Mario Pisani on a history lesson that is relevant to all civil servants
Money is one of the best examples of a human-inspired idea which has endured since the beginning of civilisation. Indeed, sterling is the oldest currency in the world still in continuous use today.
In this article I will argue that all money over time has ultimately been based on trust, and that trust in money is strengthened by the role of the institutions of the state. The story reminds us how all state institutions – including those that underpin the Civil Service – can contribute to the public good.
Let’s start with an image of money.
Figure 1: Edward VIII coin. Credit: Royal Mint Museum
The beautiful Edward VIII five sovereign coin in Figure 1 is dated 1937, but what is its value? Its nominal face value is £5 – so it could be used to buy five pounds’ worth of goods. But that would not be very wise. That is because it is made of 22-carat gold, which at recent gold market prices would make this coin worth around £3,000. So, is that the coin’s value? Maybe, or maybe not. Because in 2021 a coin just like this one sold at auction for $2.3m – making it the most valuable sterling coin ever sold. So the answer to the question of value depends on what we mean when we talk about the value of money.
Money and trust
First, let us examine the link between money, value and trust. For most markets to function, there needs to be a medium of exchange. Most of the time that medium of exchange is money. Economists often describe money as something that can act as a unit of account, a store of value and a medium of exchange. These are useful definitions, but they tell us what money does, not what it is. To me, money is a social technology which helps us represent and exchange economic value. But how did money come to represent economic value?
These days we are accustomed to the idea of so-called fiat money, or money which has no intrinsic value. But for many centuries, up to the end of the Bretton Woods system in the early 1970s, many of the world’s leading currencies were linked to gold or other precious metals. In fact, the earliest metal coins date from around the 7th century BC, when the ancient Lydian civilisation in Anatolia produced coins made of electrum, an alloy of gold and silver.
However, money has also taken other physical forms beyond precious metal. Today in museums around the world we can see many examples, such as clay tablets, sea shells, playing cards or the circular stones from the Pacific island of Yap. Interestingly, unlike the Lydian electrum coins, many of these examples of physical money did not have any intrinsic or commodity value. They were simply tokens used to represent economic value.
As has been well documented, before money existed in physical form it existed as an intangible system of credit and clearing. The Sumerian and Babylonian civilisations were able to transact by issuing debts, so that goods were received in return for a promise to pay later. Bilateral obligations were recorded using a central organising system.
Whatever its form, physical or intangible, money is always a form of credit, a liability. This requires trust. In simple terms, money is like holding an IOU which the holder believes will retain its value until it is passed on to someone else in the future. That is why the most successful forms of money are those that are underpinned by a workable and stable relationship of trust that is widely held across society. Successful public service institutions are key to establishing that relationship of trust.
I like the idea of trust, but I think it can be defined more precisely. We can do this by looking at some of the characteristics of successful forms of money. At the core of trustworthy money, there are two important characteristics. First, the issuer of the money has to be creditworthy – so that users know that the economic value that the money represents will be maintained over a reasonable time period. Second, money needs to be transferable – users need to know that the vast majority of people will accept it as payment in the future.
English silver coin in the sixteenth century is a good example of this. Its creditworthiness came from the precious metal contained in the coins themselves: the user knew that the economic value represented by the coin was backed by the value of the silver within it. Over time, though, these coins became worn, reducing their silver content. What’s more, before the introduction of a milled edge, coins were susceptible to clipping and counterfeiting. Worst of all were the deliberate debasements, which started under Henry VIII in the 1540s. The high silver content of English coin (92.5%) had given the currency its name – sterling – but by 1551 newly issued coin was only around 16% silver. This damaged the security provided by the coin, affecting its creditworthiness. It also meant that different coins of the same currency were not considered equivalent in value, so some coins traded at a discount, impairing transferability.
The four state institutions
Let us next consider the various state institutions which have supported the development of money in Britain: the Mint, the Treasury, the Exchequer and the Bank of England.
Coins are among the oldest forms of physical money in England, dating back at least to pre-Roman times. After the Romans, systematic production of coinage started at local mints. The Royal Mint traces its beginnings to a large issue of silver pennies bearing the image of Alfred the Great in the late 9th Century. By the following century there were around 70 local minting locations, which by royal decree had to be near towns and markets. Since then, the Royal Mint has produced sterling coins for the Crown. Today the Royal Mint is owned by HM Treasury, the UK finance and economics ministry, and produces sterling coins on its behalf.
The Treasury is not quite as old as the Royal Mint. The role of the Treasurer, or the person charged with safeguarding the King’s treasure, goes back to at least the 11th Century. An official named “Henry the Treasurer” is recorded in the Domesday Book of 1086. Over time this role evolved into that of the Lord High Treasurer, who oversaw both the Treasury and the Exchequer.
The Exchequer is another ancient institution, dating from the 12th Century. The ancient Exchequer was divided into two parts. The “Lower Exchequer” issued funds, received revenue, and was akin to a central safe deposit for the Crown. The “Upper Exchequer” featured half-yearly audits with checkered cloth used as an accounting device, which gave the Exchequer its name.
In the financial and political reforms across England in the final decades of the 17th century, the Treasury separated from the Exchequer and acquired new powers over public expenditure. The Glorious Revolution resulted in a rebalancing of political power away from the Monarch and towards Parliament. Out of this settlement came the Bank of England.
At the time, the Crown urgently needed funds for a war against France. In return for a permanent loan of £1.2m at a rate of 8% – considerably cheaper than the cost of borrowing elsewhere – the Government gave the Bank the right to set up as a joint-stock limited liability company and non-monopoly rights to issue paper banknotes as legal tender. This was an important moment in the history of money because it allowed private money, issued by the Bank, to have the endorsement of the Crown – and therefore make its currency as trusted as coins bearing the effigy of the King. The Bank of England has been issuing banknotes ever since. Over the course of the 18th and 19th centuries, the Bank’s notes became the preferred method for settling larger transactions. These notes were eventually replaced by bankers’ balances – an earlier version of central bank reserves.
Privately issued money
Having looked at these four UK institutions, we can now look at the main components of publicly and privately issued money in the UK. Figure 2 shows the relative size of different forms of money, in recent years. There is approximately £5bn worth of coins produced by the Royal Mint in issue. There are some £82bn worth of Bank of England banknotes in circulation, plus £4.5bn worth of Scottish and Northern Irish banknotes.
Figure 2: relative size of different forms of money.
Source: author’s calculations (note these forms of money are not necessarily mutually exclusive and can overlap)
Then there are the wholesale deposits held by commercial banks at the Bank of England, so called central bank reserves. This is another form of money, used for electronic transactions between commercial banks. Their total is around £760bn. Those are the three forms of public money: coins, banknotes and central bank reserves.
But the majority of money is not public: it has been issued by private sector institutions. That is because by far the largest form of money are the deposits of households and businesses held at commercial banks, which stands at £2,200bn. So a question immediately comes to mind: how can this type of private money – by far the largest – be linked to the state?
The answer is that public policy institutions, like the Bank of England and the Treasury, have been entrusted with safeguarding our entire banking system. They do this in a number of ways. All deposit-taking banks need to be authorised and regulated by the Bank of England and hold enough high-quality capital to absorb losses in a range of stress scenarios. They have access to the Bank of England’s lending operations, should they need liquidity, in normal times as well as in crises. Retail deposits of up to £85,000 are protected by the Financial Services Compensation Scheme, which is funded by the banking industry but underpinned by access to government funds. And if all this fails, ultimately the Treasury has its financial power which can be deployed as a last resort – just as we saw in 2007 and 2008.
And that is why, looking at money today, it is always possible to trace a line back to the state. All forms of money are either direct liabilities of the state, or liabilities backstopped by a contingent claim on the state. At the core of this complex organisational web is the Treasury, sole shareholder of both the Bank of England and the Royal Mint. Treasury ministers appoint the governors of the Bank, the CEO of the Mint, as well as members of the boards at both institutions. And the Treasury can use the legislative process to set the objectives of both Bank and Mint.
If money requires faith in its financial backing, then the Treasury has the most powerful financial backstop available: its tax-raising powers. The Treasury can use legislation to increase revenue, including to protect the value of our money at a time of crisis.
If we think of money as a liability, it is governments – thanks to the tax-raising powers of their finance ministries – which are best able to issue liabilities. But their ability to do so also depends on a number of other conditions. For example, a belief that the authorities will maintain control over inflation, so that the value of liabilities will not be eroded over time, and a belief that society will continue to support the political system, so that governments will continue to be able to use taxes to meet its obligations. In a world of multiple objectives, policy institutions have to consider how to navigate these trade-offs without eroding trust.
The lesson of Edward VIII
To paraphrase financial economist Hyman Minsky “anyone can issue money – the problem is to get someone else to accept it.” Trust in money comes from its creditworthiness and transferability. My contention is that these qualities stem from the historical links to the institutions of the state.
But what does this all tell us about the Edward VIII coin discussed earlier? The discrepancy between the face value of the coin (£5) and its bullion value (£3,000) shows the challenge of the conventional view of money as a commodity. Precious metal standards persisted because the state periodically revalued the currency to reflect economic reality. Money can best facilitate exchange when the monetary standard is able to adapt without the constraint created by the precious metal in the coin.
The Edward VIII coin also shows us the importance of respecting institutions. One of the reasons the coin has such a high value to collectors ($2.3m) is because Edward VIII broke with the tradition, going back to Charles II, that each new monarch’s effigy should face in the opposite direction to that of their predecessor (Figure 3). This makes the coin extremely rare – but not very good money.
Figure 3: effigies of the monarch in sterling coinage. Credit: author and the Royal Mint
Mario Pisani is Deputy Director in the Financial Stability Group at HM Treasury, and a Trustee of the Royal Mint Museum.
This article is based on a talk he delivered at the 2024 Engelsberg Seminar and published as part of an anthology by Bokförlaget Stolpe. The views expressed are personal and do not represent the views of HM Treasury, the UK Government, or any other body to which the author is affiliated.
