Cash Is a State-Backed Utility – Part 2

The first recorded use of fiat money was in 1000 AD in China, which in form was more like a state-backed note. It wasn't until the 10th or 11th century that fiat money gained momentum in China. First the Song dynasty, subsequently followed by the Yuan dynasty, institutionalized paper currency as a fiat of the state. The Song dynasty linked the value of fiat money to gold, silver and silk, or were effectively proponents of commodity money. By comparison, thanks largely to Genghis Khan’s writ, the subsequent evolution of money in China was backed almost entirely by state fiat.

There is some historical data from the period that is open to interpretation, which indicates that the Song initiative led to inflation. In comparison, fiat money during the Great Khan’s era, as termed by Marco Polo, not only flourished but was also a critical driver for trade and commerce. Genghis Khan’s paper money, which used different-sized denominations of the bark of the Mulberry tree for different values, would in current parlance, be akin to a traveler check or a closed-loop stored-value card. Irrespective of how we define it, there is no doubt that without state fiat, the Great Kaan’s fundamental driver for commerce across his vast empire would not be effective.

Medieval England had its fair share of experimentation with commodity money and fiat money. Commodity money, which has always been a store-of-value, constrained trade owing to shortages and forced reclassification or redenomination due to ‘clipping.’ The situation was alleviated by the formation of the Bank of England in the 17th century during the reign of William III, which then set the stage for the adoption of the gold standard that provided stability and promoted commerce for a good part of the following two centuries.

We have already witnessed several instances where a combination of going long on greed and shorting memory almost drove the modern monetary system over the cliff. Every spectacular rescue has been followed by a vigorous debate around how far the state should intervene. There was much anguish in most of the western world around the extent of the state’s intervention after the financial crisis of 2008/2009, particularly when it came to saving the large banks that were deemed too big to fail.

From a layman’s perspective that debate is ridiculous for the simple fact that irrespective of which bank one banks with, a dollar bill, or a euro, or a yen, or a renminbi, or a rupee, carries its respective state’s guarantee stating that for every unit that particular piece of paper promises, the state will ensure that the bearer receives the same. That piece of paper carries a particular value and authenticity, not because of the banks or their brethren involved in its storage and settlement, but because of the explicit backing of the state.

The Great Khan was definitely onto something.

The purpose of the above tirade is to establish a simple guiding principle; money – fiat, commodity or otherwise – is a state-backed utility.

Check out Mehul Desai’s August of Money.