What History's Greatest Currencies Tell Us About the Future of the Dollar | Barry Eichengreen

27:23Demetri Kofinas:I mean, it really, it's fascinating when you think about the power that bankers began to accumulate in this period and going forward? Not just power in commercial relations, but power over sovereign entities. Help me understand where the opportunity emerged for sovereign lending, and help me also, and the listeners also understand, how was it that these private actors were able to accumulate so much power? Was it because commercial opportunities had grown so plentiful and sovereign entities understood that there was a way to mobilize resources and labor through capital outside of their own borders in order to leverage that for their own purposes.

28:05Demetri Kofinas:That in other words, it had to be decentralized. They couldn't do it in a kind of centralized, top-down fashion. So it's very interesting to look at how these banking houses, be they in Florence and Genoa, later in history, be they in the Netherlands or in England with the rise of the Rothschild family, how they are at the same time centralized and decentralized. There is kind of the family or the father at the center of the network, but communications technology being what it was at the time, whether you have to have a guy on horseback or a carrier pigeon later in time to transmit information means that the branch managers, if you will, other branches of the widely branched merchant bank have considerable autonomy.

29:03So they are typically supposed to execute instructions from the head office, but they have an awful lot of freedom and practice to interpret or sometimes ignore those instructions. In the period we're now talking about, the early modern period, you begin to see the growth of commerce. So you get these large merchant houses. You see the growth of merchant banking because the commerce and the finance complement one another. They get packaged together. And you see developments on the military front, which makes waging war either offensive or defensive more expensive. So sovereigns, kings, they borrow for a variety of reasons to equip the court with all the nice things that courts expect, but also to wage offensive and defensive of war.

30:06So, they need to borrow more in order to maintain themselves. So, modernization has these different aspects to it, the growth of commerce, the growth of finance, but also the development of military technology, which becomes more costly at around the same time. So, the bankers grow more powerful. The sovereigns need the bankers more, if you will. The funny thing about sovereign borrowing, of course, is we call them the sovereign because they are the highest power. There is no higher earthly power to compel the sovereign to repay. So the paradox of sovereign borrowing and lending is the sovereign can declare unilaterally his or her unwillingness to repay.

30:54And yet this process has been of sovereign borrowing and sovereign lending has been going on for the better part of a millennium now.

31:04Demetri Kofinas:I'm glad you brought that up because traditionally when we think about sovereign lending, at least to large developed economies with deep bond markets, we consider that to be the safest form of collateral we can get for a loan. We don't see it, in other words, as an opportunity to make more money than would otherwise be available to us. But in the case of sovereign lending at this stage in human development and civilization, it seems that all forms of sovereign lending were really emerging market style deals where the lenders were actually taking on enormous amounts of risk in lending money to sovereigns exactly because the returns were so lucrative.

31:41Right. So, I described the paradox of sovereign lending and borrowing before that sovereigns can and repeatedly did default on their debts, refuse to repay or after a period of negotiation to repay only part. Why did the process nonetheless continue? Why did the Genoese lend to Spanish kings over and over again, despite the kings defaulting over and over again? The answer is they were very well compensated. Interest rates, economic historians have gone back to try to reconstruct the interest rates received on these loans. They were typically well into the double digits. So the risk premium attached to these credits, so long as interest was paid, compensated generously, lavishly, I don't know what the best word is, the bankers who undertook the loans, the bankers could cut off the sovereign borrower if the borrower defaulted on his debts.

32:52Over time, they learned to form basically cartels. The threat of curtailing market access is not very credible if there are other potential lenders. So they learned how to form coalitions with other bankers to make that threat credible. And if the kingdom in question is engaged in a conflict with another kingdom, lack of access to credit can threaten its existence. So that could be a credible threat as well.

33:25Demetri Kofinas:So how did the success of the Florian impact the rest of Florence's economy? So there is some controversy. There are people who say that the Florentines took their eye off the ball. They had to have a strong economy. They had to continue to update their woolen and silk industries, but they got caught up in finance. The economy became increasingly excessively financialized. They engaged in financial business rather than attending to more mundane economic business. And that was why they were unable to keep up with the low countries and with the English in terms of international competition. The evidence there is, I think, a bit thin.

34:16There are a lot of people today who worry about excessive financialization in the case of the United States and whether we are similarly taking our eye off the ball in terms of maintaining manufacturing. Whether we suffer from an overstrong dollar exchange rate, something that there are hints about similar worries in 15th and 16th century Florence, economic rise and fall are complicated phenomena. There may be something having to do with financial markets at work there. There may be, in the case of Florence, a lot having to do with scale there. It was a small city state with very limited natural resources.

35:08So I'm not sure I would put everything on the doorstep of the Florin was a great advantage for Florence until it became a great disadvantage, but there is that interpretation out there.

35:21Demetri Kofinas:So we'll have a chance in the second hour to dig into that more deeply, because I actually agree with your observations towards the end of the book about the cost versus the benefit associated with being an international currency. I think a lot of people who believe that devaluation is a solution to the US's problems, I think are over-indexing to the industrial period and also to a world that wasn't as fully globalized as ours is today. Because of course, a more valuable currency means cheaper inputs to your manufacturing process. One more question about Florence before we move on. How developed at this stage were the market for bills of exchange, how much discounting was going on, were there secondary markets?

36:03Demetri Kofinas:And when it comes to money, at this stage, these Florentine banks were also issuing receipts for deposits, but were these still thought of as receipts on specific assets that were on deposit at the bank? Or was there already some thinking or inkling of thought that these were liabilities of the bank itself? Well, I think inkling is the right word. These primitive promissory notes that begin to circulate and increasingly claims on individual Florentine merchant banks, goldsmiths or the like were not really negotiable. They couldn't be sold on to other individuals. The law didn't allow the protections that the original holder of that bill of exchange enjoyed to be passed on to another individual.

37:02That only came later, we'll get there in the case of 17th and 18th century Holland. So they were really specific claims on specific individuals or specific merchants or specific merchant banks.

37:20Demetri Kofinas:So the next chapter in the book is Spain and Spanish silver, but actually let's move to Holland because it fits so naturally. And then maybe we can double back to the case of Spanish silver, which offers some, I think, important lessons, especially about the globalization of commerce and currency. What did the Dutch... It seems the Dutch very much... Well, first of all, they were very similar to the Florentines, though they had a large trading network and a navy and became an empire in their own right. It seems that they really took the innovations of the Florentines and ramped them. Right. So I think the Dutch, as you know, were essentially global trading powers.

38:01The Dutch East India Company was a hybrid commercial military operation at scale. It was funded by shares that were issued to multiple shareholders. It was a permanent organization in contrast to the prior practice of investing in commissioning individual voyages. Partners would get together to fund an individual voyage and then they'd wind it up when the ship came back. Again, and not as efficient way of organizing commerce as having a standing company. In terms of international currency use, they moved from the promise, sorry, note to the bill of exchange that was negotiable, that could be bought and sold repeatedly where whoever the current holder was had a legal ability to enforce his rights under the promise made by whoever issued the bill.

39:05So that led to the development of more active and liquid financial markets, which made it attractive to buy, sell, hold, use the Dutch Gilder. It had the first central bank, a proto-central Bank, the Bank of Amsterdam to stand behind that market to act as a liquidity provider of last resort to the market, keeping the exchange rate and the cost of credit relatively stable. And by some definitions, it had the first fiat currency after a certain point in time, claims on the Bank of Amsterdam could not be redeemed in precious metal. You couldn't show up with your bank note or your deposit at the Bank of Amsterdam and withdraw an equivalent amount of specie gold or silver coin.

40:01So the Bank of Amsterdam's reputation substituted at least in part for the gold and silver backing that had been the basis for previous international currencies. So in all these respects, the Dutch were critically important in the 17th and 18th century and moving us from the early modern period to the present day.

40:28Demetri Kofinas:So this recurs over and over again in the history that you recount from the book, which is that our relationship to the tangible products of commerce become increasingly abstract. In this case, I mean, the entire notion, it actually took me a little while to wrap my head around it. It seems that what essentially happened in the case of Holland is that people associated receipts with very specific coins. So I gave some specific coins to the Bank of Amsterdam. I got a receipt for those specific coins, and I expect to get those specific coins back. And that what happened at some point, I think it was, what was it, 1683 or somewhere around there, deposits that had been given before that date no longer had a corresponding receipt associated with the specific coins.

41:14Demetri Kofinas:And you simply, it's not that you couldn't get gold in return for your receipt, but you just had to get whatever the bank was willing to give you. And the institutional claim was that you trusted the bank wouldn't do you dirty and give you an honest sum of gold, if it was gold that you were getting based on that receipt. That seems to be as small, seemingly insignificant as that is. It points to just how revolutionary that next leap of abstraction was in the mind of commercial entities at the time. Yeah, I think that's right. There's another very good book from two years ago now by a couple of financial historians, Will Roebirds and Stephen Quinn on the Bank of Amsterdam that lays out that transition, describing it very much in the same way that you just did.

42:05And they make a compelling case, and I agree that this change in the receipt system of the Bank of Amsterdam was a pivotal development in modern money and finance.

42:16Demetri Kofinas:This reminds me of, the audience will permit me, hopefully one very brief digression, a story I first learned about during my time studying information theory and linguistics. And I'm sure I've mentioned it in previous podcasts. It comes from the work of a famous Soviet psychologist named Alexander Luria from one of his field studies interviewing illiterate peasants in Central Asia in order to test whether or not they could engage and deductive reasoning. And he would, in the course of interviewing them, present them with thought experiments. And then in this particular one that comes to mind, he would ask these Uzbek peasants, in the far north where there is snow, all the bears are white.

42:55Demetri Kofinas:Novaya Zemlya is in the far north and there's always snow there. What color are the bears? And the typical response from these illiterate peasants would be, well, how would I know? I've never been to the north. In other words, because they'd never been there and because they hadn't learned how to think conceptually, they felt that they couldn't answer the question because they hadn't experienced it for themselves. Whereas the test subjects who had just learned to read and write understood the distinction and were able to respond with something along the lines of, by your words, they should all be white.

43:32Demetri Kofinas:And this evolution in finance and the ability to think conceptually about capital and economic relations across time and space feels very similar. In other words, it feels like something that you would have to learn. And if you were to have plucked someone from 15th century Florence, or maybe even better, ancient Lydia, and ask them to engage in the most rudimentary forms of modern finance, they'd be totally lost because this isn't something that we're born with. It's not natural. It's not part of our hardware. So anyway, that was a bit of a digression, but one I felt compelled to make. So we have so much history to run through, Barry.

44:07Demetri Kofinas:Let's go back to Spain. In some ways, Spain is a very boring story, but in terms of innovation, at least for me, it seems that a lot of what the Spanish did had already been invented and put into practice in the ancient world, especially by the Romans. And what they did, what was notable perhaps in the case of the Spanish, was to scale it to a level that we hadn't seen before. What would you say were the major implications of what the Spanish accomplished with the minting and distribution of Spanish silver that made them worth devoting an entire chapter to? The Spanish silver dollar was the first true global currency that circulated everywhere around the world was used for all manner of transactions following the Spanish discovery or acquisition of colonies in the new world that could, as you say, deliver Spanish coin and bullion at scale, at immense scale.

45:10So when I was putting the book together, I was thinking about the period we've just been discussing the late 16th, 17th, and 18th centuries as dominated both by Spanish silver and Dutch currency and credit. I thought of one as kind of a retrograde development the way you put it. The Spanish were still relying entirely on coinage and lumps of silver. Some of their newly mined silver was coined in the New World, in Mexico, in Peru. Some of it was simply put on the boat, shipped to Europe, ostensibly to Spain, although a lot of it was smuggled to other places like Holland and England from where it might then be coined in Spain and then shipped on to Asia.

46:05There were the famous Spanish galleons that sailed directly from the New World, from Peru to Asia, another way that Spanish silver got to other parts of the world. It's worth recalling that the Spanish silver dollar often cut up into pieces of eight, eight slivers like - Like a pizza pie. Like a pizza pie was the small change used in the United States all the way up to 1857. So Alexander Hamilton famously established a mint, but we didn't have enough of the raw material until the California gold rush and the Nevada silver rush almost a half century later to support minting on the scale that the US required.

46:52So we imported Spanish silver dollars and gave them legal tender status all the way up almost to the eve of the civil war. This was a global currency, the main unit used in China for cross-border transactions, used in North America, as I just described, used around the world. It wasn't an important financial innovation, but it was an important demonstration, as you say, of how coinage can be scaled globally and used around the world. So my initial design for the book was to package the Spanish case and the Dutch case together. They were both sources of important international currencies in the 17th and 18th centuries.

47:41One was kind of a retrograde development. The other one was a progressive development. In the end, And I ended up treating the two cases separately, just like you and I have done up until now. But it's interesting to juxtapose them.

47:55Demetri Kofinas:Yeah. I undersold the logistical innovations of the Spanish, which were formidable and which also led to the closing of a persistent and very large arbitrage, global arbitrage between gold and silver that I had not been aware of until I read this book. Maybe just tell me a little bit about that. So how long did this arbitrage persist and how significant was that commercial opportunity? And why? Why was silver trading at a premium in Asia for so many decades? Because silver was not as abundantly available in Asia and because silver had more utility for a variety of transactions. Gold is too valuable to be used in everyday transactions in many settings.

48:43Even in Europe in the 18th century, the smallest gold coin, maybe the size of a dime, would be worth a week's wages for a typical working man. So, that can slip between the seams of your coarsely woven wool pockets. So, you need something else with which to do a variety of other transactions. And in Asia, where come the 18th and 19th centuries, incomes are lower than they are in the West. Gold is impractical for everything but large value cross-border transactions. So there's a demand for silver as well as a relative shortage in terms of supply. Silver gets from the New World to Spain and Europe, and then it's exported from Spain and Europe to China and other parts of Asia in return for porcelains and silks and the other things that Asia famously supplied to the West.

49:47And as that process continues, that's what you described before as arbitrage. The relative price of silver compared to gold gradually declines to the point where it's more or less equal to that relative price in the West. And the trade of silver by Europe in return for porcelains and silks from Asia begins to level off, if you will. The arbitrage opportunity goes away.

50:17Demetri Kofinas:So I have actually one more question that I thought of now before we move to the second hour about Spain that seems to me actually to be very important that I hadn't thought of. Up until now, we've talked about, especially when we're talking about Holland and the Florentines, what we were talking about in part, at least when it comes to currency, was really innovations in bank money, which was a way of expanding credit because ultimately it was a liability of the bank. Even if it wasn't a liability of an institution, it was a liability of the bank to fulfill the promise of the receipt. In the case of Spanish silver, it was really an expansion of base money.

50:54Demetri Kofinas:And it seems to me from the reading that expanding base money did much more for lubricating the wheels of international commerce in this particular case, then the expansion of bank money did. And am I wrong in reading it that way? Is that just a reflection of the particulars of the time in which Florence and Holland were innovating on that? Or actually, does it say something powerful about the need for elastic currency that can't be replicated simply by expanding bank money or through credit? So the expansion of bank money was critically important. And I emphasize it in the other cases, we've discussed the Florentines and the Dutch and in the second hour, the English, because it kind of presages our modern world where it's all about bank money or looking forward tech platform money or something.

51:54But bank money is hard to use across very long distances and very different cultures. So you see the Florentines innovating and developing new vehicles for conveying bank money within Europe between Florence and the low countries between Florence and England, between the Tuscans and Spain. But you don't really see bills of exchange drawn on the Dutch East Indies or China, except when the Dutch are doing business within their own different branches of their own company, the East India company. But when they're doing business with locals, bank money, different language, different culture, very long distance, difficulty of enforcing a abstract written contract, that's when you want to settle up with specie or coin.

52:51And that's why the Spanish silver dollar was used so widely in these transactions across very long distances between continents, between different cultures. We are able to bridge that gap come the 19th century with the development of global banks with a branch in Hong Kong and a branch in London, HSBC, et cetera. But you have to have improvements in transportation communication and enforcement technology for that to become possible. And I think that explains the persistence of the Spanish silver dollar in these kinds of transactions around the world.

53:32Demetri Kofinas:So this ties into something else that you didn't cover in the book, but we did talk about in your appearance on Hidden Forces in 2018, which is the case of the populist demand for silver in the 19th century in America, and the demand for elasticity and the decentralization of money outside of the New York banking system. Maybe that's a question I'll hold to ask you about in the second hour. But as you said, this is where we're going to get into a conversation about the United Kingdom, Britain, and what it was able to do both in terms of innovations, but also scaling all the innovations we talked about up until now.

54:08Demetri Kofinas:And then the case of the United States, both the centralization of its banking system in the late 19th and early 20th century, and then subsequently through World War I and World War II, the internationalization of the US dollar, the end of bread and woods, the non-system that emerged from it, and the world that we live in today. And then what comes after really? What are the threats to the US dollar, what would be required in order to displace it? Is displacing in a discrete binary way the only scenario or could the US dollar persist alongside other currencies? And is there a risk really that there would be sort of a vacuum, which is I think one of the concerns that you raise in the book.

54:47Demetri Kofinas:For anyone new to the program, Hidden Forces is listener supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want to access the second hour of today's conversation with Barry Eichengreen, head over to hiddenforces.io slash subscribe and sign up to one of our three content tiers. All subscribers gain access to our premium feed, which you can use to listen to the rest of the day's conversation on your mobile device using your favorite podcast app, just like you're listening to this episode right now. Barry, stick around.

55:19Demetri Kofinas:We're going to move the second hour of our conversation onto the premium feed. Sounds good.

55:50Demetri Kofinas:forces.io. You can follow me on Twitter at Kofinas, and you can email me at info at hiddenforces.io. As always, thanks for listening. We'll see you next time.