Voltaire is a known 18th century French philosopher, from a time when France produced some legendary names in arts, literature and philosophy. It is said that Voltaire hypothesised paper currency’s value eventually returning to its intrinsic value, that is, zero. In other words, he saw paper currency as worthless. Many instances after Voltaire’s death seemed to support his point. The collapse in the value of assignats, issued by the French government during the revolution years, was taken by many as validating his point. In modern times, we’ve had Weimar Germany (20th century), Zimbabwe and Venezuela (21st century) where paper money eventually became worthless.
But there is a paradox. Looked in terms of historic evidence, the above stated instances seem to be an exception rather than the norm. This ‘worthless’ piece of paper has been growing steadily in popularity around the globe. In the US, currency (mostly paper-based cash) that is in circulation amounts to $1700 billion, up from $200 billion in 1987. In countries like Pakistan, major part of economic transactions is based in paper-based currency, perpetuating the growth of informal economy. The currency in circulation was Rs2.8 trillion in December 2015. By December 2016, the number had jumped to Rs3.4 trillion. By the end of June 2018, the number had reached Rs4.4 trillion. A large part of this consists of paper currency.
If paper currency ultimately proves to be worthless, then what explains its continually rising demand? There are no easy answers to this paradox. Let me venture forth to offer a few. But first, a short history of paper money for the interested reader. I thought it necessary to narrate it briefly since people seem to take paper currency as a recent (20th century) invention. In fact, some time ago, I witnessed one esteemed gentlemen (regarded highly in Pakistan’s intellectual circles) basing the rise of modern interest based system on advent of paper money in the 20th century. That is nonsense.
Paper money goes back in time more than a thousand years, while practice of charging interest is even older, rising with advent of civilization and sedentary living. Anyway, paper money was invented in China and its use goes back to at least AD 700. Gordon Tullock’s research and other studies determined that between AD 700-800, the promissory notes (receipts) issued by private merchants in various parts of China were accepted as payment. The practice became popular (and profitable) enough to the extent that by AD 1000, there were several private firms across China that printed paper currency for circulation.
Perhaps the earliest known government sanctioned paper currency was the Jiaozi, issued by the Song dynasty. They were first sanctioned for use in the Sichuan province, apparently to relieve the merchants of the burden of carrying heavy metallic currency. Since then, it became a regular feature of Chinese economy of those times. Readers may recall that the presence and use of paper currency was one of things that surprised Marco Polo during his famous trip to China.
Back to our question of why paper currency is in such high demand, as against Voltaire’s prediction. First, in Voltaire’s time, paper money was something new, unlike metallic currency that had earned peoples’ trust over time. So it was natural that people would cast aspersions upon its worth. Moreover, it was decreed by the government. People couldn’t understand how a piece of paper, given colour and design, could be of value in economic transactions.
This aspect brings us to our second important point: government credibility. Governments at that time, mostly governed by kings and princes, were incessantly embroiled in warfare, which induced an increased sense of fear over its longevity and credibility. That is not the case now as nation states seem to survive far longer, thus lessening the fear surrounding their longevity. We also have to keep in mind the important fact that the rule by kings and princes imparted a monopoly rather than a democratically elected parliament where there were chances of equal representation. Put simply, the decreed money carried the backing of a monopoly rather than reflecting representation of a government that itself represented the whole country. As representation became more widespread, so did trust in government and its currency, something akin to the ‘network effect’ that I’ll discuss in the following lines.
Third, at least since the Great Depression (and maybe even before), people have understood that ultimately it is the government that would act as the last resort, not only in ending such bouts of economic hurt, but also taking lead in providing essential services and welfare. The Great Depression of 1930s started with the stock market crash in 1929. Similarly, the Great Recession of 2008 was perpetuated after the fall of Lehman brothers and Bear Stearns, two private firms that dabbled in shady financial products. But it was the collective efforts of governments of that time that put a halt to the destructiveness of those episodes. Thus, the trust in government rather than the private sector for economic emancipation has also risen over time, giving more credence to government decreed products.
Fourth, the ‘network effects’ of fiat currency over time have made it the most readily acceptable form of intermediary (meaning most liquid) in terms of exchange, thus keeping its demand intact. As exchange in an economy grows (growth in GDP and incomes is usually thought of as a good proxy for growth in economic exchange), so does the demand for an intermediary and liquid forms of wealth. Paper currency, at present, is the most liquid form of wealth. As its demand rises, so does its value.
Fifth, paper currency gives a sense of equality since everybody has access to it. Same is not true of alternate currencies like Bitcoins or financial services going electronic because only a small fraction of population understand how to operate it and thus gain access to it. In essence, it is monopolistic, and the society would be back to where it was in Voltaire’s time in the sense of process of printing, operating and disseminating money being a monopolistic undertaking rather than a truly democratic representation. Also notice the important point that paper currency keeps our privacy intact, something not possible with electronic earns of payment (like credit or debit cards). Billions of algorithms unleashed by companies like Google and Amazon would pick up on consumer preferences (as they are doing already), and make life relatively difficult by swamping us with similar offers 24 hours a day.
Last, but not the least, although there have been ‘money mischiefs’ like Weimar Germany, Zimbabwe or Venezuela, these are what economists call ‘outliers’, that they are exceptions rather than the norm. The fact of the matter is that governments and central banks have, overall, done an amiable job in terms of preventing runaway inflation that erodes the value of a currency. Put another way, they have given the confidence to the public that they won’t let the value slip to a point where it’s no longer profitable to hold paper currency.
In conclusion, the above stated were a few quick pointers in terms of why the demand for paper currency has remained intact and why paper currency has maintained its value. This likely to remain true for a considerable time to come.
The writer is an economist.
But there is a paradox. Looked in terms of historic evidence, the above stated instances seem to be an exception rather than the norm. This ‘worthless’ piece of paper has been growing steadily in popularity around the globe. In the US, currency (mostly paper-based cash) that is in circulation amounts to $1700 billion, up from $200 billion in 1987. In countries like Pakistan, major part of economic transactions is based in paper-based currency, perpetuating the growth of informal economy. The currency in circulation was Rs2.8 trillion in December 2015. By December 2016, the number had jumped to Rs3.4 trillion. By the end of June 2018, the number had reached Rs4.4 trillion. A large part of this consists of paper currency.
If paper currency ultimately proves to be worthless, then what explains its continually rising demand? There are no easy answers to this paradox. Let me venture forth to offer a few. But first, a short history of paper money for the interested reader. I thought it necessary to narrate it briefly since people seem to take paper currency as a recent (20th century) invention. In fact, some time ago, I witnessed one esteemed gentlemen (regarded highly in Pakistan’s intellectual circles) basing the rise of modern interest based system on advent of paper money in the 20th century. That is nonsense.
Paper money goes back in time more than a thousand years, while practice of charging interest is even older, rising with advent of civilization and sedentary living. Anyway, paper money was invented in China and its use goes back to at least AD 700. Gordon Tullock’s research and other studies determined that between AD 700-800, the promissory notes (receipts) issued by private merchants in various parts of China were accepted as payment. The practice became popular (and profitable) enough to the extent that by AD 1000, there were several private firms across China that printed paper currency for circulation.
Perhaps the earliest known government sanctioned paper currency was the Jiaozi, issued by the Song dynasty. They were first sanctioned for use in the Sichuan province, apparently to relieve the merchants of the burden of carrying heavy metallic currency. Since then, it became a regular feature of Chinese economy of those times. Readers may recall that the presence and use of paper currency was one of things that surprised Marco Polo during his famous trip to China.
Back to our question of why paper currency is in such high demand, as against Voltaire’s prediction. First, in Voltaire’s time, paper money was something new, unlike metallic currency that had earned peoples’ trust over time. So it was natural that people would cast aspersions upon its worth. Moreover, it was decreed by the government. People couldn’t understand how a piece of paper, given colour and design, could be of value in economic transactions.
This aspect brings us to our second important point: government credibility. Governments at that time, mostly governed by kings and princes, were incessantly embroiled in warfare, which induced an increased sense of fear over its longevity and credibility. That is not the case now as nation states seem to survive far longer, thus lessening the fear surrounding their longevity. We also have to keep in mind the important fact that the rule by kings and princes imparted a monopoly rather than a democratically elected parliament where there were chances of equal representation. Put simply, the decreed money carried the backing of a monopoly rather than reflecting representation of a government that itself represented the whole country. As representation became more widespread, so did trust in government and its currency, something akin to the ‘network effect’ that I’ll discuss in the following lines.
Third, at least since the Great Depression (and maybe even before), people have understood that ultimately it is the government that would act as the last resort, not only in ending such bouts of economic hurt, but also taking lead in providing essential services and welfare. The Great Depression of 1930s started with the stock market crash in 1929. Similarly, the Great Recession of 2008 was perpetuated after the fall of Lehman brothers and Bear Stearns, two private firms that dabbled in shady financial products. But it was the collective efforts of governments of that time that put a halt to the destructiveness of those episodes. Thus, the trust in government rather than the private sector for economic emancipation has also risen over time, giving more credence to government decreed products.
Fourth, the ‘network effects’ of fiat currency over time have made it the most readily acceptable form of intermediary (meaning most liquid) in terms of exchange, thus keeping its demand intact. As exchange in an economy grows (growth in GDP and incomes is usually thought of as a good proxy for growth in economic exchange), so does the demand for an intermediary and liquid forms of wealth. Paper currency, at present, is the most liquid form of wealth. As its demand rises, so does its value.
Fifth, paper currency gives a sense of equality since everybody has access to it. Same is not true of alternate currencies like Bitcoins or financial services going electronic because only a small fraction of population understand how to operate it and thus gain access to it. In essence, it is monopolistic, and the society would be back to where it was in Voltaire’s time in the sense of process of printing, operating and disseminating money being a monopolistic undertaking rather than a truly democratic representation. Also notice the important point that paper currency keeps our privacy intact, something not possible with electronic earns of payment (like credit or debit cards). Billions of algorithms unleashed by companies like Google and Amazon would pick up on consumer preferences (as they are doing already), and make life relatively difficult by swamping us with similar offers 24 hours a day.
Last, but not the least, although there have been ‘money mischiefs’ like Weimar Germany, Zimbabwe or Venezuela, these are what economists call ‘outliers’, that they are exceptions rather than the norm. The fact of the matter is that governments and central banks have, overall, done an amiable job in terms of preventing runaway inflation that erodes the value of a currency. Put another way, they have given the confidence to the public that they won’t let the value slip to a point where it’s no longer profitable to hold paper currency.
In conclusion, the above stated were a few quick pointers in terms of why the demand for paper currency has remained intact and why paper currency has maintained its value. This likely to remain true for a considerable time to come.
The writer is an economist.