Gold, Silver and the New World

The mountain of silver

On the Andean plateau, at an altitude that takes the breath away, rises a mountain of almost perfectly conical shape that the Spaniards called the Cerro Rico, the Rich Mountain. Beneath its reddish surface lay one of the greatest concentrations of silver the Earth had ever offered to men, and when, around the middle of the sixteenth century, that treasure was discovered and began to be exploited, at its foot there arose, within a few years, a city. Potosí, born from nothing in an inhospitable place where no one would otherwise have lived, became within a few decades one of the most populous cities in the world, comparable in number of inhabitants to the great European capitals — and this at over four thousand metres of altitude, in the midst of a frozen desolation where everything, from food to timber, had to be brought from afar. Only silver could justify such madness; and of silver, from the belly of the Cerro Rico, there came forth for generations in quantities that astounded the world.

But beneath the splendour of Potosí lies a horror that cannot be passed over, and that is an inseparable part of the history of money. To extract the silver from that mountain required immense and deadly labour, and supplying it was, in very large part, coerced indigenous manpower. The Spaniards adapted and bent to their own ends an Andean institution of rotating labour, and added to it the harshness of colonial exploitation: generations of indigenous workers were sent into the bowels of the mountain and into the refineries where the silver was separated from the ore, in dreadful conditions, with a mortality that the sources of the time already denounced as terrible. The mercury used to refine the metal poisoned those who handled it; the galleries swallowed men; cold and toil killed others. However much the precise figures escape us and must be handled with caution, it is certain that the human price of the silver of Potosí was immense, paid by the peoples of the New World. The money that was about to inundate Europe and to set in motion the first truly global economy was born, at its source, from one of the darkest pages in history. It is well to bear this in mind: behind the luminous abstraction of money that circulates there are always, somewhere, real bodies and real toil, and never was this more true than for the silver of the Americas.

This chapter tells what happened when that river of precious metal poured onto the world. It is a story with three protagonists: the metal itself, which for the first time bound distant continents in a single monetary network; inflation, the long “price revolution” that the influx of silver accompanied, and that forced people to ask, perhaps for the first time, about the relationship between the quantity of money and the value of things; and Spain, which possessed that treasure and which, paradoxically, was impoverished by it rather than enriched. From these three intertwined stories emerges one of the most important ideas in all of economics, the quantity theory of money, and with it a truth that the rest of the book will only confirm: that money is not wealth, but only a sign of it, and that to multiply the signs does not multiply the things.

The first global money

Before the sixteenth century, the world was made of largely separate economies. There existed great trade networks — the Silk Road, the trade of the Indian Ocean, the Mediterranean routes — but no money truly bound the entire planet in a single circuit. The silver of the Americas changed this forever, and did so by following a trajectory worth reconstructing, because it is the first time in history we can speak of a monetary system on a world scale.

The first wave of metal, moreover, was not of silver but of gold, and came not from mines but from plunder. When the Spaniards, in the first decades of the sixteenth century, brought down the great empires of Mexico and Peru, they laid hands on the treasures accumulated over centuries by those civilisations: objects of gold and silver of extraordinary workmanship, masterpieces of indigenous goldsmithing, which were for the most part melted down without regard so as to turn them into ingots and coins to be shipped to Spain. It was an immense cultural destruction, as well as a robbery, and it marked the beginning of the flow of American metal toward Europe. But the plundered gold, however fabulous in the imagination, was soon far surpassed, in quantity and in duration, by the silver extracted systematically from the mines, and it was silver, not gold, that made up the bulk of the American treasure and produced the monetary effects of which we speak. Gold kindled the legend — Eldorado, the fever of the conquerors — but it was silver, humbler and more abundant, that truly changed the history of money.

The metal extracted at Potosí and at the other American mines was melted, struck into coins or cast into ingots, and loaded onto the fleets that, under armed escort, crossed the Atlantic toward Spain. There arrived the famous “treasure of the Indies”, which made the Spanish crown the richest in Europe. But that metal did not stay in Spain: from there it poured into the rest of Europe, to pay for the goods Spain imported, the debts the crown contracted, the armies that fought its wars. Spanish silver thus flowed to Antwerp, to Genoa, to Amsterdam, to all the centres of European commerce and finance, irrigating the economy of the continent. And it did not even stop there. An enormous part of the American silver took the road to the East, because in Asia, and above all in China, silver was worth more than in Europe: China, with its immense economy, had an insatiable hunger for silver, which it used as money and as a store of value, and was willing to give in exchange its precious goods — silks, porcelains, tea. Thus a Pacific trade route opened: from the American coasts, through the Philippines and the port of Manila, New World silver travelled to China, while Asian goods returned toward the Americas and Europe.

It is worth asking why, exactly, silver flowed toward China, because the answer reveals a mechanism that governs money even today: arbitrage. In Europe and in China there prevailed, in effect, two different ratios of value between gold and silver. Almost everywhere both metals circulated as money — a system called bimetallism — and their exchange ratio, how much gold was worth so much silver, was not the same in the two regions: in China silver was relatively more precious compared with gold than it was in Europe. This simple difference created an enormous opportunity for gain: whoever carried silver from Europe to China could exchange it for more gold, or for more goods, than he would have obtained by staying in Europe. The metal, like water seeking its own level, flowed spontaneously toward the place where it was worth more, until the flows tended to bring the two ratios back together. It is the principle of arbitrage: when the same good has different prices in two markets, commerce undertakes to transfer it from the cheap market to the dear one, profiting from the difference and, in so doing, reducing it. This mechanism, which we shall see at work throughout monetary history — from the gold flows of the nineteenth-century gold standard down to the currency markets of today — was what set in motion the river of silver toward the East, and what made the ratio between the precious metals a question of world scale, because it bound the monetary systems of different continents through the flow of the metal [Eichengreen 2008].

For the first time, then, a single monetary metal connected in a continuous circuit four continents: extracted in America by the hands of the indigenous peoples, transported to Europe, from there scattered across the Old Continent or shipped across two oceans to Asia, in exchange for goods that returned along the same routes. This Pacific route even had its concrete and legendary symbol: the galleon that, for over two centuries, linked once a year the American coasts to the Philippines, crossing the immensity of the ocean in a long and perilous voyage. Laden with silver on the outward journey and with silks, porcelains, spices and other marvels of the East on the return, that galleon was the material thread that stitched together the two ends of the world, the vessel on which, literally, the first globalisation travelled. Consider what it meant: silver extracted from a mountain of the Andes, carried overland to the Pacific coast, loaded onto a ship that crossed the greatest ocean on the planet, landed at Manila, and from there distributed toward China, where it would become money and store of value for the most populous economy on Earth — while in the opposite direction Chinese goods took the same road to reach the Americas and, across the Atlantic, Europe. A single metal, extracted from the bowels of a continent, put into communication and mutual dependence civilisations that until shortly before did not even know for certain of one another’s existence. It was something absolutely new in human history.

The first global economy had been born, and what held it together was silver: a substance desired everywhere, accepted everywhere, that served as the common language of exchange between worlds that until then had ignored one another. Note, once again, the dual nature of money we have followed from the beginning: silver functioned as global money insofar as it was a commodity — because it was worth its metal content, recognised in every culture — but precisely this universality made it something more than a commodity, the first true planetary means of exchange, the remote ancestor of every future international currency [Goetzmann 2016].

Too much money

When so enormous a quantity of precious metal pours onto an economy, something must happen, and what happened in sixteenth-century Europe was a phenomenon historians have called the price revolution. In the course of the century, and in the one following, prices in Europe rose in a prolonged and generalised way, until they multiplied several times over compared with the starting levels. To our eyes, accustomed to inflations even violent, a rise in prices spread over a century and a half may seem modest; but to the world of that time, accustomed to substantially stable prices for generations, it was an upsetting change, which eroded incomes, disrupted the relations between classes, ruined those who lived on fixed rents and enriched those who owned land and goods. The value of money — of that same silver that flowed in abundance — was waning: ever more metal was needed to buy the same things.

It is worth dwelling on the social consequences of this long inflation, because an inflation does not strike everyone in the same way, and precisely in the diversity of its effects lies much of its historical importance. The prolonged rise in prices ruined above all those who lived on fixed incomes, established in money and unchanging over time: the owners who had let their lands at rents fixed for long periods, the creditors who had to be repaid sums lent when money was worth more, all those in short whose income was nailed to nominal figures while prices raced ahead. For these, inflation was a silent and inexorable erosion of their standard of living. At the opposite end, advantage was drawn by those who owned real goods whose price rose — land, goods, produce — and those who had debts to repay, because they returned in debased money what they had received in money of greater value. Inflation, in general, harms creditors and favours debtors, strikes those who live on fixed rents and rewards those who own or produce real things: it is a hidden redistribution of wealth, which occurs without anyone deciding it, by the mere fact that the yardstick of value shortens. This capacity of inflation to transfer wealth from one category to another without an explicit political decision makes it one of the socially most disruptive phenomena in monetary history, and we shall meet it again, with even more violent effects, in the great inflations of the twentieth century.

The connection between the two things — the influx of silver and the rise in prices — seemed evident to the keenest contemporaries, and it does indeed appear intuitive: if the quantity of money in circulation grows enormously while the quantity of goods remains more or less the same, it is natural that each unit of money should be worth less, and therefore that prices, expressed in money, should rise. It is as if, at a party, the cloakroom tickets were suddenly doubled without increasing the number of coats: each ticket would be worth half, and one would have to give double to get the same coat back. Money, in the end, is a ticket that gives a right to a share of real wealth; and if more tickets are printed without increasing the wealth, each ticket is worth less. This intuition, which today seems to us almost obvious, was one of the great intellectual discoveries of the age, and it was born precisely from the observation of the price revolution.

Here, however, the prudence of the historian imposes an important clarification, which the reader must keep well in mind so as not to fall into too easy an explanation. The connection between American silver and the price revolution, however plausible and for a long time taken for granted, is in reality the object of a lively and still open historiographical debate. Later studies have shown that prices had begun to rise in some regions of Europe before American silver arrived in quantity, which suggests that other causes were at work. Among these, the most important is probably demography: after the devastations of the epidemics of the late Middle Ages, the European population had returned to growth, and a growing population exerts an upward pressure on prices, in particular on those of foodstuffs, because it increases the demand for goods whose supply cannot expand as rapidly. The influx of silver, in this more nuanced reading, was not the sole cause of the price revolution, but one of the factors that concurred in it, alongside demographic growth, the increase in the velocity of money’s circulation, and other elements. The truth is that the great inflations of the long period almost always have multiple and intertwined causes, and to attribute them to a single factor is a simplification: the case of the sixteenth century is a classic example of how historians, examining closely, complicate explanations that are too linear. What concerns us, however, is not to resolve the debate, but to grasp the idea that was born from that experience, and that proved one of the most fruitful in economic science.

The quantity theory

The idea is the one we today call the quantity theory of money, and it was formulated for the first time, in explicit form, precisely by the observers of the sixteenth-century price revolution. Curiously, some of its first enunciators were men of the Church: the theologians and jurists of the School of Salamanca, in Spain, who, observing the influx of American metal, were the first to grasp the connection between the abundance of money and the height of prices. Later, in the same century, the French thinker Jean Bodin gave the principle a famous formulation, indicating in the abundance of gold and silver the principal cause of the rise in the price of everything. From then on the quantity theory would become one of the pillars of economic thought, crossing the centuries down to the monetary debates of our own time.

It is worth dwelling a moment on those thinkers of Salamanca, because their contribution goes well beyond the quantity theory alone, and makes of them a kind of forgotten ancestors of economic science. They were theologians, engaged in resolving problems of conscience — is this gain lawful? is this price just? — but precisely by tackling such moral questions they developed economic analyses of surprising acuteness. Reflecting on the “just price” of a commodity, they came to the conclusion, anything but obvious for their time, that the just price is not the one fixed by an authority or calculated on the basis of cost, but the one that forms freely on the market from the meeting of seller and buyer: an early defence of the market price as the measure of value. They intuited that the value of a good does not depend on an intrinsic quality of it, but on the esteem men make of it, on its utility and its scarcity — anticipating by centuries ideas that economics would systematise only much later. And, observing American silver, they grasped the connection between its abundance and the rise in prices. That all this should have been born from moral theology need not surprise: for centuries, as we have seen, the questions of money were first of all questions of conscience, and it was often by reflecting on what was lawful that men learned to understand how the economy works. The School of Salamanca is a fascinating chapter of this history, in which moral reflection and economic analysis still walk together, before parting in the following centuries.

In what does the quantity theory consist, in substance? In the assertion that the general level of prices depends on the quantity of money in circulation: if money increases more rapidly than the available goods, prices rise; if it decreases, prices fall. Money, in this view, has no fixed value of its own: its purchasing power depends on its relative quantity compared with the things one buys with it. It is an idea with profound consequences, because it means that whoever controls the quantity of money — once those who owned the mines, today the central banks — controls, at least in part, the value of money and therefore prices.

The best-known form in which this idea has been expressed is a simple relation, worth looking at once, not to make technical use of it, but because it sums up the intuition elegantly. Consider, on one side, the quantity of money in circulation and the rapidity with which it passes from hand to hand — because a single coin, if it circulates quickly, performs more transactions; on the other, the volume of goods exchanged and their price. The idea is that total monetary spending — how much money circulates, multiplied by how many times it turns over — must equal the total value of exchanges — how many goods are sold, multiplied by their price. In symbols, denoting by $M$ the quantity of money, by $V$ its velocity of circulation, by $P$ the level of prices and by $T$ the volume of transactions, this equality is written $M \cdot V = P \cdot T$. The relation, in itself, is almost a bookkeeping truth, an identity: it says only that the same thing, seen from two sides — the money spent and the value bought — must coincide. But it becomes a theory, and a powerful one, when one adds a hypothesis: that the velocity of money and the volume of exchanges are relatively stable, at least in the short period. If that is so, then an increase in the quantity of money must translate, predominantly, into an increase in prices: more $M$, with $V$ and $T$ unchanged, means more $P$. This is the heart of the quantity theory, and it is exactly what seemed to happen in the sixteenth century, when American silver swelled the quantity of money and prices rose.

It is worth insisting on one point, because it is the ultimate sense of the whole affair and will return in every following chapter. The quantity theory reveals that money is not wealth. It seems a paradox, because we are accustomed to identifying money with wealth; but the price revolution demonstrated it in the most striking way. Spain received immense quantities of silver, and yet that silver, multiplying, lost value, and prices rose until they cancelled much of the advantage. To have more money, if everyone has more money, does not make one richer: it only makes prices higher. The true wealth of a nation is not the quantity of precious metal it possesses, but its capacity to produce goods and services; money is only the sign by which that wealth is measured and exchanged, and to multiply the signs does not multiply the things. It is a lesson men should have learned once and for all in the sixteenth century, and that instead they would have to relearn, at a high price, countless times over the centuries: every inflation in history, down to those of the twentieth century, is in the end a new edition of the same discovery.

The Spanish paradox

We come thus to the third protagonist of this story, and to its paradoxical destiny. Sixteenth-century Spain possessed the greatest source of precious metal in the world, and received for over a century a river of gold and silver that no other power could equal. It was, on paper, immensely rich. And yet, at the end of that golden century, Spain found itself impoverished, indebted, in decline, while other nations that possessed no mines — Holland, England — were setting out toward prosperity. How was it possible? How could the nation richest in precious metal come out poorer from the age of its greatest wealth? The Spanish paradox is one of the most instructive enigmas in economic history, and its explanation illuminates once again the difference between money and wealth.

Part of the answer lies precisely in the quantity theory. The silver that flowed into Spain made Spanish prices rise more rapidly than elsewhere, and this made Spanish goods expensive and uncompetitive compared with foreign ones. It was more convenient to buy abroad, where prices were lower, than to produce at home; and so the silver, as soon as it arrived, set off again at once to pay for imports, crossing Spain without stopping, without feeding a national industry and agriculture which, on the contrary, languished, crushed by rising costs and foreign competition. Spain became a kind of conduit through which the American metal passed on its way to fertilise the economies of other countries, those that produced the goods Spain bought. The silver did not transform itself into Spanish productive wealth: it merely crossed the country, leaving behind inflation and little else.

But there was more, and it touches the way that treasure was spent. The Spanish crown used much of the American silver not to invest in the development of the country, but to finance an ambitious and ruinous policy of power: continual wars across Europe, immense armies, the defence of a boundless empire and of a religious cause. The metal flowed in and was immediately burned up in military expenses, often even before it arrived, because the crown went into debt anticipating the future revenues of the fleets. The result was that Spain, though receiving so much silver, accumulated enormous debts, and — as we saw in the previous chapter speaking of the Fugger — the Spanish crown was forced several times, in the course of the sixteenth century, to declare in effect bankruptcy, suspending payments to its creditors. The nation richest in precious metal in the world repeatedly went bankrupt. It is the paradox in its most acute form: the treasure of the Indies, instead of being the source of a lasting prosperity, was a curse that fed unsustainable ambitions, discouraged domestic production, and left Spain, in the end, weaker than when it had begun [Davies 2002].

A partly mirror-image destiny befell, at the other end of the world, China, which was the great absorber of that silver. For centuries the American metal flowed toward the Chinese empire, which swallowed it in boundless quantities, integrating it deeply into its own fiscal and monetary system, to the point that the taxes themselves came to be collected in silver. This bound the fortunes of Chinese public finance to a metal that came from the other side of the planet, and when, in the following centuries, the silver flows knew interruptions and crises, the Chinese economy too was shaken by them: a dangerous dependence on an external resource, which shows how the global monetary interweaving, once established, binds the destinies of far distant countries in ways no one controls. China did not undergo the Spanish paradox in the same form — it did not ruin itself through an excess of military ambitions financed by the metal — but it too experienced, in its own way, the truth that silver conveyed: that to entrust one’s stability to a flow of precious metal means to expose oneself to forces that come from afar and that cannot be governed.

Modern economists have a name for phenomena of this kind, observed also in recent times among countries suddenly enriched by a natural resource: they speak of the “resource curse”, the apparent paradox by which the abundance of an easy natural wealth — a precious metal, oil — can harm the long-term development of a country, discouraging the labour, the industry and the institutions that produce a more solid but more laborious prosperity. Sixteenth-century Spain is perhaps the first great historical example of it, and its destiny still admonishes today: true wealth is not found in a mountain, however full of silver; it is built with labour, ingenuity and institutions, and no treasure can replace it.

The dollar born in Spain

There is a concrete and lasting legacy of this whole affair, and it hides, surprisingly, in the name of the most powerful currency in the contemporary world. The great silver coin that Spain struck with the American metal was the “piece of eight”, the real de a ocho — so called because it was worth eight reales, the Spanish monetary unit. Struck in boundless quantities, of good silver and constant weight, the piece of eight became what Athenian silver and the Byzantine solidus had been for their worlds: an international currency, accepted and desired everywhere, from the Americas to Europe to Asia. For centuries, in a world fragmented into a thousand different currencies, the Spanish piece of eight was the universal money of world commerce, the common yardstick by which exchanges between the continents were measured.

Its diffusion was such that it circulated freely even in the English colonies of North America, where British money was scarce, and became there one of the current currencies. And when those colonies, having become independent, had to give themselves a national currency of their own, they chose as model and as base precisely the great Spanish silver coin they already used: they called it, with a name of Germanic origin that designated generically the great silver coins, the “dollar”. The American dollar was born, in short, as the direct heir of the Spanish piece of eight, of the silver of Potosí struck by the crown of Spain. Even the dollar sign, according to the most credited hypothesis, would derive from an abbreviation tied to the Spanish coin. It is one of the most eloquent ironies in the history of money: the currency that today dominates the world, symbol of American power, carries in its name and in its origins the memory of the metal extracted from the peoples of the New World and struck by the Spanish empire. The thread that binds Potosí to the contemporary dollar is one of those hidden continuities that make the history of money so fascinating: nothing, in it, truly begins from nothing, and every currency carries within itself the memory of those that preceded it.

What silver teaches

Let us draw together the threads of this story, because its lessons run through the whole book. The silver of the New World was, first of all, the demonstration on a planetary scale of a truth we had already met in the ancient world, speaking of the debasement of the denarius: that the value of money depends on its quantity, and that to multiply money does not create wealth but only inflation. What in Rome had occurred through the deliberate dilution of the metal in the coins, in the sixteenth century occurred through the natural influx of an enormous quantity of new metal; but the result was the same, the loss of value of money and the rise of prices. Two different roads, the same landing: money that depreciates when one has too much of it. From this twofold experience was born the quantity theory, one of the founding ideas of economics, which will accompany us down to the chapters on twentieth-century inflation, where we shall find it at the centre of the bitterest monetary debates of our time.

In the second place, the affair of silver shows for the first time the global dimension of money. With the American metal, and with the piece of eight struck from it, money became for the first time a planetary phenomenon, a common language that bound distant economies and cultures in a single circuit of exchange. It was the dawn of monetary globalisation, of that process by which the economic fates of the world’s different countries would become ever more intertwined and interdependent — a process that, through the gold standard of the nineteenth century and the international monetary systems of the twentieth, reaches down to our present of global markets and instantaneous capital flows. The network that the silver of Potosí wove across four continents was the first sketch of the interconnected financial world in which we live.

Finally, and perhaps above all, the story of silver and of the Spanish paradox teaches the decisive difference between money and wealth. To possess money is not to possess wealth; and a nation, like an individual, does not become prosperous by accumulating signs of value, but by producing things that have value. Spain, which had the money and did not build the wealth, declined; nations that had less metal but built industries, commerce, institutions, prospered. This lesson — that money is a means and not an end, a sign and not the thing signified — is perhaps the most important the history of money can offer, and it runs through the whole book like a ground bass. We shall meet it again, under other forms, when money abandons metal entirely and becomes pure promise: because the risk of mistaking the sign for the substance, the shadow for the body, accompanies money in every form, and never is it more insidious than when money becomes, as it will, completely immaterial. But before dematerialising entirely, money had to take another great step: to learn to be paper, to be worth as a promise of metal instead of as metal. That is the story of the first banknotes and of the first, vertiginous bubbles they made possible — the story of the next chapter.