In an episode of the Netflix medieval series The Last Kingdom, the protagonist Uthred, trying to purchase a sword from a blacksmith in a town he is just passing by, is instantly asked “Do you have silver?”.
In one scene, insignificant to the plot, the series creators neatly raised some fundamental questions in monetary economics, illustrating the relative use of credit and cash and the importance of finality.
For many centuries, the very payment system between people set severe constraints on what kinds of transactions they could – or dared – engage in. There are two main ways of providing payments (with quite a few variations within these categories): cash or credit.
Cash (sometimes referred to as ‘money transactions’) refers to payments with direct finality; the economic chain is instantly settled, and gives rise to no other economic relation. Examples here would be pure barter (where one object is traded for another) or commodity money (where an object is traded for a common media of exchange, with history providing countless fascinating examples: cattle, skin, olive oil, feathers, pearls etc).
The other category, credit, involves trading someone else’s liability or incurring a new one. Modern credit cards easily comes to mind: swiping that card settles the trade between the vendor and the customer who used the card only by creating two new (future) economic relations – a promise by the credit card company to transfer funds to the vendor, and a promise by the customer to pay the credit card company at the end of the month. The same features can be – and were – applied in many early societies; I give you some of my items, and you owe me; later I may transfer this “claim” to somebody else is the community in exchange for something I wanted, and instead of owing me, you owe them.
Some of the difficulties of monetary economics are here quickly revealed. In order for credit to work, a sufficient level of trust, repeated dealings or enforcement mechanisms must exist. If one or more parties do not trust each other, the two are unlikely to trade again or cannot socially or legally force the other into upholding his or her contract, they may refuse the deal up-front and lose the benefits of trade (the “backward induct,” in Game Theory-speak). Nevertheless going through with this transaction requires a different payment system: instant finality, such as provided with cash. Here’s the conundrum that troubles monetary economists:
The frictions that are needed to make money essential typically make credit infeasible and environments where credit is feasible are ones where money is typically not essential (Ugolini, The Evolution of Central Banking, p. 169)
If we trust each other enough (or have enough repeat dealings and a system of keeping track of everyone’s debts), there is no need for cash. If there is need for cash, that means we do not trust each other (or can’t keep track/enforce debts), indicating the presence of “frictions” that make us reluctant to use credit at all.
Let’s go back to our Last Kingdom protagonist. It is clear that the two characters are strangers (no previous dealings, no trust) and from simply passing through a village, no reason for the blacksmith to believe that there may be repeat dealings. A credit transaction is thus clearly out of question. Instead he directly asks for silver (cash), which initially seems to solve the problem. However, two further issues emerge:
- if all transactions were like this, the amount of cash everyone must carry around in the economy would be enormous. A common problem in medieval and even early modern societies were the lack of coins. If enough cash was simply not there and recourse to credit system unfeasible, we quickly realise how difficult transacting would be.
- even if the customer had enough cash, the very reason they were reluctant to use credit in the first place (no trust, no repeat dealings, no credible enforcement) harms their ability to transact in cash. Howso? Because both parties can opportunistically defect from the agreement. If the sword is paid for up front, the blacksmith can take the money and run – since they are strangers and unlikely to meet again, the cost of cheating is comparatively low. If the sword is paid for at delivery, the customer can easily renege on payment once delivery is obtained.
Is there no way out?
Uthred and the blacksmith use a method most of us are familiar with – indeed, probably even used as kids – pay half up-front, and half on delivery, with the possibility of a bonus payment (tip) at the end. Risk-minimising, yet offering payoff through the gains from trade.
Good monetary economics does precisely that: illustrating how monetary systems, including payment systems, can facilitate transactions and expand rather than limit the available gains from trade. It concerns itself with one of those spheres of (economic) life that we don’t notice until they breaks down. Try completing everyday transactions in countries with small-change shortage for a neat flashback to eighteenth century Britain or U.S., or in countries impaired by hyperinflation or sanctions. Monetary economics, in essence, is fascinating in its complexity of otherwise quite mundane things. Thanks to The Last Kingdom team for illustrating that.
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Nguyen Ha left this thoughtful comment about my post on protectionism in Africa that I am embarrassed I missed:
Would you care to explain how “stronger economic ties will hasten the demise of current African states’ superficial institutions”?
What a tough question! First, though, I stated that it was my hope that deeper trading ties would lead to more states, not my prediction. My hope is based on current trends around the world: stronger economic ties have led to more states (and more aspirations for statehood within existing states).
The best academic treatment on this topic comes from Giacomo Ponzetto, an economist currently at CREI in Barcelona (he’s been mentioned at NOL on more than one occasion, too), and especially the Introduction and Section 5 of his working paper titled “Globalization and Political Structure.” Here:
As globalization proceeds, localities remove borders by increasing the size of countries. The number of countries declines and the mismatch between each locality is ideal and actual provision of public services grows. Eventually, this mismatch is large enough to justify a move to a two-level governance structure. The world political structure shifts from a few large countries to many small countries within a world economic union. The two-level structure is more expensive, but it is nonetheless desirable because it facilitates trade and improves preference-matching in the provision of public services.
By “two-level governance structure” Ponzetto means one level, a locality, that’s focused on delivering public goods to that specific locality, and another level, a world economic union, that’s focused on protecting property rights and eliminating border costs.
You can see this concept play out in a few different federative structures, especially the EU, the US, India, and China. In the European Union, multiple localities have tried to separate from countries (Catalonia from Spain, Scotland from UK) while still remaining part of the international economic union in place. Deeper trade ties, more states.
Three new states were created in India in 2000, and China is currently grappling with federalism as a way to keep up with its predictable economic success. The US hasn’t seen any new states added since 1959, but that’s because its system does a good enough job overall to keep all its member states content (happy, even).
The free trade zone in Africa will be interesting to watch because there are so many different variables at play than in China, the EU, India, or the US. India was governed by one overseas empire; the EU has been able to maintain stability because of American military power and the security umbrella it provides; China has been unified on and off again for centuries; and the US is, for all intents and purposes, a polity underscored by British cultural, economic, and political mores. Africa has none of these traits, yet its various leaders recognize that free trade leads to prosperity and often (not always) to better diplomatic ties.
If all goes well, and current trends elsewhere are any indication, Africa would see more states come into being to go along with its deeper economic ties. (This might be a major factor why Nigeria refused to join; Abuja fought a vicious civil war in the 1970s against separatists in Biafra and its leaders are probably tacitly aware of current global trends.) If all doesn’t go well, then violence and poverty will be just around the corner.