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The Undercover Economist Is Back

The Undercover Economist Strikes Back coverTim Harford, who writes the Financial Times‘s “Undercover Economist” column, has appeared on our blog many times. This guest post is adapted from his new book The Undercover Economist Strikes Back: How to Run or Ruin an Economy. Harford also appeared in our podcast “Hey Baby, Is That a Prius You’re Driving?

Perhaps the strangest currency in the world can be found on the island of Yap, in Micronesia in the West Pacific. This coin, the rai, is a stone wheel with a hole in the middle. Some rai are fairly portable—a handspan or less across, and the weight of a couple of bags of sugar. But the most valued stones are far bigger—one British sailor wrote in the late nineteenth century of a stone wheel that was four and a half tons in weight and more than nine feet in diameter. In other words, it was almost completely immovable.

Yap’s stone money used to be a serious business. The stones were quarried and carved on the island of Palau, 250 miles away. One Victorian naturalist witnessed four hundred men from Yap, a tenth of the adult male population, at work in the quarries of Palau. Getting the stones from Palau to Yap on a little bamboo boat was a difficult and sometimes lethal affair—some of the stones weighed as much as two cars. (And rai were especially valuable if someone had died on the expedition to fetch them.) The biggest stones might have been used for major transactions such as buying land or wives; more modest-size stones—a couple of feet across—were exchangeable for a pig. Even then, it would have been a lot easier to move the pig than to move the stone.

All this meant that for purely practical reasons, the Yap islanders had to develop an important monetary innovation: they divorced ownership of the stone from physical control of the object. If you wanted to buy my pig, that transaction would be publicly witnessed: I’d give you the pig and in exchange, you’d transfer ownership of one of your stones—the one leaning against the tree, second on the left behind your hut. Now everybody would know that that particular stone was Tim’s stone. You and I wouldn’t have to go to the trouble of actually moving the thing.

One day, a crew from the quarries was bringing a new large stone from Palau when they ran into a storm not far from the coast of Yap. The stone sank, and the men swam to shore to tell the tale of their lucky escape and their loss. But of course, if the stone propped up outside your hut doesn’t need to move around to change ownership, why should the stone at the bottom of the sea be any different? This giant stone on the seabed had an owner—the chief who had sponsored the expedition to get it. And now his ownership could be transferred to another rich islander, and then to another, just as with any other stone. It was perfectly good money, even though it was out of sight and out of reach.

Yap’s monetary system sounds pretty close to insane. But is it? For many years the monetary systems of the developed world were based on gold. The gold itself—heavy stuff, although the ingots were not usually as heavy as a giant stone doughnut—would be left in bank vaults, after having been mined at great cost and risk from far-off lands. Naturally, in an anonymous urban society such as London or Venice, nobody could use the Yap island honor system of “everyone knows that’s Tim’s gold lying there.” But the idea was much the same. The gold, like the stone rai, rarely moved. It stayed in the bank vaults. People would instead carry around pieces of paper recording the fact that they owned the gold.

At first this was a purely private arrangement: a merchant with some gold would rent space in a secure vault from a goldsmith. The goldsmith would give him a note acknowledging that the gold belonged to the merchant. If the merchant wanted to buy something from a second merchant, he’d take the note to the goldsmith, collect his gold, use the gold in the trade, and then the second merchant would take the gold back to the goldsmith and collect his credit note. After a while, it became obvious that it was easier to pass around the credit notes than to go back and forth to the goldsmith all the time.

Banknotes such as the U.S. dollar and the pound sterling were descendants of this system. (Paper money has a much longer history, however. Kublai Khan, Chinese emperor in the thirteenth century, introduced a system of purely paper money that astounded the visiting Italian merchant Marco Polo.) Modern British and old American notes promise to pay “the bearer on demand,” a promise that once referred to redeeming the banknote in gold, just as with the private goldsmiths’ banknotes. But modern currency is no longer linked to gold at all—it once was but most countries broke that link, the “gold standard,” in the early 1930s.

So on Yap, they have this crazy system where the precious stone can be perfectly good money even when it is at the bottom of the sea. In the modern world, we have a far crazier system: the precious metal can be perfectly good money even though it isn’t there at all. We just circulate the bits of paper, with their nods and winks toward the old days when they were claims on gold in a vault. Now they are claims on nothing in particular, and somehow also claims on anything at all.

Reprinted from The Undercover Economist Strikes Back: How to Run or Ruin an Economy by Tim Harford, published by Riverhead Books.