A Brief History Of Money — A Guide For Beginners

Why do we use paper currencies? Who is responsible for the invention of government bonds? And the story of the first modern insurance fund.

Chapter 1: Paper Currency — Say Goodbye to Coins

With the head of Athena on one side, and the owl of Athena on the other, the Athenian tetradrachm (circulated from 510BC to 38BC) was one of the most widely used coins in all of Antiquity. However, the usage of precious coins was not limited to the Greeks. Across the globe, these coins were the de-facto form of transaction in many ancient civilisations, monopolised by powerful individuals who minted them for revenue.

Image of an Athenian tetradrachm, credit of alphapolitismos.gr

But why? These coins were heavy and the raw materials used to produce them were difficult to extract. Not to mention early iterations were vulnerable to clipping, which resulted in massive devaluation and inflation.

The breakthrough came when money makers realised that precious metal — or any other form of currency for that mattered — had no absolute value. What made precious metal valuable was the common knowledge between buyers and sellers that precious metal was indeed valuable. Our financial system, in other words, was a fiduciary one. Bills (paper currencies) slowly replaced traditional coins all over the world, and took off in the second half of the first millennium. Our fiduciary financial system also laid the groundwork for increasingly abstract forms of financial instruments such as bonds, stocks, options, futures, and cryptocurrencies.

In the words of Kublai Khan, “What matters about money is not what it looks like, or even what it’s backed by, but whether people believe in it enough to use it”

Image of Kublai Khan, credit of www.history.com

Chapter 2: Bonds, Bonds, Bonds

Paper currencies and their superior physical properties made transactions with large sums of money significantly easier. But what does a nation do if it doesn’t have enough money to begin with?

Let’s visualise a scenario: you are a part of the Venetian government in the 12th century. You are tasked to fend off merciless Byzantine forces while conducting military campaigns in the Eastern Mediterranean. Your men are weak, and deprived of food and equipment. You need money, but there was none, not nearly enough at least, what do you do? What did the Venetian government do?

They essentially forced wealthy citizens to give the Venetian government money in exchange for a note that entitled citizens to get back their principal sum with interest at a later date — they had ‘issued’ the first-ever government bonds.

Though they were the first, they were certainly not the last. Over time, many new forms of bonds have been created, though the principle behind them stayed the same. Though I would love to delve into their individual histories, I might never publish this article if I attempt to do so. But one bond in particular stands out, and I believe it deserves a little extra attention from us — mortgage bonds.

Unlike the other bonds, mortgage bonds are different because the mortgage loans that make up the bonds have no fixed maturity date. A homeowner could — when interest rates fall — pay back the loan and refinance it at a lower interest rate. But this would leave the bond owner sitting on a pile of cash, making the bond a terrible investment.

It was Lewis Ranieri (head of the mortgage department at Salomon Brothers) who played a huge role in pioneering the market for mortgage-backed security through creating a system of tranches. Millions of dollars of mortgage loans would be piled together, sold to a trust, and split into tranches. Owners of the first tranche would receive their money before the owners of the second, the second would receive theirs before the third, and so on. Doing so would allow owners of the third tranche to be well protected should homeowners pay down their loans or refinance them before maturity. This made MBS a lot more attractive to investors and thus, modern mortgage bonds were born.

Chapter 3: Insurance — Risk is Back!

The earliest forms of insurance dealt mostly with the sea. Maritime insurance was a common practice in ancient Babylon (1750 BC). Under ‘the code of Hammurabi’, traders could pay a premium on their loan to guarantee that should the shipment be lost, the loan would be forfeited and traders spared.

The Code of Hammurabi includes many harsh punishments, sometimes demanding the removal of the guilty party’s tongue, hands, breasts, eye or ear. But the code is also one of the earliest examples of an accused person being considered innocent until proven guilty. — History.com

Image of ‘Code of Hammurabi’, credit of Upworthy

Up till the 18th century, insurance remained in its primitive and unsophisticated form. The system was as such:

The insured pays a premium to the insurance who uses the principle and the premium to pay down whatever mishaps occur and profits the remaining.

It was only in 1748, with the establishment of the Scottish Ministers ‘Widows’ Fund, that true modern insurance was born. The company takes a premium every year — they would invest this premium — and if a Scottish minister died, the widowed wife would receive an annuity each year paid out through the profits of the invested funds.

Under the law of Ann (1672), the widow and children of the deceased Scottish minister only received half a year’s stipend on the year that the minister died — a sum that was clearly inadequate.

The founders — Alexander Webster and Robert Wallace — used data to calculate the probability of deaths and find an appropriate premium. If their calculations were accurate, they could use the premiums to invest in profitable funds and the profits gained from those investments would suffice to pay down the cost of insurance. Today this fund is known as Scottish Widows, with almost $300 billion asset under management.