how did money acquire such power along with a soiled reputation?

Barter was the standard medium of exchange in most of history. Goods were made and their makers traded these goods to satisfy mutual needs. If one had spare grain and another made cloth, they exchanged them of their own accord. They mutually decided what quantity of grain would be sufficient to acquire the cloth that was needed. And so this barter exchange carried on till the number of commodities and people involved became larger.

Grains and textiles could suffice the need of trade only up to a point. A more acceptable medium of exchange had to be invented to meet the needs of increased volumes. Cowries were used to exchange goods and could buy almost everything. In Africa, as late as the 18th century, an observer wrote, “Twelve thousand weight of cowries would purchase a cargo of five or six hundred Negroes.”

Mostly, however, metallic money became the norm. Coins were used to buy goods as far back as the eighth century. Their first appearance is traced from the west coast of Asia Minor to China in the east. Royal mints produced coins on orders of administrators. Ordinary subjects, too, could convert their precious metals into legal tender money by paying a fee called seigniorage.

Enter the modern industrial age, wherein faster transport and mechanised mass production added trade as a major factor in the economy. From the 16th century, the silver of the Spanish colonies of Latin America (mainly Mexico and Peru) funded the increased global trade in a large number of goods. At some times, however, even gold was used in some transactions and regions.

Speaking about trade in the early modern period, economic historian Andre Gunder Frank wrote, “Money went around the world and made the world go round”. Precious metals became the equivalent of world money. By 1500 BC, it is estimated world trade was funded by 3,600 tonnes of gold and 37,000 tonnes of silver. To this, 133,000 tonnes of silver (or four times more stock than available in 1500 BC) were added by Latin America from 1545 to 1800.

These numbers are large but the volume of trade was larger. Due to the immense growth of trade and growing connectivity in the world, credit started being used on a greater scale in the economy. The form this fiduciary money took was loans, securities, bonds, credit transfers, negotiable obligations and the like. Now, in this form of money, commodities and precious metal were replaced by the value of securities and the reputation of the issuer. Between 1700 and 1745, 20 per cent of the trade of the British and Dutch East India companies began to be conducted in fiduciary instruments.

Trade and services, in our times, are mostly paid through fiduciary money. So, we are inheritors to a precarious financial architecture which few understand. This ignorance is magnified in times when financial booms are followed by crashes or when, after busts, global economies take a while to rejuvenate as seen after the crash in 2008. 

Before the 17th century, only China had experimented with paper money. Apart from that all money was a commodity – be it silver, gold, copper or other less expensive alloys. To organise money in all forms at the macro level was quite a task. To look after the magnitude and velocity of money, central banks were created in regions where nation-states were beginning to rise. So, for example, Sweden established its central bank in 1664 followed by England in 1694, France in 1800 and the US in 1913. India got its Reserve Bank in 1935, after the Great Depression.

Control over money supply could help regulate wages, prices and employment was the opinion of acclaimed economist Milton Friedman. During the Great Inflation in the 1970s, the Nobel Laureate felt that the decrease in money supply could help arrest prices and wages. If wages were less, there would be a double benefit. First, the cost of production would be lessened due to low wages and employers would also employ more hands because wages were low. Thus came about Friedman’s policy on monetarism.

This open invitation to governments to directly deflate money supply and indirectly decrease prices and wages was heard in the late 1970s. The economic policies of pioneer neo-liberalists, like Ronald Reagan and Margaret Thatcher, were marked by such ideas. Neo-liberalism was boosted by other ideas also, but monetarism was an important component of that thinking.

Monetarism is about the supply of money and the velocity of its circulation. Friedman and the monetarist policy believed “there are no free lunches” and the “government is the problem”.

Checking inflation and controlling unemployment are the twin objectives monetarists set to address. Of course, they would like to check inflation without controlling prices because a regulated economy gives them the nightmares of communism, a planned economy and so on. Allowing market forces so much free play as to decide the “natural rate of unemployment” is the preferred policy with monetarists.

It is not for nothing, therefore, that while explaining ‘The Warring Schools in Economics’, Paul Samuelson noted three central points in monetarist thinking. First, monetarists hold “only money supply matters”. They think some macro-economic phenomena like employment, prices and aggregate demand depend on money supply. Fiscal ideas on government spending or tax rates may have an influence, they grudgingly admit, over private consumption or defence but not on nominal Gross Domestic Production (GDP).

Second, if acclaimed economist John Keynes wanted government to create “effective demand” because wages and prices were “sticky”, monetarists felt differently. The same money supply which determines nominal GDP would also make prices and wages “flexible”, they thought. Third, left to its own devices, the private sector is stable. Hence, the government must just steer away from compulsive interference or malignant regulation.

Barter perished with the increase in commerce and planning died with socialism. Capitalism is driven by the market, we know. But the institutions guiding capitalism know little why trade cycles inflict tragedies on people they are supposed to benefit. Inversely, these institutions and their overlords are also ignorant about what triggers a boom. Like poor historians, the financial experts only record events and build connections between them, after the storm or boom has passed!