Lessons for Today from the History of Money

By Antti Heinonen, European Central Bank

One of the recurrent themes in Currency News is the role of the central banks in the cash cycle. The main challenges in this context are well reflected in the title of Bob Rankin's interview in the January issue - 'Cash Efficiency versus Quality and Confidence - Getting the Balance Right'. However, it is fascinating that the two concepts of confidence and efficiency are not only important in today's debate, but have been the key factors in the development process of money throughout its history. This article summarises the development of money and addresses how issuers have established confidence and efficiency in their banknotes, whether through design, theme, symbolism or issue policy. In conclusion, we can draw lessons learned from history to apply to the current challenges and issues facing cash.

The Development of Money
Money is anything that can be used to make a payment or settle a debt. Therefore, money must be as old as mankind, because as soon as there are meetings of people, the exchange of goods and services take place. The first form of exchange, barter, benefited both parties, but presumed a double coincidence of wants. However, by agreeing on a common means of payment or unit of account - commodity money - it became possible to extend significantly such exchanges of goods and services.

There are numerous examples of commodity money from various cultures. Pieces of metal were one popular form because, on the one hand, they were valuable and therefore commonly accepted and, on the other hand, they were easily transferable and measurable on the basis of their weight. The weighing process, however, could be simplified by making standardised metal pieces of fixed sizes and weights, and stamping them with marks guaranteeing their value. This system of coinage was invented by the Lydians, a Greek people, more than 2600 years ago.

The first coins were minted from gold and silver, but as the pieces intended for low-value payments were so small that they were difficult to handle, other less valuable metals, such as copper, were introduced. In the course of time, coins were minted just for payment purposes and their face values did not have to match the value of their metal content. This was a significant step towards fiduciary money.

The Move to Paper
However, one problem remained: when large quantities of coins were needed for payments, they were heavy and cumbersome, and when being transported an easy target for thieves. As a way around this problem, merchants started to deposit their coins with banks or goldsmiths, receiving certificates of deposit in exchange. These certificates were easier and safer to transport and could be used as a means of payment by transferring their ownership, wholly or in part, to another person.

The introduction of paper certificates as a form of fiduciary money led to a new possibility and, instead of certificates backed by specific deposits, banks started to issue notes for stated rounded amounts made out to the bearer. Thus, in the 1660s in Sweden, 'bank notes' in today's sense were first introduced.  They were commonly redeemable for precious metals but, when this link was also abolished, banknotes became purely fiduciary money.

While new payment instruments have been developed and old ones abolished, banknotes and coins have kept their popularity over the centuries and even millennia, remaining the predominant instruments of payment until the twentieth century despite the introduction of several new payment instruments such as checks and bank transfers.

In particular, since the Second World War, the development of new payment instruments has intensified with the introduction of credit and debit cards, electronic purses and, most recently, internet and mobile payments. Looking at all these developments, from barter to today's electronic payments, every innovation that has occurred has done so to make certain types of transactions more efficient, and the new 'money' has been successful on a more permanent basis only if there has been confidence in its issuer.

Names of Monetary Units
Before discussing how issuers have historically addressed the matter of confidence in and efficiency of their banknotes, I will briefly consider the names of monetary units.

Even if the names of coins often developed naturally, being determined for example by the weight they represented or the metal they were minted from, one may assume that, implicitly or explicitly, the factors of confidence and efficiency also played an important role in the development of monetary units. Names for weights, like mark, pound, lira, peso, peseta, shekel and baht, or subdivisions thereof, like dinar, cent and centime, created confidence because of their familiarity and, for the same reason, fostered efficiency.

Similarly, names reflecting precious metals, such as gulden, zloty, ore (gold) and ngultrum, mongo and rupia (silver), national or religious symbols like crown and lev and leu (lion), escudo (shield) and real and cruzeiro, or national heroes, such as colon (Columbus) and boliviano (Bolivar), have created confidence in the respective issuers at the same time as they have reinforced the national identity.

Fostering Confidence
Given that the predecessor of the banknote was a certificate of deposit, it is understandable that the issuer of a banknote should validate it with a signature(s). When banknotes were first introduced by Stockholm's Banco in the 1660s, they bore no fewer than eight signatures to create confidence.

By contrast, the Bank of England, which has issued banknotes without interruption since the 1690s, has from the beginning consistently used just one - that of the Chief Cashier. Nevertheless, confidence was also established with a printed commitment by the Chief Cashier: ';I promise to pay to (the Bearer)...'.

So, whether because of the origins of the banknote, or just tradition, issuing authorities have generally continued to use signatures as a means of fostering confidence in their banknotes.

Continuity of Design
Confidence has also been fostered through the continuity of design. The design of the British white five-pound note remained unchanged from the 18th century century until the 1950s, and US dollar bills had practically the same design from 1928, when the small size dollar banknotes were introduced, until 1996, when the series with enlarged portraits was phased in. The $1 bill, which has not been part of the recent upgradings, is still very similar to the silver certificate of 1928. Evidently, in the course of time the continuity of the design becomes a symbol, but even symbolism creates confidence.

Design Themes
Since the early days, it has been evident that confidence in banknotes can be fostered through the selection of design themes, as was the case with coins. National symbols, and later portraits of monarchs and other prominent persons, have been widely used. In this context, it is also interesting to note how popular the use of the central bank building as a design theme on banknotes is. Close to half of the issuing authorities around the world have used this theme on their banknotes. Since a typical central bank building is a symbol of stability and credibility, it is obviously an appropriate theme for a banknote.

Naturally, a banknote is also the business card of a state or currency, and themes are used not only aim to instil confidence but also to convey other messages both to the citizens of the state and to foreign visitors. Hence, design themes often also reflect political changes, particularly during upheavals.

Counterfeit Penalties
A banknote is merely a piece of paper with no intrinsic value. Banknotes have therefore been copied and counterfeited since their very beginnings. If counterfeiting can diminish confidence in banknotes and, in the worst case, cause the breakdown of a payment system, it follows that penalties for counterfeiting should be at the higher end of the scale. In previous centuries, the penalties for counterfeiting were often even printed on the banknotes themselves, as in the case of Swedish banknotes until the nineteenth century ('Who imitates or counterfeits this banknote shall be hanged') or early North American banknotes ('To counterfeit is death').

Similar penalties were also printed on early Chinese paper money ('The user of counterfeits will be beheaded. Informer will be rewarded with ...taels of silver in addition to the confiscated property of the convicted'). Later the texts printed on banknotes often referred to the relevant articles in the penal code.

Security Features
In addition to the high penalties for counterfeiting, confidence in banknotes has been created through the incorporation of security features addressing the counterfeiting threats of the time. Without addressing this issue in detail, the development of photography in the nineteenth century and of digital reproduction technology more recently has created paradigm changes in finding solutions to these threats. So, in terms of the prevention of counterfeiting, confidence in banknotes has been created using both the stick and the carrot.

Price Stability
Banknotes are not only used as a means of payment but, increasingly, as a store of value. One of the prerequisites of fiduciary money is that the public trusts in the preservation of its value. In this respect, the history of money is full of examples of failures right up to the present day.  The re-establishment of confidence has required and will require decades of persistent work, as demonstrated by the wide use of currencies with a stable track record outside their jurisdiction.

The importance of the preservation of the value of money is well reflected in the statutes of central banks, eg. in Article 105 of the Treaty establishing the European Community, which says that 'The primary objective of the European System of Central Banks shall be to maintain price stability'. The fact that the value of euro banknotes has increased more rapidly than the value of the former national currencies of the euro area countries shows that there is confidence in the value of euro banknotes both inside and outside the euro area.

Fostering Efficiency
The introduction of 'bank notes' in the 1660s was a major step towards greater efficiency; instead of certificates backed by specific deposits, banks started issuing notes for stated amounts. For a long time, banknotes fulfilled the user requirements of the developing economies, and developments during the next three centuries or so were mostly geared towards establishing and maintaining confidence in them through issuance policy, design themes and security features.

The efficiency factors have gained greater significance only during the last fifty years, when new user requirements, particularly mechanical processing and acceptance of banknotes, have been introduced. This has meant that banknote sizes have been standardised in order to make their production, handling, packaging, storage, etc. more efficient and that new machine-readable security features have been developed to speed up their mechanical processing and authentication.

These, and other tendencies such as the outsourcing and shortening of the cash cycle, have also led to a greater involvement of the different cash-cycle stakeholders in the development of banknotes and their efficiency.

Conclusions
The basic reasoning of this article is that the development of money has been guided by two characteristics: the efficiency of payment instruments and confidence in their issuers.

Accordingly, if we draw any conclusion from the thousands of years of history, it is this: money that has the confidence of its users and that is cost-efficient and user-friendly will continue to have a role in the future. Issuing authorities should therefore look after the integrity of their banknotes by keeping users' confidence in them high and by continuously developing their efficiency relative to other payment instruments.