Money and the state are like toast and butter, two different realms that always go together. You can’t talk about money without talking about government, and you can’t talk about finance without thinking about where finance sits as far as its role in funding political programs — whether those are war, welfare, or largess. You’re about to embark on a journey through history that looks at the development of money and finance at a high level, and shows how politics and banking almost always go together. By the end of it, you should be able to better flesh out aspects of your world’s (or worlds’) financial systems. This guide serves for modern, post-modern, and past tech worlds.
To conserve length, this guide is divided into two parts: pre-modern money and modern banking. This first part starts with the Bronze Age and takes you through the Roman Empire and, more so, Medieval Europe. We also touch on money in China, the first society to introduce paper money.
I don’t intend this guide to explain how your monetary and banking system should work. Rather, the intention is to help with the details of your worldbuilding, so that you can build scenarios around economic tensions. For example, perhaps you want to roleplay an ancient government mired with inflation. This guide can help you with the details of that inflation and how it comes about. Or, perhaps in your roleplay you are a city under siege. This guide can help you determine how your city pays its soldiers if it can’t import the silver or gold to mint coins. Beyond big questions, this guide can also help you understand some of the motivations and problems that people dealt with as it concerned business, finance, and taxes.
The subject matter is complex, disputed, and oftentimes difficult to follow, so by all means you are welcome to ask me any questions or for clarification.
Coinage And Public Finance Before Modern Banking
Financial Debt Instruments Before Money
The theory goes that, at first, societies relied on barter. However, as societies became more complex, barter became a limiting factor because of the double coincidence of wants. Suppose you produce wheat and you want shoes, your neighbor produces shoes but wants wood — you can’t get shoes because you don’t have what your neighbor wants. As a result, society invented money, which is typically defined as a general medium of exchange. Meaning, money is a good or a set of goods that has value specifically because of its role as a token that can be accepted on the knowledge that it can be traded for whatever you need.
We tend to think of money as a coin or a piece of paper, but most monies have never been physical. Before money in the way we know of it came about, there was credit. In ancient Mesopotamia, according to anthropologist David Graeber’s research, workers on large public works projects like temples and canals were allowed to purchase goods for their day-to-day needs, like beer and food, on a tab. These tabs would be reconciled at the end of the period by the temple or government institution. Thus, large divisions of labor could be organized and paid for through a simple credit system like this one.
Ancient debt instruments could be more sophisticated. We have evidence — see especially Mogens Larsen’s Ancient Kanesh— from early Bronze Age Anatolia of joint-stock organizations, which issued each stockholder with a tablet that explicitly defined the value of that stock. That tablet could subsequently be traded for gold, silver, and/or other goods. That tablet represents a liability to the organization, and the act of trading it is very similar indeed to trading the liability of a bank — these tradeable bank liabilities are often known as banknotes (like dollar bills)! These joint-stock companies allowed investment into large trade caravans that would export goods like tin and textiles to northern Syria and Anatolia, and import gold and silver. Oftentimes, these caravans were sold wholesale to merchants who would then distribute the wares eastward, meaning they required credit for large upfront costs.
4,000–5,000 years ago, private actors and governments alike developed credit systems to facilitate exchange and foster new markets. Coins were a small slice of the overall picture, compared to credit, and we’ll see how they came into being next.
The Advent Of Coins
The first coins most people can think of are the stamped kind, with a king’s or important person’s face on them. These were introduced around the 6th century B.C., if we are to believe Herodotus, and were the product of governments. There is evidence, see for example Graeber (2011), that money-like tokens had been circulating as a result of private-sector production for some time before the first stamped coins. Regardless, stamped coins represent the earliest physical money in widespread circulation used for commercial exchange.
Graeber (2011) has an interesting theory as to why Iron Age states began to mint coins. Armies, especially armies that are expected to equip themselves to one degree or another — the case for most Iron Age armies — need to be supplied and equipped, and it’s much easier to allow markets to coordinate this by giving soldiers the means to participate in markets. With physical money, soldiers could buy what they needed from merchants operating with the camp. Of course, creating supply markets for soldiers doesn’t require stamping a king’s face on a piece of electrum, and so these coins also primarily served as propaganda tools (or branding, if you prefer that term).
What about paper money? Is all early physical money metallic? Chinese governments have issued paper money since at least the 11th century, under the Song dynasty, and 400 years before then promissory notes which were claims on goods circulated as paper money in much the same way that the Old Assyrian tablets introduced above did. In fact, given that credit came before coins, promissory notes are likely to circulate before coins. In that sense, Old Assyrian clay tablets were essentially a form of paper money — let’s call it: token money.
The Economics Of Pre-modern Coinage
Government Coinage And Fleeting Markets
The introduction of government-stamped coins helped to foster markets, typically around armies and bureaucratic centers. The experience of the Roman Empire gives us an extreme case of this fact. It’s well-known that Western Mediterranean trade, which for centuries had been growing, experienced a significant reduction in volume after the late 2nd century A.D. As Goldworthy (2009) writes, “Maritime archeologists have discovered far more Roman shipwrecks dating from the first century BC through to the second century AD than for any subsequent period…[I]t is clear that trade in this area peaked during the early Principate…[E]xcavations on land also suggest that from the third century onwards there was a substantial decrease in the number of objects circulating that had been manufactured outside the province.” This decline in Roman trade was not universal, however. Rather, it followed the money.
Mediterranean trade began to narrow on the imperially subsidized grain trade between North Africa and Rome, and thus while we see archeological evidence for a reduction in trade and income to certain parts of Western Europe, we see a burgeoning North African Roman society. There is also evidence of economic prosperity in the east. Likewise, and possibly more interesting, is the growth of trade networks in central and northern Europe concerning the Roman Empire. Burns (2003), in an archeological and literary survey, gives a pretty convincing explanation as to why. As Roman governance around the Mediterranean stabilized and consolidated, the Roman Army in Europe began to concentrate along the Rhine and Danube frontiers. Partly, we see the implication through the rise of emperors stationed in Pannonia. We also see growth in villas around, for example, Trier, which was used as a capital of the Western Roman Empire in the 4th century A.D. We also see the results in the growth of trade networks across the Danubian frontier, and also the collapse of these networks — and resulting political instability in central Europe — when the Danubian frontier was denuded of troops during civil wars or transfers of soldiers to the east.
A similar story is told by the archeological evidence of the growth and decline of cities in Roman Spain. In a survey of the archeology and literature, Kulikowski (2004) shows that the general narrative of a decline in the size and prosperity of cities in the 3rd century A.D. and after is not universally true. Most cities did decline, but cities used for imperial administration grew. As said earlier, trade follows money, and when states control the money they control the trade.
Thus, coinage helped to foster markets, but it also helped governments to capture these markets around their own logistical needs. This “distortion” of trade could cause the rise and fall of different political players and states who benefited, or lost, from it.
State Money And Shortages
In markets dominated by physical money, a decline in the supply of coins can cause significant upheavals. Again, the Roman Empire offers us an extreme example (Morris, 2021). In the first decade of the 5th century, Roman Italy suffers an invasion by Alaric the Goth. Coinciding with this invasion is the sudden drying up of discovered Roman coins in Britannia (Roman Britain). Roman London was once itself a mint, but this ended in 388 when the Britannia-based usurper Magnus Maxentius was executed by Theodosius I. From that point onward, all newly minted coins came from the continent. This supply ended as Rome had bigger problems and we find the beginning of large-scale clipping, which consists of removing metallic content from the coins to make more of them. In a coin-dominated market, without sufficient coins, you can’t pay soldiers. If you can’t pay soldiers, you can’t defend yourself without recourse to a third party. For Britain, that third party was the Saxons, who originally came as mercenaries in exchange, probably, for land grants. Within 100 years, the legacy of Roman Britain had all but disappeared and the Saxons were in political control over most of southern, eastern, and northern Britannia.
Even when the institution of coinage was alive and well, shortages of coins are quite common in pre-modern societies. Before we dive into money shortages in pre-modern societies, let’s talk through some monetary economics. The next section is based on the research of Sargent and Velde (2002).
The Big Problem Of Small Change: Some Monetary Economics
Empirically (historically), we observe that in pre-modern societies periods of shortages of coins coincided with periods of monetary depreciation. How can something in short supply lose value?
First, the value of money is not the value of the content it’s made up of. This is obvious in today’s world, where the value of the paper of a $1 and $100 bill is the same, but the two bills are not worth the same. The value of the paper isn’t even $1. The value of money is determined by its function as a medium of exchange, i.e. its liquidity — and, as a result, the supply and demand of money as money.
Second, consider that not all coins are made the same. There are “large-denomination” and “small-denomination” coins.
Large-denomination coins are typically made of silver or gold and are useful for large, wholesale transactions. They are not useful for everyday purchases because it’s akin to trying to break a $1,000 bill at the Walmart cash register.
Rather, small-denomination coins are typically made of bronze, copper, et cetera. Only small-denomination coins can be used for small purchases.
Third, minting coins costs money and, if you imagine it as a flat percentage fee, the relative costs of minting are higher for small-denomination than large-denomination coins. This is because in nominal terms that percentage fee will remove a large amount of value from the small-denomination coin than it will from the large-denomination coin. Long story short, the actual content of small-denomination coins tends to be valued at much less than what it’s trading at.
Fourth, there’s economics to the incentive to mint and melt both large-denomination and small-denomination coins. Those incentives are a function of the price level, which is determined in a sense by whichever coin is the unit of account (typically, the large-denomination coin, whether silver or gold or something else). I will spare you a detailed explanation of the supply-side economics of minting and the two intervals within which coins are minted. The core idea is that it only makes sense to mint any given coin if the value of the coin is higher than the value of the metallic content. And, if the value of the metallic content rises above the value of the coin, there is an incentive to melt it.
The Big Problem Of Small Change: Shortages Of Small Denomination Coins And Loss Of Trust
It was relatively easy to counterfeit coins. The incentive to counterfeit coins is:
You don’t have to pay the minting charge.
You don’t have to necessarily use the full amount of metal a mint would require.
The second incentive is a function of the fact that coins circulate by tale rather than weight, which means that the coin trades at the value stipulated by decree rather than the metal content. Although not discussed by Sargent and Velde (2011), part of the reason this is so is because coins circulate by tale because that’s how they’re accepted when taxes, including — especially in pre-modern days — tariff fees, are paid.
Anyway, the price level is a function of the total amount of all coins. When counterfeiters increase the amount of small-denomination coins in circulation the price level increases, i.e. there’s inflation. As a result, you need more coins to buy the same amount of goods or state another way the value of each coin falls. When the value of the coin falls below the value of its metallic content, there’s an incentive to melt them. Even when coins are in demand, people need coins to trade, but because it’s not profitable to mint them there will be a shortage of coins.
When coins circulate by tale and there are a significant number of counterfeit or underweight coins, there’s an incentive to circulate the “bad money” and hoard “good money.” The logic is straightforward: if you have a close to full-weight silver coin and a similar-looking coin that’s at half-weight will circulate at the same value, you’re going to save the one with the most silver because of the opportunity cost of spending it is higher. Thus, it’s more difficult to get your hands on “good money” by exchanging goods for it, and trust in money falls.
Governments came up with interesting solutions when minting coins was not immediately possible, but plausible over the long run. Concretely, imagine that your city-state is under siege and you can’t mint new coins because the supply of metal is temporarily disrupted. Alternatively, imagine you’re a military commander in a fort that is under siege and you cannot immediately get your hands on coins to pay soldiers. In these cases, leaders could issue “siege money.”
“Siege money” is an IOU that leadership issues to soldiers, and contractors, that promise a future sum of money in terms of purchasing power. It’s interesting in that, at least exclusively to Western Europe, it was an early form of token, or fiat, money. Of course, fiat money was invented much earlier in China, as we will see below. In any case, if your history is closer to Western Europe, siege money is an interesting detail you can introduce into your roleplaying and worldbuilding to give your stories a little bit of additional depth.
What about the runaway minting of coins by governments? We talked about how counterfeiting can cause a shortage of coins, while still making everything expensive in terms of the number of goods you can buy with a given amount of coins. That being said, nowadays we tend to think of inflation as a result of central banks “printing” more money; i.e. inflation tends to be government-induced. Was that the case before the advent of modern central banking?
Certainly, there are a lot of historical examples of government-induced inflation in pre-modern times. The ones we have the most evidence on don’t tend to be the product of rampant money-minting, however. Printing bills or adding credit into an economy comes at a marginal cost of near-zero, making it easier for governments to grow the money supply through central management. Minting coins, however, has a higher marginal cost, which is the value of the metal in the coin. This puts a limit on government-induced inflation through money minting. Furthermore, in Medieval times mints usually operated through a pseudo-market mechanism in the sense that private actors brought their own metal for minting, paying governments a tax (seigniorage). Finally, the idea of rampant money-minting doesn’t fit the facts that in documented Medieval history the bigger problem with metallic coins was a shortage, not surplus.
That doesn’t mean that rampant money-minting didn’t happen. The problem is that it’s relatively poorly documented and, therefore, is disputable according to economic theory. For instance, there is a general belief that government-induced monetary inflation was a big problem during the Late Roman Empire. Certainly, we have records of a rising price level and attempts to curb inflation through price controls before and after Diocletian’s reign. We also have archeological evidence of debased coinage, meaning — for example — silver coins made of smaller amounts of silver, with the rest minted from cheaper metals like tin and copper. All the same, this isn’t the only evidence we have and all of it needs to be considered before we can come to a conclusion.
The Romans also suffered from depopulation as a result of recurrent empire-wide plagues. Plagues would kill millions of people. Economic output, or the number of goods available for purchase, is a function of the total amount of labor and capital available to an economy. When there is a significant reduction in the amount of labor, the number of goods available for purchase declines and, because they are scarcer, their price will rise. Unsurprisingly, documented inflation began after the reign of Marcus Aurelius, during whose reign the empire suffered from the devastating Antonine Plague. Thus, you can’t pin inflation during the Roman Empire solely on debasement.
As you’re building your pre-modern world, rampant money-minting is unlikely to be a cause of inflation. Pre-modern government-induced inflation typically resulted more so from experiments in non-metallic money, also known as token money. For example, China is well-known to be the first known country to introduce paper money. They are also known for having recurrent monetary crises caused by the over-issue of paper money by governments, making their paper money worthless. Similarly, in Castille — an example we will explore further in the next section —, when the government replaced small coins with token money, there was an over-issue of token money, very heavy inflation (known as the “European price revolution”), and a financial crisis in Sevilla.
Political Incentives For Token Money: A One Time Profit
Pre-modern governments had an incentive for introducing token money in the form of a one-time transfer of wealth from the private to the public sector. This case is best illustrated by a monetary experiment with token money initiated by the Kingdom of Castille in the late 16th century, during the reign of Phillip II. Specifically, in 1596 Phillip II issued a decree replacing silver billon coins with copper coins circulating at the same value by tale — that is, the copper coins would be worth the same in trade as the old silver billon coins they replaced. Initially, the policy did not cause inflation. There was a more-or-less one-for-one replacement of silver coins with new copper coins. The amount of money in circulation remained the same, and the government earned a nice bonus by taxing the silver brought in for melting. That silver, like most of the silver and gold that flowed through Spain from the New World, could be sold.
Phillip II died in 1598, succeeded by Phillip III. Phillip III had no compunctions about increasing the number of token copper coins by more than the one-to-one ratio that resulted in a clean swap. Rather, he began minting copper coins in large amounts, as minting these coins was very cheap, and the result was a period of runaway inflation and financial crises.
The case of Castille and the Price Revolution also serves as a good example of why the runaway minting of metallic coins was not typically a problem in pre-modern society. There is a widespread belief that the import of silver and gold from the New World was the cause of inflation in Europe. This belief cannot stand up to the empirical evidence:
- At least a third (and most likely much more) of this silver and gold did not circulate in Europe, rather it flowed to East Asia. Indeed, New World silver and gold did not go into new coinage; it was used to purchase goods, such as silk, from the Far East — in fact, a significant amount did not go to Europe at all, rather it traveled to the Spanish colony of the Philippines and, from there, into China.
- Furthermore, if there is a large inflow of silver and gold, the value of the metallic content will decrease and there is an incentive to mint coins of that metal. That is not what happened; rather, coins were debased. More accurately, copper coins were deliberately introduced to replace silver coins. You don’t need to debase coins if silver and gold are cheap.
- Likewise, and finally, if it was New World gold and silver on which Spain relied to pay for its expenses, it would not have had to incur colossal debts with Italian and Spanish banks.
Unsurprisingly, the end of the Price Revolution in Europe coincides with the end of Spain’s experiment with copper coinage in the middle of the 17th century.
Coin Shortages, Credit, And Trade
When monetary orders broke down as a result of coin shortages, before the advent of token money and modern banking, economic hardship followed. This doesn’t mean that all trade stopped or that people didn’t innovate to find solutions. If you recall from earlier, when newly minted Roman coins stopped being exported to Britannia, the locals responded by clipping their existing coins to make more of them.
Unsurprisingly, the development of advanced credit instruments and, ultimately, paper money in Western Europe began during a time of recurring metallic money shortages. The growth of intercontinental trade in large volumes also played a significant — probably more significant — role, because metal is heavy and impractical to transport around. As we’ve seen in the evidence from ancient Kanesh, it has always made much more sense to trade-in credit and only clear debts with metal only at the highest level if actually at all.
Paper money, as mentioned earlier, was invented much earlier in China. Jin Xi makes the very interesting observation that the primacy of silver coinage did not signal periods of economic strength in China, but rather periods of economic recession and weakness. The reason was that during periods of flourishing trade and advanced credit instruments, governments leveraged these technologies to pay for their expenses by over-issuing money that essentially was costless to produce. When monetary systems composed of token money collapsed as a result of government over-issue, much like what occurred in Spain during the 16th and 17th centuries, there was a reversion to metallic coinage because paper money could no longer be trusted. Nevertheless, there has always been a strong trend toward the use of debt instruments rather than metal for trade.
I end Part I of the guide here, for the history of paper money in Western Europe will take us into the world of modern banking.
- Burns, Thomas S., Rome and the Barbarians (2003, The Johns Hopkins University Press)
- Graeber, David, Debt: The First 5,000 Years (2011, Melville House)
- Goldsworthy, Adrian, How Rome Fell (2009, Yale University Press)
- Heather, Peter, The Fall of the Roman Empire (2006, Oxford University Press)
- Kulikowski, Michael, Late Roman Spain and Its Cities (2004, The Johns Hopkins University Press)
- Larsen, Mogens Trolle, Ancient Kanesh: A Merchant Colony in Bronze Age Anatolia (2015, Cambridge University Press)
- Morris, Marc, The Anglo-Saxons (2021, Pegasus Books)
- Sargent, Thomas J., and Velde, François R., The Big Problem of Small Change (2002, Princeton University Press)
- Selgin, George, Good Money (2008, The Independent Institute)
- Xi, Jin, Empire of Silver: A New Monetary History of China (2021, Yale University Press)