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There is one particular day of primary school, in Grade 4 (Standard 2 back then), that has stuck in my memory. The reason I remember it so clearly, is that it was one of the relatively few times during my school career when I learned something that really excited me. Don't get me wrong, I have always loved to learn, and have done so avidly and constantly since I began reading at the tender age of three. What I'm getting at is that learning was seldom made interesting at school, and the vast majority of useful, exciting knowledge was attained on my own time.

However, on this particular day it was different. We'd each been told to bring along a coin and a one Rand note, still a meaningful amount of money back in the early 1970s. Back then one could buy four Chappies (bubble gum) or Wilson's toffees for a cent, a small packet of Simba crisps for five or six cents, and a loaf of white bread for ten cents. (Brown bread, if I remember correctly, was 7c.) Well, when the time for the appropriate lesson arrived, we were told to take out the money we'd brought, and proceeded to learn about our local currency. We looked at watermarks and learned that the paper was not just any old paper. We heard how money was printed, or in the case of coins, minted, and were told about the South African Reserve Bank, and how it controlled the amount of money available in the entire country. It was all quite interesting in a theoretical kind of way, until the advent of that one, memorable moment.

Finally, as her pièce de résistance, our teacher brought to our attention a phrase printed on the front of our banknotes. It simply, and somewhat enigmatically said, "I promise to pay the bearer on demand at Pretoria". We were confused. What could this possibly mean? One didn't get paid for money, one paid for things with money. Who was “the bearer”? Who would pay “the bearer”? What would be paid? How much would be paid? Why would anything or anyone be paid? Our teacher played it really well, she let the questions fly, building the interest, encouraging our usually bored brains to come up with increasingly fantastic and imaginative answers to our own questions. The answer, when it finally came, was more wonderful, exciting and strange to our minds than many of our own flights of fancy. We were told that a banknote was actually a promise; a promise made by none other than the financially-all-powerful South African Reserve Bank. A promise that if we took our one Rand note to Pretoria, we would be paid one Rand's worth of gold in exchange for our promissory banknote.

What is better than money, especially in the mind of a nine-year-old, adventure-reading boy? Gold! I was entirely overwhelmed by visions of treasure chests, lumpy moneybags, and softly gleaming piles of bullion – or even just a small nugget that I could keep in my pocket. Unfortunately, my initial, incandescent burst of excitement and wonder, like so many things in the life of a nine-year old, was short-lived. The promise, it seemed, was largely theoretical, because South Africans were not allowed to own gold other than jewellery or minted coins, such as Kruger Rands. The disappointment was palpable. Yet, there remained a glimmer, a spark, an inner awareness that my lowly one Rand note was the direct representation of an equal value of gold.

Just a few years later, South Africa followed the lead of most other developed and developing nations, and removed its currency from the gold standard. Somehow, my banknotes have never looked, or felt quite the same without those words that conjured up the weight, solidity, and gleam of gold, “I promise to pay the bearer on demand at Pretoria”.

So, if our currency, and those of nearly every nation in the world, no longer represents a proportionate amount of gold, what does it represent? Back when currencies were on the gold standard, their inherent value was easy to understand, but what is it now that lends value to the Rand, Dollar, Pound, or Euro? It used to be fairly straight-forward, if the price of gold went up, then the value of your currency went up. But, currencies are no longer connected to the gold price, so what is it now that causes their value to fluctuate? Why are the Dollar, Pound and Euro worth more than a Rand, and the Rand worth more than a Malawian Kwacha? How do some currencies, the Zimbabwean Dollar being the obvious example, completely lose their value? Once again, the search for answers to all these questions begins with one question, “If currency's value is no longer informed by gold, what is it that gives and takes value to and from currency?”

Unless you have studied economics, which I haven't officially, and (in my opinion) have strongly masochistic tendencies, you will probably want to avoid slogging through the swamp of intricately complex theories and methodologies surrounding the creation and valuation of currency. With this in mind, I will attempt to simplify things somewhat.

Let's start with, “What is money?” Reduced to its most simple definition, money is just a record of goods and services (work) available within any given communal system. It might help to think about it this way. If I have a chicken and need a woven basket, and you, a basket weaver, need a chicken, then we have an ideal exchange of goods & services. In this case, no external record or valuation of the goods or services is required. You and I simply agree on what we feel is a fair exchange of chickens and baskets. This is known as a barter system; a direct exchange of goods and/or services, in which value is synonymous with the goods and/or services exchanged. Value is entirely defined by the parties directly involved in the transaction. For example, while a chicken may be intrinsically more valuable than a single basket, it is actually my level of need of a basket that ultimately decides the value of the basket within that single transaction.

However, what if you need a chicken and I already have sufficient baskets. In other words, I have something of value to you, but you have nothing of immediate value to me. In this case, something external is needed, something that represents the value still owed in the incomplete transaction; the amount of work unaccounted for within the system.

If you are a member of my immediate community, or if we have in some way built sufficient trust, then we could enter into a highly complex tangle of goods and services owed within our community or communities. In other words, I would give you the chicken on the understanding that it has a value of, let's say, two baskets. I do not currently need these baskets, so I can either keep this “two-basket credit promise” until I do, or I can in turn trade it for something else that I do need, and for which I cannot barter directly. It does not take much thought or imagination to realise just now complex and open to abuse such a system could be. Keep in mind that in these bygone days most people were illiterate. This complex system of transferred barter, unaccounted for work, and subjective valuation was therefore almost entirely memory-based.

Once literacy began to gain a foothold in society, at least among the merchant and artisan classes, it was precisely this system of delayed barter that led to promissory notes and ultimately, bank notes. Enter the first “paper money”. However, somewhere back in the mists of time, some bright spark had already had the idea that started it all. What if there were some external, valuable, and preferably controllable commodity that could be given a standardised value, which could then be used as a completely flexible, interchangeable record of transactional value? There are a number of examples of such early currencies in the historical record. in Africa and China, cowry shells were used, while in Sumeria, Mesopotamia, and Japan, weight based units of exchange were used. These weight-based units of exchange, or currencies, set a particular value for a given weight of a certain substance such as grain or metal. In Mesopotamia this was known as a shekel (a specified weight of barley), and in Japan as a koku (a unit of rice per year). This weight-based currency system extends into our modern monetary systems, if only due to the echoes provided by currency names, such as the Pound (originally a given mass of silver), and the Shekel, still a fairly common Middle-Eastern currency.

While literacy was rare outside of the merchant, artisan and upper classes, the promissory notes that developed out of the barter transfer system worked really well. However, as more people became literate, the problem of forged promissory notes also began to emerge.¹ This in turn, resulted in the first anti-forgery methods, including signatures, seals, secret marks, complex printing, and special paper.

¹(It is commonly claimed that education is the nemesis of crime. Educate the masses, and they will no longer have to commit crime. I think history tells us the truth. Educate people, and they will use that education to commit new, more innovative crimes more effectively. Crime has more to do with human nature than with education.)

Then of course, anywhere that there is currency of any kind, some people will have more of it than others. Where some people have more currency than others, there will be people who will lend currency to those that need it. Both then, as now, money is not lent out of a sense of kindness or pity, but rather to make money from the investment in some way. Now, if your local currency is shekels of barley, or one-pound lumps of silver, neither of which lend themselves to easy transport, human ingenuity needs to come up with a more convenient solution. If I, as a “money” lender, lend you fifty pounds (of silver), it is very inconvenient, expensive, and dangerous for you to leave my establishment with a literal fifty pounds of silver. This is especially true if the transaction for which you need it is only on the other side of the city, with someone to whom I am known. The inconvenience and danger are multiplied when you have to return that silver to me, with interest. Money lenders therefore quickly adopted the system of promissory notes. In this way, the silver remained in a nice safe vault in my basement, surrounded by armed guards, while you did not have to incur the inconvenience, danger, or expense of moving large amounts of bullion across the city. The person with whom you were transacting, knew that he, in turn, could use my promissory notes for his own transactions, or alternatively, at any time, return them to me to redeem their value in silver.

As these money lenders grew in wealth, power and reputation, they became known as banks. At first each money lender or bank had their own, private promissory, or bank notes. However, as the idea of bank notes caught on, and as the need for central currency control became more apparent, governments stepped in and began to standardise both coins and notes. In order to do this, governments set up their own central banks, that held vast stocks of whatever “treasure” was the basis of their currency – usually gold.

Which of course, brings us full circle. These national bank notes, supplied by the government's central bank, were still really just promises to pay over a specified amount of gold or silver to the person holding the note. A bank note was, and is, really just a fancy IOU from the government's central bank; a record of the “work” within that system.

“I promise to pay the bearer on demand at Pretoria”. My Rand used to represent a specified amount of gold, but no longer; its value then was easy to see and understand. But what now? My bank note is no longer a promise to pay me gold. My bank note no longer represents a value of gold. What value is represented by my Rand in 2011?

Stay tuned for “Making Money – Part 2 (Smoke and Mirrors)”.

Author: Robin Bownes.