The myth of Midas is about the power of money – it magically transforms everything in its path and turns it into something denominated by money itself. The Midas story comes from the ancient lands of Phrygia and Lydia, in western modern day Turkey, close to the Island of Lesbos and to the Ionian Greek city Smyrna where Homer was born. It was the land of a people who fought Persians and Egyptians, who had an Indo-European language, and who were pioneering miners and metal workers. It was the land of Croesus, the King of Sardis, the richest man in the world whose wealth gave rise to the expression “as rich as Croesus.” Click HERE for a map.
Croesus lived in the 6th century B.C., a century dominated by powerful monarchs such as of Cyrus the Great of Persia (3rd blog appearance), Tarquin the Proud of Rome, Hammurabi II of Babylon, Astyages of the Medes, Zedekiah the King of Judah, the Pharaoh Amasis II of Egypt, Hamilcar I of Carthage. How could the richest man in the world at that time be a king from a backwater place such as Sardis in Lydia? Mystère.
In the time of Achilles and Agamemnon in the Eastern Mediterranean as in the rest of the world, goods and services were exchanged by barter. Shells, beads, cocoa beans and other means were also used to facilitate exchange, in particular to round things out when the goods bartered didn’t quite match up in value.
So here is the simple answer to our mystère: The Lydians introduced coinage to the world, a first in history, and thus invented money and its magic – likely sometime in the 8th century B.C. Technically, the system they created is known as commodity money, one where a valuable commodity such as gold or silver is minted into a standardized form.
Money has two financial functions: exchange (buying and selling) and storage (holding on to your wealth until you are ready to spend it or give to someone else). So it has to be easy to exchange and it has to hold its value over time. The first Lydian coins were made from an alloy of gold and silver that was found in the area; later technology advances meant that by Croesus’ time, coins of pure gold or pure silver could be struck and traded in the marketplace. All this facilitated commerce and led to an economic surge which made Croesus the enduring personification of wealth and riches. Money has since has made its way into every nook and cranny of the world, restructuring work and society and creating some of the world’s newest professions along the way; money has evolved dramatically from the era of King Croesus’ gold coin to the present time and Satoshi Nakamoto’s Bitcoin.
The Lydian invention was adopted by the city states of Greece. Athens and other cities created societies built around the agora, the market-place, as opposed to the imperial societies organized around the palace with economies based on in-kind tribute – taxes paid in sacks of grain, not coin. These Greek cities issued their own coins and created new forms of political organization such as democratic government. This is a civilization far removed from the warrior world of the Homeric poems. The agora model spread to the Greek cities of Southern Italy such as Crotone in Calabria known for Pythagoras and his Theorem, such as Syracuse in Sicily renowned for Archimedes and his “eureka moment.” Further north in Rome, coinage was introduced to facilitate trade with Magna Graecia as the Romans called this region.
The fall of Rome came about in part because the economy collapsed under the weight of maintaining an overextended and bloated military. Western Europe then fell into feudalism which was only ended with the growth of towns and cities in the late middle ages: new trading networks arose such as the Hanseatic League, the Fairs of the Champagne region (this is before the invention of bubbly), and the revival of banking in Italy that fueled the Renaissance. The banks used bills of exchange backed by gold. So this made the bill of exchange a kind of paper money, but it only circulated within the banking community.
Banks make money by charging interest on loans. The Italian banks did not technically charge interest because back then charging interest was the sin of usury in the eyes of the Catholic Church – as it still is in Sharia Law. Rather they side-stepped this prohibition with the bills of exchange and took advantage of exchange rates between local currencies – their network could transfer funds from London to Lyons, from Antwerp to Madrid, from Marseilles to Florence, … . The Christian prohibition against interest actually goes back to the Hebrew Bible, but Jewish law itself only prohibits charging interest on loans made to other Jews. Although the reformers Luther and Calvin both condemned charging interest, the Protestant world as well as the Church of Rome eventually made their peace with this practice.
In China also, paper exchange notes appeared during the Tang Dynasty (618 A.D. -907 A.D.) and news of this wonder was brought back to Europe by Marco Polo; perhaps that is where the Italian bankers got the idea of replacing gold with paper. Interestingly, the Chinese abandoned paper entirely in the mid 15th century during a bout of inflation and only re-introduced it in recent times.
Paper money that is redeemable by a set quantity of a precious metal is an example of representative currency. In Europe, the first true representative paper currency was introduced in Sweden in 1661 by the Stockholm Bank. Sweden waged major military campaigns during the Thirty Years War which lasted until 1648 and then went on to a series of wars with Poland, Lithuania, Russia and Denmark that only ended in 1658. The Stockholm bank’s mission was to reset the economy after all these wars but it failed after a few years simply because it printed much more paper money than it could back up with gold.
The Bank of England was created in 1694 in order to deal with war debts. It issued paper notes for the British pound backed by gold and silver. The British Pound became the world’s leading exchange currency until the disastrous wars of the 20th century.
The trouble with gold and silver is that supply is limited. The Spanish had the greatest supply of gold and silver and so the Spanish peso coin was the most widespread and the most used. This was especially the case in the American colonies and out in the Pacific. In the English speaking colonies and ex-colonies, pesos were called “pieces of 8” since a peso was equivalent to 8 bits, the bit being a Spanish and Mexican coin that also circulated widely. The story of the term dollar itself begins in the Joachimsthal region of Bohemia where the coin called the thaler (Joachim being the father of Mary, thal being German for valley) was first minted in 1517 by the Hapsburg Empire; it was then imitated elsewhere in Europe including in Holland where the daler was introduced and in Scotland where a similar coin took the name dollar. The daler was the currency of New Amsterdam and was used in the colonies. The Spanish peso, for its part, became known as “the Spanish dollar.” After independence, in the U.S. the dollar became the official currency and dollar coins were minted – paper money (except for the nearly worthless continentals of the Revolutionary War) would not be introduced in the U.S. until the Civil War. En passant, it can be noted that the early U.S. dollar was still thought of as being worth 8 bits and so “2 bits” became a term for a quarter dollar. (Love those fractions, 2/8 = 1/4). The Spanish dollar also circulated in the Pacific region and the dollar became the name of the currencies of Hong Kong, Australia, New Zealand, … .
During the Civil War, the Lincoln government introduced paper currency backed by a quantity of gold to help finance the war. Before long, Lincoln lowered this quantity because of the cost of the war, debasing the dollar in the process.
The money supply is limited by the amount of gold a government has in its vaults; this can have the effect of obstructing commerce. In the period leading up to World War I, in order to get more money into the economy, farmers in the American mid-west and west militated for silver to back the dollar at the ratio of 16 ounces of silver to 1 ounce of gold. The Wizard of Oz, written in support of this movement, is an allegory where the Cowardly Lion is really William Jennings Bryan, the Scarecrow is the American farmer, the Tin Man is the American worker; and the Wizard is Mark Hanna, the Republican political kingmaker; Dorothy’s magic slippers are silver not red in the book. Unlike the book, in the real world, the free silver movement failed to achieve its objective.
Admittedly, this is a long story – but soldier on, Bitcoin is coming up soon.
Needless to say, World War I had a terrible effect on currencies, especially in Europe where the German mark succumbed to hyper-inflation and money was worth less than the cost of printing it. This would have tragic consequences.
In the U.S. during the depression, the Roosevelt government made some very strong moves. It split the dollar into two – the domestic dollar and the international dollar; the domestic dollar was disconnected from gold completely while the dollar for international payments was still backed by gold but at $21 dollars the ounce, a significant devaluation. A paper currency, like Roosevelt’s domestic dollar, which is not backed by a commodity is called a fiat currency – meaning, in effect, that the currency’s value is declared by the issuer – prices then go up and down according to the supply of the currency and the demand for the currency. To increase the U.S. treasury’s supply of gold, as part of this financial stratagem, the government ordered the confiscation of all privately held gold (bullion, coin, jewelry, … ) with some small exceptions for collectors and dealers. Today, it is hard to imagine people being called upon to bring in the gold in their possession, have it weighed and then be reimbursed in paper money by the ounce.
Naturally, World War II also wreaked havoc with currencies around the world. The Bretton Woods agreement made the post-war U.S. dollar the currency of reference and other currencies were evaluated vis-à-vis the international (gold backed) U.S. dollar. So even the venerable British Pound became a fiat currency in 1946.
The impact of war on currency was felt once again in 1971 when Richard Nixon, with the U.S. reeling from the cost of the war in Vietnam, disconnected the dollar completely from gold making the almighty dollar a full fiat currency.
Soapbox Moment: The impact of war on a nation and the nation’s money is a recurring theme. Even Croesus lost his kingdom when he was killed in a battle with the forces of Cyrus the Great. Joan Baez and Marlene Dietrich both sang “When will they ever learn?” beautifully in English and even more plaintively in German, but men simply do not learn. Louis XIV said it all on his death bed: the Sun King lamented how he had wrecked the French economy and declared “I loved war too much.” Maybe we should all read or re-read Lysistrata by Aristophanes, the caustic playwright of 5th century Athens.
Since World War II, the world of money has seen many innovations, notably credit cards, electronic bank transfers and the relegation of cash to a somewhat marginal role as the currency of the poor and, alas, the criminal. Coupons and airline miles are examples of another popular form of currency, know as virtual currency; this form of currency has actually been around for a long time – C.W. Post distributed a one cent coupon with each purchase of Grape Nuts flakes as far back as 1895.
The most recent development in the history of money has been digital currency which is completely detached from coin, paper or even government – its most celebrated implementation being Bitcoin. A bitcoin has no intrinsic value; it is not like gold or silver or even paper notes backed by a precious metal. It is like a fiat currency but one without a central bank to tell us what it is worth. Logically, it should be worthless. But a bitcoin sells for thousands of dollars right now; it trades on markets much like mined gold. Why? Mystère.
A bitcoin’s value is determined by the marketplace: its worth is its value as a medium of exchange and its value as a storage medium for wealth. But Bitcoin has some powerful, innovative features that make it very useful both as a medium of exchange and as a medium of storage; its implementation is an impressive technological tour de force.
In 2008, a pdf file entitled “Bitcoin: A Peer-to-Peer Electronic Cash System” authored by one Satoshi Nakamoto, was published on-line; click HERE for a copy. “Satoshi Nakamoto” then is the handle of the founder or group of co-founders of the Bitcoin system (abbreviated BTC) which was launched in January 2009. BTC has four special features:
• Unlike the Federal Reserve System, unlike the Bank of England, it is decentralized. There is no central computer server or authority overseeing it. It employs the technology that Napster made famous, peer-to-peer networking; individual computers on the network communicate directly to one another without passing through a central post office; Bitcoin electronic transfers are not instantaneous but they are very, very fast compared to traditional bank transfers – SWIFT and all that.
• BTC guarantees a key property of money: the same bitcoin can not be in two different accounts and an account cannot transfer the same bitcoin twice – this is the electronic version of “you can’t spend the same dollar twice.” This also makes it virtually impossible to counterfeit a bitcoin. This is achieved by means of a technical innovation called the blockchain, which is a concise and efficient way of keeping track of bitcoins’ movements over time (“Bob sent Alice 100 bitcoins at noon GMT on 01/31/2018 … ”; it is a distributed, public account book – “ledger” as accountants like to say. A data compression method called hashing is employed to keep the size of the blockchain under control. Blockchain technology itself has since been adopted by tech companies such as IBM and One Network Enterprises.
• BTC guarantees that bitcoin transfers are secret, known only to the sender and the receiver. For this, in addition to hashing, it uses sophisticated cryptography protocols such as public key encryption; this is the method that distinguishes “https”from “http” in URL addresses and makes a site safe. Public key encryption is based on an interesting mathematical idea – the solvable problem that cannot be solved in our lifetimes even with the best algorithms running on the fastest computers; this is an example of the phenomenon mathematicians call “combinatorial explosion.” The receiver has created this set of problems or puzzles himself and so his private key gives him a way to decrypt the sender’s message. This impenetrability makes Bitcoin an example of a crypto-currency since transactions are decipherable only by the buyer and the seller. This feature clearly makes the system attractive to parties with a need for privacy and makes it abhorrent to tax collectors and regulators.
• New bitcoins are created by a process called mining that in some ways emulates mining gold. A new bitcoin is born when a computer manages to be the first to solve a terribly boring mathematical problem at the expense of a great deal of time, computer cycles and electricity; in the process of mining, as a side-effect, the BTC miners perform some of the grunt work of verifying that a new transaction can be added safely to the blockchain. Also, in analogy with gold, there is a limit of 21 million on the number of unit bitcoins that can be mined. This limit is projected to be reached around the year 2140; as is to be expected, this schedule is based on a clever strategy, one that reduces the rewards for mining over time.
The bitcoin can be divided into a very small unit called the satoshi. This means that $5 purchases, say, can be made. For example, using Gyft or eGifter or other system, one can use bitcoin for purchases in participating stores or even meals in restaurants. In the end, it is supply and demand that infuse bitcoins with value, the demand created by usefulness to people. It is easy enough to get into the game; for example, you can click HERE for one of many sites that support BTC banking etc
The future of Bitcoin itself is not easy to predict. However, digital currency is here to stay; there are already many digital currency competitors (e.g. Ethereum, Ripple) and even governments are working on ways to use this technology for their own national currencies. For your part, you can download the Satoshi Nakamoto paper, slug your way through it, rent a garage and start your own company.