Why has the recovery from the financial crisis of 2008 been so slow? To answer that question, it helps to reflect on two items in the newly opened Citi Money Gallery at London’s British Museum. The first is a photograph of a two-tonne carved stone which once served as money on the Pacific island of Yap. The second is the exhibit of counterfeit notes and coins.
Yap’s use of big rocks as currency poses some obvious problems, but the carved stones, known as rai or fei, did not actually pass from owner to owner. Possession was merely noted down by inscriptions. The economist Milton Friedman wrote an elegant paper about the Yap arrangement in 1991, explaining that the system worked because of the Yap residents’ “unquestioned belief” in it.
Friedman realised that modern monetary systems are also faith-based. The faith used to reside in the value of gold and silver, whether minted in coins or held in central bank vaults and represented by paper. Now people are asked to believe in the value of a currency which is almost entirely intangible and which can be created and destroyed by the fiat of central banks.
For a monetary system to continue working, the authorities, whether tribal leaders or central bankers, must defend the monetary faith. In Yap, the currency system was inextricably woven into the complex net of tribal social relations. The rai were trusted as long as – and because – the whole society worked as a unit. The modern system of fiat money and ample credit needs more active support. The authorities must ensure that the financial intermediaries that keep the accounts are trustworthy. Also, they should prevent sharp variations in the value of money (the quantity of stuff which a set sum of dollars or euros can buy).
For the most part, modern societies do these tasks very well. Even after the crisis, the “dematerialised” monetary system has not broken down. However, the crisis experience points to a serious problem: there has been too much tolerance for monetary manipulation. Consider the Money Gallery’s display of counterfeit coins and bills. The exhibit’s curator told me it was one of the most popular. That is hardly surprising; there is something compelling about trying to turn dross into gold, whether though Roman slugs or Bernard Madoff’s Ponzi scheme.