Two gentlemen who should have found a mention in the museum’s exhibits are Isaac Newton and Thomas Gresham, both intricately linked to how money has evolved over the years. Newton, other than playing a key role in the scientific revolution, was also the Master of the Royal Mint from 1699 until his death in 1727.
In 1717, as Master of the Mint, Newton made a decision which ensured that gold became England’s money, with the country gradually moving towards the gold standard, under which paper money was backed up by gold stored in vaults.
Interestingly, as the British Empire expanded, other countries thought the gold standard was one of the reasons behind that success and gradually started moving towards it.
Thomas Gresham was a financial advisor to Queen Elizabeth I, who ruled from 1558 to 1603. When she became the queen, rulers over the centuries had been debasing money by issuing coins whose face value was more than the amount of precious metal in them.
Further, these rulers insisted that a debased coin with lower metal content was worth the same as a whole one with full metal content. This meant that citizens were expected to ignore the precious metal content of a coin and just look at its face value.
This led to a peculiar situation where the good coins—whose metal content was equal to their face value—were hoarded, resulting in their vanishing from circulation. The bad coins, which had less metal content, were used for transactions within the country.
Elizabeth I wanted to correct this anomaly and issue new silver coins whose face value would be equal to the amount of metal in them. Gresham warned her that bad money would drive out good money, meaning that people would stash away the newer coins for their metal content and continue transacting in old coins. This came to be referred to as Gresham’s Law.
So, how is this bit of history relevant to the world that we live in? Through the 20th century, as democracy became the norm globally, the link between paper money and gold broke down. Now we have fiat money, where money isn’t really backed by anything except a fiat which says that money is worth what the government says it is.
Fiat money also lets central banks create more money out of thin air by simply printing it or creating it digitally. In the past, when gold backed money, it wasn’t very easy for central banks to create money out of thin air because there was always the danger of people wanting their paper money converted into gold. And central banks did not have unlimited access to the yellow metal, which was and remains scarce.
Indeed, central banks now are not held back by this dynamic and can create any amount of money they want to. It’s only the fear of high inflation that holds them back.
The central banks of the Western world and Japan printed a lot of money in the aftermath of the financial crisis of 2008, first to rescue financial institutions and then to drive down interest rates in order to encourage individuals and firms to borrow and spend more. Something similar happened on a bigger scale after the covid pandemic broke out in 2020.
This is where the current day version of Gresham’s Law comes into play. As too much of ‘bad’ fiat money was created, individuals exchanged it for what they thought is ‘good’ money: stocks, real estate, artworks, gold, jewellery, high-end cars, fancy watches, etc. Younger investors even looked at crypto tokens as a form of good money.
From March 2022, the US Federal Reserve has been gradually sucking out the money it had printed and pumped. Up until early August, it had managed to suck out close to $1.8 trillion.
So, now all eyes are on the other big central bank, the Bank of Japan, which recently raised interest rates. But the question is when will it start sucking out all the money it created out of thin air?
Now, that remains a big worry for the global investor ecosystem, given that low interest rates in Japan have encouraged big financial investors to borrow in yen and invest in other parts of the world in search of higher returns.
If interest rates in Japan start going up, this carry trade will have to unwind, sending global financial markets, everything from stocks to cryptos, into a tailspin.
The US Fed has already been withdrawing printed money and is likely to continue doing so. And that, in turn, can create a slowdown or a recessionary environment, which central banks will have to deal with all over again.
To conclude, this is not a call for the world to go back to the gold standard or any other similar system. Nonetheless, central banks do need to go easy on the idea of creating money out of thin air, and not go berserk as they seem to have in recent years, because that has consequences which they are not in a position to control. Oh, and the Bank of England Museum needs to have Isaac Newton’s role among its exhibits.
