Fiat Money of the Past, Part 2

This entry is part 16 of 31 in the series 2011B


China deserves a mention for their fiat money even though their use of it is considered a colossal failure by gold standard anti fiat advocates.
What is not pointed out is that every money system has had its failures. In fact, every advance that humanity has made has had failures along the way. Perfection is achieved when the causes of failure are examined and the lessons learned are incorporated.

Take our space program for example. We had all kinds of failures with the early Jupiter rockets as we competed with the Soviets. Did we throw our hands up and run away from creating a system that could orbit satellites?

Of course not.

We looked at the principles involved and knew that we could achieve stable rocketry if we worked out the bugs.

The same applies to fiat money. The principle is sound, but the obstacles to the principle working soundly must be discovered and removed.

China invented paper and was the first to use paper currency that was backed by metals as well as pure fiat money.

Their first paper money was way back in 140 BC though little is known about it outside of the fact it existed.

During the Song dynasty (960-1279 AD), paper money surfaced again. During the reign of Chengtsung in 997-1022, the Chinese beat our bankers to the punch in creating fractional banking and issued more paper money than was covered by bullion. To make sure there was not a run on the money they restricted redemption to once every three years The people called these notes “changelings” to describe their uncertain character. They also called it “flying money.”

Wars that took three quarters of the tax revenues and the increasing bureaucracy made the temptation to print up excessive money too great to resist and they began to suffer from inflation.

They tried to rectify the problem by legalizing metallic money again but this was siphoned off to Korea, Southeast Asia, Japan, and Vietnam leaving the country with a famine of the metallic money supply.

With little money left for redemption in 1189 AD they changed the fractional money with redemption to 100% fiat with no redemption. They seemed to have no other choice.

This was not a planned fiat currency but was a desperate attempt to save their financial system. Attempting to go back to gold, silver and copper didn’t work so maybe a fiat system would.

As one would expect the people felt cheated. They felt lied to for they were told they could redeem their money for coins and now they could not. Obviously in this situation the currency was doomed to failure and by 1197 AD the situation was dire.

In a desperate move they minted coins of all the silver they could get their hands on but inflation just became worse. Nothing seemed to work.

In this weakened state they were invaded and conquered by the Mongols.

Despite the discontent of the people with paper money the Mongols liked the paper money idea and continued with it. When you think of it this comes as no surprise for it has obvious value for convenience alone and that convenience continues to be a positive factor to this day.

In 1260 they passed laws making the use of copper, silver and gold coins illegal while claiming their paper money was backed up with gold, silver and silk floss.

This Yaun Dynasty called the money the “Yaun” which is term is still in use today. This money then gained wide acceptance not only in China but neighboring countries.

Because gold and silver money was illegal the people mainly redeemed the paper money for metals to be used as jewelry, or perhaps as a secure investment. Because of the low redemption rate it appeared the government could issue large amounts of paper and not worry about a run on their reserves.

They didn’t seem to anticipate another problem though which was inflation. They allowed provinces and private enterprise to also issue money which created more problems. Del Mar says:

“Many kinds of paper were in circulation – government, provincial, and private – besides many counterfeits; and the government was powerless to limit the circulation. The notes therefore continued to depreciate.”
A History of Money in Ancient Countries from the Earliest Times to the Present By Aleander del Mar Page 31

This system sounds like a combination the U.S. monetary policy in the 19th century and FDR after 1933. In 19th century America there were many private banks issuing many different versions of banknotes some securely backed and others fraudulent or counterfeit. Then after 1933 U.S. citizens were forbidden to own gold and use it as money but the dollar was supposedly backed by gold.

By 1351 a monetary crises was exacerbated and reform was attempted, again with no positive results. The Yuan Dynasty fell and was replaced by emperor Hongwu the first of the Ming Dynasty.

Even though paper money had major problems from the beginning Hongwu decided to use it again, but this time with a communist style very authoritarian approach controlling all aspects of life. They prohibited the citizens from using gold and silver as money and in 1374 AD created a fiat currency, this time backed by nothing but the authority of the emperor. Even though the money was not backed they tried to create the illusion of it being backed by assigning the notes, called “Da Ming baochao,” a value equal to one ounce of silver or a quarter ounce of gold. The people didn’t buy this and seemed to think the emperor was pulling a fast one on them.

It helps to put yourself in the situation of a peasant in those days who was used to seeing silver as money or the value behind money. Then the government takes away this money and gives him a piece of paper and says, “Here. This piece of paper is like one ounce of silver which you can no longer have.” One can see here why the common people in that age didn’t have faith in this from the beginning.

Within nine years the depreciation was astounding. Within 25 years it had become virtually worthless but circulated until about 1450 AD. The people, and then the government, switched over to bartering with silver and commodities which became their main form of money for some time.

It is interesting to break down this turbulent economic period of 450 years. During this time, except for a couple decades, the kingdom used paper money backed by gold and silver or the coins themselves. There were only a couple short decades where 100% fiat money dominated, yet this whole paper money period is pointed out as an example by many as a time where fiat money ran amuck.

Using this same logic one could say these times illustrated gold and silver backed paper money and coins themselves are not workable since they dominated most of the tempestuous period.

Reasonable investigators will acknowledge that both conclusions fall short of the true picture, which is this. The Chinese made a great discovery in using paper money. They tried to implement it in turbulent uncertain times and they had no instruction book to follow. They experimented, and, as with all innovations, a lot of mistakes were made.

The fact that there were problems did not mean paper money was useless. We know it is not for without it civilization as we know it would not exist. They had problems with gold and silver coined money also, but these have been useful for thousands of years. Even so, for two short periods of time they had problems with 100% fiat money. Again this is far from enough evidence to condemn this type of money.

Outside of using some bad judgment the problems they had stemmed from a shortage of precious metals for coins. The creation of paper money, fractional banking and fiat money were all moves designed to improve the money supply. In the process they created too much money on one hand, and, after failure, they wound up with metallic shortages again on the other.

This problem has plagued all civilizations since money first appeared in history and is with us today. Lack of enough sound money still creates havoc and no solution seems to be in sight.

To understand why fiat money didn’t work in China it is helpful to realize there are two ways it can be created.

The first is through debasement of currency. In this situation the people are led to believe their money is either backed by a commodity or has a certain value and then by fiat that value is diminished or removed. When this happens the people feel cheated and are reluctant to accept the money at the decreed value. This was the type of fiat money that appeared in China and it is usually doomed to failure.

The second is fiat money that is not a debasement of current money with promised value, but a new creation using no deception, debasement, or short changing the people. Its introduction should not go against the will of the majority.

This second fiat system can work as long as excessive money is not moved into the economy.

Greece and Rome’s early fiat money operated on this second system and was well accepted because the people did not feel cheated. Next we’ll give a few more examples.

A History of Money in Ancient Countries from the Earliest Times to the Present By Aleander del Mar

The East Asian maritime world 1400-1800: its fabrics of power and dynamics … By Angela Schottenhammer

Imperial China 900-1800, By Frederick W. Mote

The Chinese Monetary System: From Ancient Times to the Early Modern Period By Sarah Gruen 2004

A History of Money by Glyn Davies, 1994

Read This entire series. Here are the links.

Copyright 2011 by J J Dewey

Copyright by J J Dewey

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3 thoughts on “Fiat Money of the Past, Part 2

  1. . Great site here. Many blogs like this cover subjects that can’t be found in magazines and newspapers. I don’t know how we got by 10 years ago with just newspapers and magazines.

  2. JJ Quote for the Day from the Archives

    Lifting Spirits

    On the non physical level one of the greatest causes of depression and apathy is guilt. Guilt is a negative force that focuses Attention on your imperfection and paralyzes your power of decision. It is caused by your allowing your attention to be placed on some outside authority who has taken the place of the God within. If God, or the power of God, is seen as existing in some man or influence from without then this entity has power to control you through guilt and thus control you through fear and depression.

    You take back your power by turning to the Holy Spirit within and letting this be your only final authority. When this happens, the chains that hold you bound come undone and you will enter into the joy of the Lord and in this state depression is impossible.

    Copyright 1999 by J.J. Dewey, All Rights Reserved

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