Financial systems and development

with the expansion of nonlocal trade in Europe. quently introduced in Japan. In Europe, bank
These were particularly useful in triangular trade, notes (representing promises to pay on demand)
because only net settlements had to be made in were issued in the seventeenth century by goldspecie.
Commercial bills known as hundi were smiths, notaries, and merchants, who gradually
developed in India. In Japan, the need for cash developed into bankers. Banks created by special
was reduced by the use of bills and rice warehouse charter, such as the Bank of England, also issued
warrants and by the development of clearing notes. In the colonies of North America, a chronic
facilities.
shortage of bullion led to the issue of land-backed
The direct role of governments in creating paper- certificates, which circulated as paper money.
based credit instruments was limited-although The overissue of bank notes often undermined
they provided the legal framework that was neces- the credibility of paper money and led to financial
sary for their use. Governments played a greater crises and the suspension of the notes' convertibilpart
in the development of paper money. They ity into bullion. This happened in the American
were involved either directly (as in China) or indi- Carolinas and France in the eighteenth century,
rectly (which was more common), through grant- and in several European and Latin American couning
the right to issue paper money to private bank- tries in the nineteenth century. Attempts in the
ers. China invented paper money in the ninth nineteenth century to regulate the supply of goldcentury.
The ruler, acutely aware of the problems backed bank notes in England stimulated the use
of paper money, enforced acceptance with the of checks drawn on bank deposits to make paythreat
of death and by strictly limiting issuance ments and thus promoted the spread of a more
(see Box 3.1), although there were many later in- efficient and versatile instrument of payment. The
stances of overissue. Paper money was subse- growing use of bank notes issued by different
bankers led to the creation of clearing facilities,
i, _ ,_, : :! . __ ' which were later extended to cover the clearing of
i 5, ;, =, t ,,~,_ .,__,
' l 0, checks.
Box 3.1 Marco Polo discovers
As central banks evolved to cope with the recurpaper
money V ring financial crises of the latter part of the nine-
F
"In this citv of Kanbalu [Beijing] is the mint of the teenth century, they came to monopolize the note
Great Khan, who may truly be said to possess , issue. This led to the eventual adoption of fiat
the secret of the alchemists, as he has the art of i money-that is, paper (and later credit) money not
producing money .. . He causes the bark to be backed by bullion. Fiat money solved the problem
stripped from ... mulberry-trees.. . This . is I of loss of confidence in bank notes issued by indiimade
into paper, resembling, in substance, that L vidual banks, but not the problem of overissue of
which is manufactured from cotton, but quite vipa ler money by the central bank. Many countries
black. When ready for use, he has it cut into pr
' . N m~~~i Asia, Europe, and Latin America suffered epipieces
of money of different sizes, nearly square, i A
but somewhat longer than they are wide ... The sodes of hyperinflation after governments had
coinage of this paper money is authenticated with used the central bank's printing presses to finance
as much form and ceremony as if it were actually their deficits.
of pure gold or silver; for to each note a number of The twentieth century has seen further innovaofficers,
specially appointed, not only subscribe tion in payment instruments, including plastic
their names, but affix their seals also .. . The act of cards and electronic transfers. These were develcounterfeiting
it is punished as a capital offence.
When thus coined in large quantities, this paper oped primarly to improve the efficiency of paycurrency
is circulated in every part of the Great ments rather than to promote expansion of trade.
Khan's dominions; nor dares any person at the In most countries, central banks now play an imperil
of his life, refuse to accept it in payment. All portant role in the payment system: they provide
his subjects receive it without hesitation, because, F clearing and settlement facilities to banks and to
wherever their business may call them, they can other institutions that offer payment services.
dispose of it again in the purchase of merchandise K
they may require; such as pearls, jewels, gold, or Dt
silver. With it, in short, every article may be procured."
Marco Polo In preindustrial economies, governments bor-
The Travels of Marco Polo, Book II, Chapter 24 ] rowed to pay for wars, and seaborne trade was
IL (Komroff 1926, pp. 156-57) F financed, as it had been since classical times, by so-
)j 5,called bottomry loans (a combination of loan and
42