Grasping World History Through the Lens of Currency [Part 2] - The Rise and Fall of Nations and Money -

We unravel historical episodes where currency influenced the fate of nations. From the decline of the Roman Empire to modern monetary systems, let's enjoy learning world history from the perspective of currency.

Hello everyone!

In the previous [Part 1], we looked at how currency was born and how it transformed society and the economy. This time, as a continuation, let's explore together how currency has impacted the rise and fall of nations.

Currency and Nations

The management of currency and financial policies are directly linked to the economic stability and development of a nation. If the credibility of the currency is lost or excessive inflation occurs, it can lead to economic turmoil and sometimes even the collapse of a nation.

The Supply Constraint of Metallic Currency

Metallic currency is made from precious metals, so its supply is limited. So, what happens when a nation needs a large amount of funds for things like war, large-scale public works, or disaster recovery, and there's a shortage of metal to make currency?

The Debasement of Roman Currency and Decline

In the later period of the Roman Empire (1st century BC–5th century AD), facing financial difficulties, the government repeatedly carried out "currency debasement," which lowered the quality of the currency. Specifically, they reduced the gold and silver content in coins, diluting them with other metals.

However, this led to a decrease in the value of the currency and caused inflation. People began to prefer holding the earlier "good money" or goods themselves over the devalued "bad money." Rapid inflation disrupted the economy and impoverished citizens. This economic instability led to political and social turmoil in the Roman Empire, ultimately contributing to its decline.

The Oversupply of Metallic Currency

Precious metals like gold and silver are scarce and usually always in short supply. However, there are cases where turmoil occurred because metallic currency became too abundant. What would happen if gold and silver coins, which are supposed to be valuable, suddenly flooded the market, and everyone came to possess large amounts of them?

Spain's Silver Influx and Inflation in the 16th Century

During the Age of Exploration in the 16th century, Spain conquered Central and South America, destroying the Aztec and Inca Empires. From the massive silver mines discovered there, especially the Potosí silver mine, Spain acquired an unprecedented amount of silver.

This strengthened their military power, built a powerful navy called the "Invincible Armada," and quickly became the world's hegemonic nation. However, the massive influx of silver coins into Spain and Europe led to inflation known as the "Price Revolution."

In Spain, prices soared, production activities stagnated, economic competitiveness was lost, and national finances deteriorated. As a result, Spain's national power gradually declined.

The Netherlands Winning with Financial Systems

In the 16th century, Spain weakened due to economic turmoil from the Price Revolution, religious conflicts, and defeat by England in the "Battle of the Armada."

Meanwhile, the Netherlands, then under Spanish rule, rapidly developed as Europe's central market. They fought the Eighty Years' War from 1568 to 1648 to gain independence from Spain and ultimately achieved it through the Treaty of Westphalia.

The Netherlands defeated Spain and became a hegemonic nation due to the following advantages:

  • Economic Prosperity
    • Developed commercial capitalism and accumulated wealth through trade.
    • Expanded trade with Asia and America via the Dutch East India Company (VOC) and the Dutch West India Company (WIC).
  • Innovation in Financial Systems
    • Amsterdam established the world's first stock exchange, becoming a financial center.
    • Advanced credit and insurance systems supported commercial activities.
  • Advancements in Maritime and Shipbuilding Technology
    • Possessed superior ship design and shipbuilding technology, enabling the construction of numerous merchant ships.
    • Controlled global trade routes.
  • Religious Tolerance
    • Advocated religious tolerance, accepting people of diverse religions and thoughts.
    • Attracted talented individuals and capital from across Europe.
  • Political Stability
    • Functioned under a federal system with autonomous governance, where merchants significantly influenced politics.
    • Promoted policies prioritizing commercial activities.

From the currency perspective, while Spain suffered from inflation due to failed financial policies, the Netherlands introduced the world's first joint-stock companies, stock exchanges, credit systems, and insurance systems. They essentially won through innovative systems.

Currency and Credit

In China around the 10th century, during the Northern Song dynasty, the world's first paper money called Jiaozi was born. Creating paper money requires advanced papermaking and printing technologies, but even more essential is a credit system that gives value to the paper money.

Unlike metallic currency, paper money has no supply constraints. If a nation is compelled to issue large amounts of paper money due to war expenses, how would the citizens feel about using it?

Hyperinflation in Germany (Weimar Republic)

After World War I, Germany was burdened with enormous reparations imposed by the Treaty of Versailles . This placed a severe strain on the German economy.

The government had no choice but to issue large amounts of paper money to cover reparations and post-war reconstruction costs. However, issuing currency disproportionate to the economic scale rapidly decreased its value.

As a result, trust in the German Mark both domestically and internationally was lost, and its credibility as currency significantly declined. This meant the currency no longer functioned as a medium of exchange or a store of value. Citizens' savings became almost worthless, and economic activities were paralyzed.

This turmoil led to social unrest and became a factor that allowed extreme political forces (the Nazi Party) to rise.

The Gold Standard

The Gold Standard is a monetary system that directly links the value of currency to a fixed amount of gold. Under this system, each country's currency is exchangeable for a specific amount of gold, and currency issuance is constrained by gold reserves.

Expected effects include:

  • Stability of Exchange Rates
    • Fixed currencies to gold result in stable exchange rates.
  • Suppression of Inflation
    • Limited gold supply restricts unlimited currency issuance, leading to price stability.
  • Promotion of International Trade
    • Stable exchange rates and reliable currency facilitate smooth international transactions.

Britain's Central Bank Establishment and Economic Development

In the 19th century, post-Industrial Revolution Britain became the world's largest economic power and established itself as the center of international trade and finance. Adopting the gold standard was a strategy to enhance the pound sterling's credibility and lead in international transactions.

Gold-backed currency has high credibility and advantages in domestic and international transactions. Britain had acquired large amounts of gold through colonial rule and trade, providing sufficient reserves to maintain the gold standard. With advanced banking systems and financial markets, Britain had the infrastructure to support a global gold standard.

Under the gold standard, currency issuance is limited by gold reserves, helping countries maintain fiscal discipline and achieve long-term price stability. However, it constrained monetary policy, making it difficult to implement economic stimulus during recessions, with limitations becoming apparent during World War I and the Great Depression.

The Managed Currency System

The managed currency system allows governments and central banks to directly manage and adjust currency issuance and interest rates. Here, currency value is not backed by precious metals but is based on government credit.

Main features:

  • Flexibility in Currency Issuance
    • Adjusts money supply according to economic conditions.
  • Implementation of Monetary Policy
    • Central banks can respond to inflation and economic fluctuations through interest rate policies and open market operations.
  • Adjustment of Exchange Rates
    • Exchange rates can be adjusted to correct international balance of payments imbalances.

Collapse of Britain's Pound Sterling Hegemony

During World War I, to finance war expenses, Britain and many other countries suspended the gold standard. To prevent gold outflow when procuring weapons from the U.S., they halted the gold standard.

Post-war, Britain returned to the gold standard in 1925. However, exchanging gold at pre-war rates disadvantaged the war-weakened British economy and uncompetitive industries. Exports decreased, and gold flowed out to the U.S. again.

Meanwhile, global capital concentrated in the U.S., leading to an overheated stock market and the 1929 Great Depression.

U.S. Monetary Policy and the Great Depression

In the 1920s, the U.S. economy boomed due to strong domestic demand for housing and consumer goods. However, as Europe's economy recovered, exports decreased, leading to overproduction.

Despite this, gold inflows post-World War I overheated investments and skyrocketed stock prices. On October 24, 1929, the stock market crashed, plunging the economy into recession.

Banks and factories collapsed, unemployment soared, and the impact spread worldwide. This Great Depression led countries to abandon the gold standard and form economic blocs with colonies to stabilize economies.

Germany and Italy, lacking significant colonies, saw social unrest from the depression lead to dictators' rise. Japan, without stable resources, advanced into Manchuria for economic stability.

Thus, countries' departure from the gold standard ushered in the managed currency system era adopted today. Economist John Maynard Keynes advocated for this system, prioritizing domestic economic objectives over exchange rate stability.

The Bretton Woods System and the Nixon Shock

Post-World War II, the Allies adopted the gold-dollar standard to avoid high tariffs and currency devaluation races. Only the U.S. dollar was exchangeable for gold at a fixed rate, with other currencies pegged to the dollar—this was the Bretton Woods system.

Effectively a return to the gold standard, the U.S. could adopt it due to significant gold reserves post-World War I.

However, as Europe and Japan recovered post-World War II, U.S. competitiveness declined, and its international balance of payments worsened. The Vietnam War further eroded U.S. credibility.

In 1971, President Nixon suspended dollar-gold exchange to revive the economy and competitiveness. Known as the Nixon Shock, it marked the collapse of the gold-dollar standard.

The world then transitioned to the current managed currency system with floating exchange rates.

Summary

Currency is not just a means of exchange; it has significantly influenced nations' rise and fall and world history. How currency is trusted and managed can determine economic stability or turmoil, impacting political and social movements.

Today, new forms like digital and cryptocurrencies are emerging. Let's continue to watch how currency will shape the world in the future.