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  • Print publication year: 2015
  • Online publication date: May 2018

7 - Money, credit and banking


The origins of money

We have learned that one major cause of productivity increase in pre-industrial economies is the gains from division of labour resulting from occupational diversification in an economy where regions and nations exploit their comparative advantages. But these gains cannot be reaped without exchange between increasingly specialized producers. Money, as a means of exchange, developed alongside the occupational and regional division of labour. The first money, some five or six thousand years ago, did not consist of stamped coins, but rather of standardized ingots of metal which were generally accepted as a means of payment. The Chinese and Greek civilizations introduced coins which were stamped like a modern coin. To understand the advantages of money it is worth looking at its historical antecedent and alternative. Direct bilateral exchange of one commodity for another, so-called barter, requires coincidence of wants between trading partners. It means that if you want to exchange a pair of shoes for wheat you have to find someone who has wheat and wants a pair of shoes. The matching process necessary to detect coincidence of wants will be very time-consuming, and time matters because it is scarce and has alternative uses. Barter will not only be associated with high search costs, but will also reduce the volume of trade to below its potential level because trade must be balanced. However, the volumes participants want to trade need not balance and in those cases the ‘minimum’ trader will determine the volume of trade. For example, a weaver might find a baker willing to exchange bread for cloth at an agreed price, but the weaver might not be willing to buy as much bread as the baker wants to sell. After all, bread is more perishable than cloth and is typically bought daily in small quantities. The volume traded when relying on bilateral balanced trade will thus, in this particular example, be constrained by the cloth maker, the ‘minimum’ trader.

An excellent survey of the evolution of British banking, with a comparative perspective on Europe, is S., Quinn, ‘Money, finance and capital markets’, in R., Floud and P., Johnson (eds.), The Cambridge Economic History of Modern Britain, Vol. 1 (Cambridge University Press, 2004), pp. 147–74.
Y., Cassis (ed.), Finance and Financiers in European History 1880–1960 (Cambridge University Press, 1992). Of particular interest is a chapter by Richard Tilly on German banking.
M., Collins and M., Baker, Commercial Banks and Industrial Finance in England and Wales, 1860–1913 (Oxford University Press, 2003) provides a balanced overview of the merits and shortcomings of British banking.
C., Fohlin, Finance Capitalism and Germany's Rise to Industrial Power (Cambridge University Press, 2007) challenges the conventional view of German banking. Fohlin provides a re-interpretation of the role of German banks in industrialization while down-playing the unique role of relationship banking.
T., Guinnane has written with insight on German and European banking and corporate structure; see e.g. ‘Delegated monitors, large and small: Germany's banking system 1800–1914’, Journal of Economic Literature 40 (2002), 73–124.
A classic is A., Gerschenkron, Economic Backwardness in Historical Perspective (Cambridge, Mass.: Harvard University Press, 1962).
W., Kennedy, Industry Structure, Capital Markets and the Origin of British Economic Decline (Cambridge University Press, 1987). An analysis which argues that UK banks failed to modernize British industry.
R., Levine, ‘Financial development and economic growth: views and agenda’, Journal of Economic Literature 35 (1997), 688–726. A concise summary of the theoretical literature on banks and financial intermediaries.
L., Neal, The Rise of Financial Capitalism: International Capital Markets in the Age of Reason (Cambridge University Press, 1990). A pioneering quantitative study of the first phase of international capital markets.
P. L., Rousseau, ‘Historical perspectives on financial development and economic growth’, Federal Reserve Bank of St. Louis Review (2003), pp. 81–106. A rare attempt to give econometric significance to the role of banks in early growth.
A., Teichova et al. (eds.), Banking, Trade and Industry: Europe, America and Asia from the Thirteenth to the Twentieth Century (Cambridge University Press, 1997). Chapters by Herman van der Wee and Håkan Lindgren are of particular interest.
On the evolution of central banking see C., Goodhart, The Evolution of Central Banks (Cambridge, Mass.: MIT Press, 1991).
R. S., Grossman, Unsettled Account: The Evolution of Banking in the Industrialized World since 1800 (Princeton University Press, 2010). A recent history of banking.
C. M., Reinhart K. S., Rogoff, This Time It Is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009). An impressive empirical study of the relationship between financial crises and external imbalances. There seems to be a high correlation between cross-border financial flows and sovereign default and banking crises.
H. S., Shin, ‘Reflections on Northern Rock: The bank run that heralded the global financial crisis’, Journal of Economic Perspectives, 23(1), 2009.
M., Schularik and A. M., Taylor, ‘Credit booms gone bust: Monetary policy, leverage cycles and financial crises, 1870–2008’, American Economic Review, 102(2), 2012, 1029–61, trace the fundamental change in banking practices discussed in Section 7.8.