Winston Churchill once said: “The farther back you can look, the farther forward you are likely to see.” Those words apply to many aspects of our lives, not least economics.
The past few weeks have seen the pound slump in value. In May alone, it fell by around eight per cent on its year-on-year value against the dollar, a clear sign of diminishing investor confidence in the currency.
The source of this weakening investor appetite for the pound can be traced in part to the Bank of England’s response to the pandemic. To finance the government’s increased spending for measures such as the furlough scheme, the Bank of England introduced massive amounts of quantitative easing (QE). A side-effect of QE was a massive expansion in the money supply to the tune of some £450bn (20 per cent). This expansion has fuelled inflation by weakening the purchasing power of the pound and, in turn, eroded investor confidence.
As the Ancient Romans will attest, loss of trust and confidence in a currency should not be treated lightly. The Romans were financial innovators like no others before them. Under the reign of Emperor Augustus (27BC to 14AD) the Romans introduced a new currency system that would see a fixed exchange rate between the three different coins in circulation (Aureus – gold, Denarius – silver, and Sestertius – brass). This seemingly simple innovation was radical.
It created what was in effect the world’s first fiat currency. Characterised by price stability, with almost all goods — barring some seasonal commodities — able to be found at the same prices from Judaea in the east to Britannia in the north. This new currency system with its stable exchange rate facilitated commerce and enabled Rome to transition from an empire driven by military conquest to one driven primarily by trade.
But the Romans discovered their own form of quantitative easing. Under the economic mismanagement of the emperor Septimius Severus in the 2nd century AD, the currency was debased. This expansion in the money supply contributed to spiralling inflation, a banking crisis, and, ultimately, the decline of the empire.
Indeed, it wasn’t until the British Pound emerged in the 18th century that the world would once again see a currency as well organised as the one at the heart of the Roman Empire from the 1st century BC to the 3rd century AD.
This fatal debasement can be traced back to one decision. Almost overnight, Septimius doubled the wage of the Roman army. In doing so, the need for coins also doubled, and to meet this demand mints had to reduce the content of gold, silver and bronze in various Roman coins, making up the rest with cheap base metals. With coins’ values diminished, so too did investor confidence. Confidence in the currency eventually became so low that the fixed exchange rate between these coins broke down. Consumers were reduced to having to barter over the value of goods and services. Eventually, the Roman banking system collapsed around 260 AD.
Quantitative easing is a modern form of currency debasement. The Bank of England decision to continue with its programme of quantitative easing until December last year was the equivalent of Roman mints gradually reducing the quantity of precious metals in their coins. As it was with Roman coins, money now is a commodity; a huge increase in supply will lead to a decrease in its value. Quantitative easing is driving inflation, a fact which the Bank of England ignores in its quarterly monetary reports which consistently underestimate future inflation.
Former Bundesbank chief Karl Otto Pöhl once said that “inflation is like toothpaste. Once it’s out, you can hardly get it back in again.”
The Bank of England requires major self-examination. As described by Bagehot in his book Lombard Street: A description of the money markets, the Bank in the 19th century was run in a markedly different way. The Bank’s board was made up of “plain, sensible, prosperous English merchants” that acted according to “safe principles” of the business world at the time. That is a far cry from the Bank of today, whose executive of academics lacks the business acumen to truly safeguard our modern economy.
Our economy, despite its current dismal state, is still an amazing economic system overall. We do not want to see it wrecked as Rome’s was. We think of the Roman empire as a world long bygone and distant, with little in common with us.
Given the similarities in the root causes of their economic problems and our own, we have vast lessons to learn from Augustus and Septimius.