Well before the Covid-crisis struck last year there was growing discussion in policy and academic circles that, at some point in future, a currency “reset” of some sort might be necessary to address a range of seemingly intractable economic problems. In more recent months, such talk has become commonplace and is frequently intermingled with the topic of digital currencies, including bitcoin.

While distinct from the topic of currency reforms, which happen with some regularity in history, it is understandable that, in our technological age, policymakers would seek to use the most cutting-edge tools to achieve their objectives. And as it happens, digital currencies would offer economic and monetary officials some distinct advantages when it comes to regulating economies.

However, as history instructs, currency reforms and resets are not necessarily undertaken in the broad public interest but, rather, to serve a particular elite at a particular point in time. The same can be true of technology, which can be used for good or ill.

No one would deny the ability of safe nuclear technology to offer potentially huge benefits to society. Indeed, it already does so in medicine and energy, among other applications. But used in another way, nuclear technology is by far the most destructive force ever invented by man.

Money itself is a technology, albeit an old one. Indeed, so old that the concept of money is deeply embedded in language, culture and religion. The uses and abuses of this technology include numerous debasements, devaluations, hyperinflations and their associated economic crises. They also include reforms and resets, many of which were successful in restoring monetary stability, thereby facilitating stabilisation and economic recovery.

Lessons for today can be found in the above, although some are more relevant than others. In Part I of this two-part series, we will examine a few currency crises, reforms and resets, determine which were successful and, more importantly, why.

Tomorrow, in Part II, we will examine digital currency technology, including blockchain and bitcoin, and consider whether and how it might be used for good, or for ill, in our monetary future.

Part I: currency crises, reforms and resets

Precisely how money originated is a topic of perennial debate. A theory of how civilisations themselves arose is to a certain extent a theory of money.

Characterised by specialisation, civilisation at scale requires the division of labour and capital. The more specialisation, the more transactions required for producers to sell their respective surpluses and for consumers to source all the products they need. Absent a medium of exchange, it is difficult to imagine how large societies could organise themselves as increasingly complex systems and advance beyond a stone-age level of organisation.

Monetary historians and anthropologists thus generally agree that direct barter had already been to some extent displaced by media of exchange in pre-historic, Bronze Age times and references to an official monetary unit, the shekel or mina, appear in Hammurabi’s Code. That’s about 1754 BC. The regulation of money, for the purpose of facilitating commerce or taxation, is also discussed in the Torah (Old Testament) among other ancient texts.

It is no coincidence that, throughout the ancient world, gold and silver coinage was by far the most prominent form of money. Most commonly the by-products of copper, iron, nickel and tin mining, they were distinct in their properties, in particular those of being relatively rare and resisting corrosion.

It is also no coincidence that the decline of empires and civilisations was associated with monetary debasement. In the West, this was true of both the Greeks and the Romans. In the latter case, the great debasement got underway in the 3rd century AD. As Nicolaus Copernicus explained half a millennium ago, “Nations are not ruined by one act of violence, but gradually and in an almost imperceptible manner by the depreciation of their circulating currency, through its excessive quantity.”

A brief history of resets

In his masterwork The Decline and Fall of the Roman Empire, Edward Gibbon lists numerous causes that led to Rome’s eventual decline and collapse, but chief among them were excessive centralisation, requiring excessive taxation and/or debasement to finance.

However, as Rome declined it also split in two. The Eastern and Western Roman Empires subsequently followed quite different currency policies. The West continued to debase and eventually collapsed entirely, but the East stabilised its coinage in a highly successful reform.

In 312 AD, Emperor Constantine implemented a new suite of legal tender coinage laws centred around the golden solidus, colloquially known to modern economic historians as “the dollar of the Middle Ages”. Among other features of the new system, the penalty for debasement was death. Silver and bronze coins circulated alongside the solidus and their circulating supply reflected shifts in the demand for money. There was also a sophisticated banking and credit system for its time.

While the Western Empire eventually found the Barbarians at the gates of Rome, the Byzantine East remained intact and generally prosperous for a further millennium. Byzantium would fall to the Turks in 1453, but its legacy lived on. Based on sound gold and silver coinage, its money and banking system provided the model for what the Venetians, Florentines and Genoese would develop further and spread throughout Europe during the Renaissance.

Debasement on scale was rare during the next few centuries and the European economy generally grew. A middle class emerged in the cities and towns, including in the Netherlands, where it became an important political force contributing to the Dutch Reformation and Revolt against the Spanish.

The New World and new money

Long before the British acquired an overseas empire, Spain had acquired vast lands in the New World, where they found huge deposits of silver and gold. France, too, would find deposits, primarily in Africa. In both cases, their growing wealth and power was undermined by severe economic mismanagement and, when faced with economic crises, both implemented reforms, with varying degrees of success.

The Spanish may have grown wealthy and powerful from their New World windfall, but rather than pursue a policy of economic modernisation and liberalisation at home, they sought to expand their power and influence in Europe, and to hold on to prosperous Flanders and the associated tax revenues through military force. The Dutch eventually won their independence and, alongside the failure of the Armada to invade England, Spain found that even its New World riches were not sufficient to finance militaristic solutions to its growing fiscal woes.

Let them eat paper money

The French imperial experience was similar in certain respects, but the French found far less silver and gold than the Spanish. Their New World colonies did, however, find resource-rich lands and the promise of future wealth windfalls. And so, as France fought war after war in the 17th and 18th centuries, depleting state coffers, they eventually turned to infamous Scotsman John Law to implement a plan whereby a central bank would issue paper money and government debt would be financed through the share issuance of the Mississippi Company.

As the circulating supply of paper money grew, Law’s Mississippi Company issued shares and speculators would exchange the former for the latter. It was a nice arrangement on paper, but the supply of paper money and value of shares grew and grew alongside chronic government deficits. Eventually, people began to wonder whether or not the Mississippi lands were indeed resource-rich enough to justify such valuations and they began to cash out in favour of the safety of silver and gold coinage.

Meanwhile, the real economy struggled. Chronic government overspending on war, imperial expansion and court excess had drained the private sector of resources, leading to soaring inflation, including in food prices.

Things came to a head in 1720, when the shares of the Mississippi Company collapsed and peasant revolts broke out. There was a scramble to convert all forms of paper wealth, money and shares, into coins. In a futile attempt to prop up his failed monetary experiment, Law convinced the government to criminalise transacting in coin and, in a final push, to criminalise coin ownership altogether.

It was left to Louis XV’s adviser Cardinal Fleury to pick up the pieces, which he did by addressing the ultimate source of the problem: chronic government overspending. By 1726, gold and silver were restored to the centre of the monetary system at fixed rates of exchange. The economy soon recovered, helped along by growing colonial wealth, but this time on a sound monetary foundation.

Not worth a continental

Several decades later, another historic paper money experiment took place, this time in the Americas. As the Colonists organised their secession from the British Empire, the Continental Congress needed a temporary way to finance their militia and certain other activities. This they did from 1775 by paying their troops and others in paper “continentals”, an unbacked paper currency which, it was claimed, would be redeemable in coin at some unspecified future point in time.

Although possibly exacerbated by British attempts to counterfeit the currency, continentals in circulation grew and grew as their value declined. By 1778 they had already lost most of their value. By 1781 they were essentially worthless. Finally, following the ratification of the Constitution in 1789, the continentals could be exchange for US government bonds at 1% of face value.

In addition to establishing the United States as a formal government entity, the US Constitution also contained within it the framework of a monetary reset. The Congress was given the power to coin money and regulate the value thereof. Coining money is not printing. Moreover, the Constitution prohibits any state from establishing anything other than gold and silver coin as legal tender.

This reset was then formalised in the Coinage Act of 1792, in which the exact weights and exchange values of gold and silver coin are specified. The US would not again issue a paper currency until the outbreak of the Civil War some 70 years later.

What currency resets have in common

Note what all of the above currency resets have in common: they are either about fixing the amount and proportions of metals, precious and base, in the coinage; or they are a means of devaluing and ultimately repudiating the paper money, asset-backed or not, that was associated with temporary, unsustainable bubbles.

Sound, re-based coinage of some kind is always, in every instance, the remedy for the previous debasements and inflations, regardless of specifics. The US Constitution and Coinage Act thus represent a relatively recent, formal reset, but one with much historical precedent.

Moreover, it should be noted that governments don’t debase and/or print money without reason. Wars are expensive. Central administration is expensive. Perks for insiders are expensive, be they kings, courtesans, magistrates, clergy or military.

Taxation is a relatively clear and transparent appropriation of wealth or income, however unpopular it may be. Not so debasement, frequently unseen in whole or part, yet thoroughly insidious in its effects as it permeates society.

Why currency resets are needed

Nobel Prize-winning economist Thomas Sargent studied a number of large historical inflations, including some taking place in the 20th century, such as the great Weimar hyperinflation. What he found was that all large inflations began with government excess, deficits and debts, for whatever reason or reasons; and that they ended much the same, with a currency reset of some kind along with substantial, credible policies to restrain government excess in future.

The Weimar hyperinflation holds a particularly infamous place in monetary history because it is seen to have contributed to the rise of Hitler. It is also instructive, however, as an example of just how quickly confidence in an unbacked paper currency can be lost.

The mark had already been eroding in value at an elevated rate since 1921, but no one would call it hyperinflation. That all changed very suddenly in 1923, when lingering disputes around the Versailles Treaty provisions came to a head, and Belgian and French armies occupied the Saar and Ruhr industrial districts.

While stretching the analogy a bit, this is not dissimilar to a military force choosing to occupy an oilfield today in order to “protect” it or, in other words, make sure that the oil produced and associated revenues end up in the hands of the desired parties.

The Saar and Ruhr produced coal and steel, and sold them at a large profit, and these revenues were critical to Germany’s ability to service its war reparations payments to, among others, Belgium and France. No currency reset, however ambitious or advanced in technology, can possibly prevent some degree of monetary mayhem when such forces are at work.

The lesson of history is that currency resets, on their own, are not enough. Absent credible action by the fiscal authority – most frequently a change in party, in government or in regime – resets fail.

Monetary technology on its own can only facilitate commerce. It cannot paper over unsustainable government policies depleting resources and crowding out capital, thereby undermining the division of labour and capital and associated growth in the capital stock itself, which underlies all economic progress.

In recent decades, several countries have successfully reset their currencies simply by pegging them to another, more dominant currency. The dollar and euro have both provided anchors in these instances. But here, too, such arrangements are only sustainable if countries keep their finances in order.

Argentina demonstrated this rather spectacularly in the late 1990s. More recently, Bulgaria has succeeded in maintaining its peg to the euro. But what happens when the anchor currency itself it associated with weakening economic fundamentals? An anchor is only as good as that to which it is anchored. The euro-area has deep and growing economic problems, as do the UK and the US, the provider of the de facto global monetary base: the dollar.

Tomorrow we tackle what all this historical precedent suggests about our future. And the surprising turn a currency reset might take.

Although, if you’re feeling impatient, our cryptocurrency expert Sam Volkering has a rather stark prediction for you to consider here, now.

John Butler
Author, The Golden Revolution