The historic evolution of European domination of the World and the role of money creation
Nasim Beg 2023
There are several factors that researchers attribute to the rapid growth of the economies of European countries the fifteenth century onwards, timed with the Renaissance and Reformation, which led to technological advancements, including military capacities and the consequent colonisations and extraction of economic benefits from the rest of the world.
Piketty suggests that allocation of resources through high taxation towards building military capacity has played a major role in the rise of the Europe. In his book Capital and Ideology, he has referred to Philip T. Hoffman, “Why Was It Europeans Who Conquered the World?” The Abstract of this paper is:
By the 1700s Europeans dominated the gunpowder technology, which was surprising, because it had originated in China and been used with expertise throughout Eurasia. To account for their dominance, historians have invoked competition, but it cannot explain why they pushed this technology further than anyone else. The answer lies with a simple tournament model of military competition that allows for learning by doing. Political incentives and military conditions then explain why the rest of Eurasia fell behind Europeans in developing the gunpowder technology. The consequences were huge, from colonialism to the slave trade and even the Industrial Revolution.
Piketty has collated data of taxation collected to finance the military power. Quoting from him:
Around 1500-1600, the fiscal revenues par inhabitants of the main European States were between 2 and 4 days of urban unskilled wages; in 1750-1780, they were between 10 and 20 days of unskilled wages. Per inhabitant fiscal revenues remained around 2-5 days of wages in the Ottoman Empire as well as in the Chinese Empire. With a per inhabitant national income estimated to be around 250 days of unskilled urban wage, this implies that tax revenues have stagnated around 1%-2% of national income in Chinese and Ottoman Empires, while they rose from 1%-2% to 6%-8% of national income in Europe. (Please see the attached chart).
Thus, the European governments used taxation to allocate resources towards building military capacity, but what Piketty ignores is what some refer to the renaissance and the emergence of entrepreneurship and capitalism in Europe, as major factor of its advancement.
One of such factors is banking. The conventional wisdom is that it was the system of taking deposits and paying interest that helped banking become popular and at the same time, it helped route that money to productive commercial and industrial ventures, as well as financing the sovereigns of the time towards their military and other capacities.
The advent of fractional reserve banking
To my mind the factor that seems to be ignored is the money multiplier role of banking.
Bankers had been around for ages and amongst their role of acting as middlemen between depositors and borrowers, they were also issuing written notes for use by traders, who would take a letter of credit from the bank against an equivalent deposit (money/gold) with the bank and use this letter (note) to pay suppliers in other cities. Over time this resulted in the banks’ notes becoming credible enough to pass hands amongst traders, in other words these notes started being accepted in lieu of money (gold coins etc).
The acceptability of a bank’s note as if it was money, gave the banks an opportunity to embark on issuing more notes than were backed by deposits (gold etc) with them; with the Medici family playing a pioneering role.
Double entry bookkeeping, the inventor of which was Luca Pacioli and the Medicis deployed it in banking, which allowed the bankers to treat peoples’ deposits as liabilities and not as money held in trust on behalf of the depositors (the beneficial owners), but the depositor merely having a claim on the bank (the bank’s liability – one leg of the double entry bookkeeping, while the money/gold they took over, as their own assets in their books, the second leg of the bookkeeping).
This was a major step in banking, allowing the bankers to issue their notes beyond the amount of money held in deposits. They could now issue notes to traders beyond the specific deposits (money/gold) of the traders, allowing the traders to do larger volumes of business. This was the advent of money creation through what we now call fractional reserve banking.
This meant that the money supply in the market was no longer recirculation of depositors’ money, but potentially higher amounts than the initial deposits.
This was new money created out of thin air and, as long as there was a probability that some holders of the deposit receipt issued by the bank, did not have immediate use for the money, the bank could get away with issuing more notes (as interest bearing loans). So yes, interest did play a role, but the fractional reserve banking is what allowed the quantum of money circulation and economic activity to grow.
Thus, depending on the management of the economy by respective governments of the time, this allowed high levels of investment in industry as well as military capacities, enabling those countries to trade with, as well as colonise other countries and derive economic benefits, which gave a further fillip to their economies and domination capacity; thus, a virtuous cycle of economic growth set in, which continues till this day.
As a side note, as would be expected several banks sprung up and some of these became reckless in issuing more notes than prudence demanded. This resulted in several bank runs and bankruptcies. This forced the governments to set up central banks to regulate the private banks and most importantly, in order to regulate the notes being issued by the private banks, regulations were passed, through which the central bank became the sole issuer of currency notes, while allowing the private banks to make loans up to a prescribed ceiling allowed in relation to the reserves held with the central bank. Thus, all debt-based money creation by private banks is now in the legal tender of the country and not in the form of notes issued by private banks.
Piketty: At the Origins of the Great Divergence:
The Rise of European States' Fiscal & Military Capabilities 1500-1850 Vertical axis: Fiscal revenues per inhabitant in equivalent days of wages. Horizontal axis: Calendar
