Democracy and Government Control of the Money Supply

Revolutions in the form of money inevitably have political consequences. The development of modern banking and the concomitant erosion of the government's monopoly of money creation played a significant role in the development of democracy. Today, government control of the money supply faces new potential threats, the most obvious of which is the development of electronic forms of money. Another possible threat is the growth in securitisation, which has received little attention from the general public except in connection with one of its most exotic forms - Bowie bonds.

In view of these potential threats to government control of the money supply the lessons of history have great contemporary relevance.

An article in the Economist (26 November 1994 pages 25-30) entitled Electronic money: so much for the cashless society made the claim that "the transformation of the Internet from a huge virtual community into a huge virtual economy may herald the age of electronic money - and with it, headaches for traditional banks and regulators."

One of the points discussed in the Economist article was whether digital cash should be a proxy for money or whether it should be acceptable as money in its own right. The latter would, according to the article, be unpopular with governments who have always regulated banking activities carried out within their countries. "If people who log on to the Internet are localised geographically and thus subject to a particular set of national laws, the traffic that they create on the Internet is not very obviously anywhere at all." Looking further ahead the article suggests "ideally, the ultimate e-cash will be a currency without a country..."
The last time the state's monopoly over money creation was seriously weakened was when paper money was introduced and quite apart from the economic effects, that also helped to cause profound political changes as shown by the following quotations taken from the book by Glyn Davies.
Davies, Glyn. A history of money from ancient times to the present day, 3rd ed. Cardiff: University of Wales Press, 2002. 720 pages. Paperback: ISBN 0 7083 1717 0. Hardback: ISBN 0 7083 1773 1.

"Technical improvements in the media of exchange have been made for more than a millennium. Mostly they have been of a minor nature, but exceptionally there have been two major changes, the first at the end of the Middle Ages when the printing of money began to supplement the minting of coins, and the second in our own time when electronic money transfer was invented... The first stimulated the rise of banking, while the second is opening the way towards universal and instantaneous money transfer in the global village of the twenty-first century." (Page 649).

"One of the most significant but insufficiently noted results of these two major kinds of invention is the fundamental reduction they bring about in the degree of governmental monopoly power over money. When coins were the dominant form of money, monarchs were jealous of their sovereign power over their royal mints. Paper money allowed banks to become increasingly competitive sources of money, a development which led not only to significant macro-economic changes but also facilitated contemporary revolutionary constitutional changes. It was no accident that the Whigs, who supported the limited constitutional monarchy of William and Mary were prominent in promoting the Bank of England." (page 649)

"Similarly in the era of electronic banking 'national' moneys are becoming increasingly anachronistic as millions of customers, irrespective of their country of domicile, are eagerly offered a variety of competing financial institutions in a variety of competing currencies. They are spoiled for choice - and national money monopolies are thereby also being 'spoiled', in the sense of being reduced in effectiveness. The monetary authorities always try to reassert their monopolistic power - in economic jargon, to make sure that money is exogenously created - as opposed to money supplies produced elsewhere by the working of market forces - or 'endogenously' as the economists describe the process." (pages 649-650)

"The fact that more than half of the total money supply was now being created, not by the mint under the dictate of the monarch, but rather by the London money market and provincial bankers gave rise to the most profound constitutional consequences. First, in order to carry out his more burdensome civil and military duties, the monarch, after a painful but vain struggle, had been forced to call parliaments annually. Secondly because of the state's need to supplement taxes regularly and substantially with various forms of short-, medium- and long-term borrowing, the state had been forced to take into account the views and interests of the moneyed classes and the nature of the institutions which its borrowing had very largely brought into being. The national debt not only created the Bank of England but also virtually created the London money and capital markets in recognizably modern form long before an equity market in industrial shares became of importance." (page 281).

"For the first time in history money was being substantially created, not ostentatiously and visibly by the sovereign power, but mundanely by market forces..." (page 2812). Thus the constitutional reforms of the Glorious Revolution were partly caused by a financial revolution. It it is worth noting that in the following century the American Revolution was also partly the result of a dispute over paper money and the British government's control over the Colonies' money supply.

In the final chapter of the book the question of "free trade in money in a global cashless society" is considered. The economist Friedrich Hayek advocated the "de-nationalisation" of money i.e. the removal of all legal obstacles preventing individuals using whatever form of money they wanted. In that way, so he claimed, the market would produce the best forms of currency. Although Hayek was an important influence on many right wing politicians, including Margaret Thatcher, no government has been willing to go that far in giving up the state's control of money. However, the Economist article suggests that the advent of electronic cash could lead to privately issued currencies competing with official state currencies.

Another trend which some people have argued could weaken government control over currencies is securitisation, or the issuance of bonds backed by some asset. In principle almost any kind of asset could be securitised. One of the most publicised innovations in this area was the bond issue by the rock star David Bowie in 1997, using his copyrights as the security. Since then there have been quite a few similar cases in the music business. See Who's Who in Bowie Bonds for more details, or the thriller Something Wild by Linda Davies, the first novel about Bowie bonds.
Paper money was originally simply a proxy for the real thing. British banknotes still carry the phrase "I promise to pay the bearer on demand the sum of x pounds" (where "x" is the denomination of the note) with the signature of the chief cashier of the Bank of England underneath. However, one unintended effect of the adoption of paper money was to make hyperinflation possible (e.g. the Continentals of the American Revolution, the Confederate banknotes of the US Civil War, and German notes after World War I). China which invented paper money had abandoned it, before its widespread adoption in the West, for that very reason.

In general, the more regimented and "planned" that a society is, the smaller is the role played by money. An example of this was the nations of eastern Europe and the Soviet Union before the collapse of communism. A much older, more extreme example was the Inca empire. The Incas were unique in that they managed to achieve a high degree of civilization without the use of money, though paradoxically they possessed a superabundance of what has generally been regarded as by far the best material for money - gold and silver.

Thus there is a close connection between money and liberty or, in the words of Dostoevsky, "money is coined liberty" (House of the Dead, part 1, chapter 2). Consequently, if experiments with digital cash prove successful the ramifications may ultimately extend to all forms of economic activity and have profound implications for the development of society in every country of the globe, just as the development of paper money did.