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Dollars & $ense

A Kid's Guide to Using â" Not Losing â" Money

Charlesbridge Publishing, Inc.

Skulls, Sheep, and Shells

Money as a Medium of Exchange

Have you ever traded one item for another? Perhaps a slice of your pizza for a friend's candy bar? Or maybe you've traded services with someone else: "I'll babysit your little sister tomorrow, if you'll feed my cat while I'm away." Exchanging goods (pizza for candy) or services (babysitting for feeding the cat) is a form of bartering, or trading. Bartering began long before there was such a thing as money, and it continues today.

Around 10,000 BCE to 4,000 BCE, our ancestors stopped wandering in search of food and began to settle down and live in small communities. Once they had established settlements, they learned how to domesticate, or tame, animals so they could raise herds of cattle and other livestock. Next they learned to grow their own grains and vegetables. People soon discovered they didn't have to do everything for themselves. Instead they could barter with each other. For example, someone who had a herd of goats but no seeds to plant could offer a trade: a young goat for several sacks of seeds. Someone else might offer to trade a basket of apples for a clay pot.

The barter system worked pretty well, as long as the person with the seeds wanted a goat, or the person with the pot wanted the apples. But suppose you had seeds, yet you didn't really want my goat? Or suppose I wanted the pot, but my apples weren't yet ripe? How could you trade the pot now for my apples that would be ripe later? The barter system failed to work at that stage, because the things that were traded simply didn't match up evenly. There was no common medium of exchange — no widely accepted item that could be used to pay for goods and services. In short, there was no money.

Once our ancestors came up with the concept of money, things worked better for everyone. A harvest of apples could rot, and clay pots could break. On the other hand, money — or currency — would not rot or break. In addition, it could be traded for something else of equal value. For example, the potter could sell his pots to the apple farmer now and be paid with money, which could be used to purchase apples later, when they were ripe. And if the apple harvest failed, the potter still had money to purchase food from someone else. In this way money, as a medium of exchange, helped the ancient world go around.

The first money came in many forms, and none of them looked anything like today's currency. In the earliest times, a medium of exchange could be a type of food, but it had to be something that lasted and wouldn't spoil, such as seeds. Whatever was used as currency had to be in demand year-round, too, so things like a measure of grain, a vat of wine, a portion of salt, or a precious metal, such as silver or gold, often served as mediums of exchange. Of course, dragging around vats of wine or bushels of barley was inconvenient, and gold and silver are heavy. What people needed was something that represented these valuable items but was easy to transport.

In 1200 BCE the Chinese began to use cowrie shells as money. They were portable, beautiful, and rare. Before long this medium of exchange spread throughout Asia and to Africa as well. Other cultures developed their own currencies. Wampum — beads carved from shells — was the first currency used in North America. Developed by Native Americans, wampum remained a legal medium of exchange between Native Americans and New England colonists until the end of the seventeenth century.

Many Pacific Islanders had unique mediums of exchange. On the island of Yap, people once used stones as currency.

On New Hebrides (now Vanuatu), they used feathers. These are the heaviest and lightest currencies ever developed. The most disgusting currency ever has to be the human skull, which was used by the warrior headhunters of Borneo. Although they also used pigs and palm nuts as mediums of exchange, the warriors considered the skulls of their enemies so valuable that a skull became the standard for their currency.

A standard is something that other things are measured against. For example, inches are measured against a standard foot to show length. Twelve inches equals one foot, so we know immediately that something that measures six inches is shorter than a foot. It's the same with money. In Borneo it may have taken one hundred pigs or one thousand palm nuts to equal one human skull. Using the skull as a standard, it's easy to see that pigs were more valuable than palm nuts.

Fortunately, skulls did not become a common standard for currency around the world! Gold did. In other words, countries measured their currency against a standard amount of gold. They backed up that currency with actual gold, held somewhere in their treasuries. The United States adopted the gold standard in 1900. Each American dollar was now worth a set amount of gold, and gold was the only standard for redeeming paper currency. But how could the United States keep all that gold safe?

In 1937 the United States built an army post — complete with a vault — in Fort Knox, Kentucky. The nation's gold supply was shipped there on a nine-car train armed with machine guns on the roofs of the cars — and with soldiers who knew how to use them. Backed by such carefully guarded gold, American dollars seemed like a safe bet.

The delegates to Bretton Woods certainly seemed to think so. In 1944, toward the end of World War II, delegates from forty-four nations met in Bretton Woods, New Hampshire, to discuss how to regulate money exchanges between nations. The dollar replaced gold as the standard in the international financial market, where currencies are bought and sold. In turn, the United States agreed to fix the value of its dollar at a rate of $35 per ounce of gold. Theoretically, anyone holding a single US dollar anywhere in the world could exchange that dollar for its equivalent in gold.

But what if everyone in the world suddenly wanted to exchange their dollars for gold? There wasn't enough gold in Fort Knox to redeem them all. Fearing an economic disaster, President Richard M. Nixon announced on August 15, 1971, that the United States would no longer trade dollars for gold. The gold standard had come to an end.

Today the value of the American dollar and the currencies of other nations fluctuates — moves up and down — according to many factors. How much confidence people have in a country's government affects the value of its currency. To an extent, so does the price of an ounce of gold. But because the price of gold is no longer regulated, or set by law, its value is determined by supply and demand. If there's a lot of gold (a big supply) but not many people want to buy it (a low demand), then the price will go down. On the other hand, if there's a big demand and not much supply, then the price will go up.

Currency operates in a similar manner. Economists talk about "strong" and "weak" currencies. As the name implies, a strong currency has more purchasing power than a currency that is considered weak. When the US dollar is strong compared to, say, the euro, it takes fewer dollars to purchase an equivalent amount of euros. With a strong dollar, you might be able to buy a single euro for about $1.30. But if the dollar is weak, then it might take as much as $1.60 to buy that same euro. Currency values fluctuate daily around the world.

Many countries still tie their currency to the US dollar. They have confidence in the basic economic systems of the United States — in the rules and regulations that govern its financial institutions, including banks. However, American banking regulations didn't happen overnight; they had their beginnings in the ancient world.

Worry, Worry, Worry!

Keeping Money Safe

Where do you keep your money? In your pocket? In a piggy bank? In a real bank? Do you think your money is safe?

Money — whether it's in the form of bushels of grain or nuggets of gold — is a valuable resource, and anyone who has a valuable resource wants to keep it safe. Our ancestors were no different. There was always the danger that cattle would be stolen or grain would rot in the field, so they looked for safe places to keep these belongings. Though the ancients may not have called it that, what they needed was a bank.

Evidence of the earliest banks dates back to ancient Mesopotamia, an area between the Tigris and Euphrates Rivers that is often called "the cradle of civilization." Hammurabi (c. 1810-1750 BCE) was the king who united all of Mesopotamia into the kingdom of Babylon. By the time of Hammurabi's reign, people were "depositing" their extra cattle, grain, vats of wine, and other precious resources in Babylon's temples and palaces. These were safe places, much more strongly built than the average person's dwelling and always staffed by many people. The priests of the temples and the noblemen of the palaces not only took in people's deposits; they also made loans. Borrowing resources and repaying loans were so important to the Babylonians that they set up rules and regulations regarding these transactions. Those rules are contained in the set of laws called the Code of Hammurabi.

In the millennia that followed Hammurabi's rule, the practice of depositing valuables in safe buildings spread from Mesopotamia into Egypt, India, China, Greece, and Rome. Then, in 476 CE, the Roman Empire fell. The chaotic period that followed is known as the Early Middle Ages (476-1000). Sometimes referred to as the Dark Ages, this was a period when European civilization did not move forward, but instead went backward. Ignorance and superstition took over people's lives. The rule of written law disappeared. For the most part, writing disappeared, and without writing there were no records. Without records, banking disappeared, too. People who had anything of value kept it on their person, or hid it from the thieves who roamed the land.

After several centuries of lawlessness, a period of discovery, invention, and conquest gradually emerged. During this period — the High Middle Ages (from the eleventh to the thirteenth century) — the Crusades took place. Christian warriors from Western Europe marched toward Jerusalem, determined to take the Holy Land from the Muslims (people who practice Islam). The Muslims considered Jerusalem one of their holy cities. But by the end of the First Crusade (1096-1099), the Crusaders had taken control of the cities of Jerusalem, Edessa, Antioch, and Tripoli. When word of their conquest spread, thousands of Christians made the pilgrimage to Jerusalem to see the sites in the holy city.

Travel in the Middle Ages was full of danger. Bandits lurked everywhere. There were few safe places to rest for the night. Pilgrims were robbed, kidnapped, or slaughtered by roaming bands of thugs. In 1119, former Crusaders began an order — the Knights Templar — to protect pilgrims during their travels. To join the order, a man had to take a vow of poverty, chastity, and obedience. He also had to give all his wealth to the order, which grew richer and richer.

The Knights Templar set up communities in England and France, and along the pilgrimage route that led from Europe to the Holy Land. Travelers could use a Knights Templar community as a kind of "rest and resupply" stop along the way to Jerusalem. By 1129 Pope Honorius II, the head of the Roman Catholic Church, had endorsed the Knights Templar. Any contributions made to the order were now protected by the church.

By 1150 the knights had begun to allow pilgrims to bring their valuables to Templar monasteries for safekeeping while they were traveling. And the Templars provided letters of credit — a forerunner of modern checks — to pilgrims as well. In some cases the Templars loaned money to the pilgrims and members of the aristocracy to meet their various needs. Thanks largely to the Templars, safe-deposit boxes, letters of credit, and loans are a part of modern banking practices today.

In 1187 the Crusaders were defeated in the Second Crusade. Control of the Holy Land reverted to the Muslims. With that defeat, the influence of the Knights Templar as a band of fighting Crusaders faded. However, their banking practices — issuing letters of credit and making loans — did not come to an end until 1307, when the French king, Philip IV, accused the knights of terrible crimes. Philip, who had borrowed vast amounts of money from the Templars, convinced Pope Clement V to take action against them. On Friday, October 13, 1307, the pope had scores of Knights Templar arrested and tortured, and ordered them to forfeit their wealth to the church. As a result, King Philip no longer had to repay his debt, the Templars' banking practices ended, and most of the money in Europe ended up in the hands of the pope, princes and kings, and a few extremely wealthy families.

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During the Middle Ages, countries, cities, and towns issued their own coins. When a traveler arrived in town, one of the first stops was the money changer, who — for a fee — would exchange the traveler's money for local coins. The most famous banking family of the time, the Medicis, started off as money changers working from a table in an open marketplace of Florence, Italy. In 1397 Giovanni di Bicci de' Medici moved his major banking activities into a counting room inside his brand-new palace. Soon after, he expanded the family business by extending war loans to princes and trade loans to merchants. Pope Boniface IX, who controlled the Catholic Church's wealth, became Medici's biggest and most profitable customer during this time. As its wealth increased, the Medici family was able to make more loans. Soon its financial services spread across Europe, as far north as London.

The Medici Bank, like any bank today, expected to make a profit on these loans. But it had a problem.

The Catholic Church made all the laws — civil and religious — for areas under the pope's rule, which included most of Europe. The church refused to allow anyone to charge money, or interest, for making a loan. It called all interest charges usury and said this practice was forbidden according to the Bible: "If you lend money to my people, to the poor among you, you shall not deal with them as a creditor; you shall not exact interest from them" (Exodus 22:25). People were supposed to loan money out of the goodness of their hearts, expecting nothing in return.

But the Medici family had a business to run. They, among others, were able to figure out a clever way around the pope's rule against usury. Because they had banks all over Europe, the Medicis could make a loan in one country's currency and then accept repayment for that loan at another location, in another currency — which allowed them to charge a currency-exchange fee. Bankers could add interest to this exchange fee, and it would be hard for anyone to detect. Soon charging interest was an accepted practice, and anyone who borrowed money expected to pay it.

By the nineteenth century even the church had stopped forbidding interest payments. Today banks always charge interest on the money they lend; it is perfectly legal for them to do so. Interest is considered the bank's reward for risking its money to make a loan. "Usury" is now a term that refers to any interest rate that is above the rate set by law.

* * *

Money brings power. As banking has evolved, so has the need for rules and regulations to control the power that banks have. In the Middle Ages those rules were decreed by the church. Today they are made by the government.

In many ways, the birth of the United States was also the birth of a new banking system with its own set of rules and regulations. And, as everyone knows, the birth of anything new — whether it is a banking system or a baby — requires labor. Hard work.

New Money for a New Nation]

America Builds a Banking System

In early America each colony's government issued its own paper money and set its own paper and coin exchange rates. There was no uniform currency, which of course made trade complicated, since money needed to be changed from colony to colony, and later, from state to state.

In 1783 the American Revolution ended, and the colonies won their independence from Great Britain. Six years later George Washington was elected president and set with the task of structuring and running the new nation. Washington chose Alexander Hamilton to be the nation's first secretary of the treasury.

Hamilton had an idea to fix the nation's financial problems and bring about economic stability. He urged Washington to allow the establishment of a national bank, to be headquartered in Philadelphia, Pennsylvania, with branches in different cities. To fund the bank, ten million dollars of initial capital would be raised: two million from the federal government and another eight million from private investors. This ten million dollars would be used for loans to start new businesses that would get the nation's economy moving. Washington liked Hamilton's idea, and in 1791 Congress voted to establish the Bank of the United States with a twenty-year charter, or establishment agreement.

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Excerpted from Dollars & $ense by Elaine Scott, David Clark. Copyright © 2016 Elaine Scott. Excerpted by permission of Charlesbridge Publishing, Inc..
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