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the short end of the stick

hazelwood tally stick It was one of the greatest heists in history. The scene? London, 1660. The perpetrator? England’s King Charles the II. The loot? All the gold he could con out of the country’s goldsmiths, bankers and businessmen. The tool?
 
A tally stick.

Tally sticks were a brilliant invention, but they were also insidious as they formed the foundation for the fiat currency systems we still have today. One where the root of a currency’s value is in a promise from a faceless institution, and not in the actual value of an object.

Put into use about a thousand years ago, they were a common sense solution for a young gold-and-goods economy where gold was scarce. By the time of the heist they were used in everyday transactions.

Here is how it worked. When a loan was made, the debt was carved in a standard fashion on the surface of a small (preferably hazelwood) stick, and then the stick was split in half through the center of the carving. The longer end of the IOU was given to the purchaser, and its handle was called the “stock” — the root of the word’s use in today’s markets.

Even a mostly illiterate public could read the amount scratched into the wood, and the stick would only fit perfectly with its original other half. That way, when the debtor returned with the money (or goods) owed, the sticks would be matched and the debt would be “tallied.”

In that fundamental use, they worked perfectly. But of course, as is governments’ way, the King was tempted to stretch those bounds.

Charles II ruled at a time when royal power was still based on a divine mandate. His government and institutions — and indeed he himself — saw the king as the Chosen One, which was a real shame for him because it bound him to the laws of Christendom. And Christianity at the time still forbade lending or borrowing with usury (interest). When financing several failing wars against neighboring countries depleted royal coffers, Charles II needed some quick cash to continue living in kingly fashion.

King Charles II turned to the trusted tally and the keen idea of selling his (government) tallies (debt) at a discount. That way he could allow his lenders to profit without charging interest — the basis for government debt being sold at a discount today.

And the King could issue advance tallies for emergency spending, an idea that proved all too tempting. He sold the tallies collected by his Exchequer (tax collector), essentially trading future tax receipts to the country’s goldsmiths (bankers) for quick cash.

The tallies were receipts for taxes to be paid later in the year. This is a crucial part of the story: they weren’t trading on the value of the objects being traded, but on the cost of waiting for a return and the government’s ability to collect taxes and stay honest. If the government is not honest, this is an outright Ponzi scheme, one where new debt issue could theoretically pay for passing bills. For a while.

The King realized that he’d stumbled onto something big. He could wage all the war he wanted and pay his bills with the gold he got for hazelwood. The King spent and spent, and the goldsmiths’ vaults filled up with more and more sticks.

Goldsmiths were handing out certificates for fractional gold reserves and inflating the young economy in a con all their own. And since the King played along with their early building of a banking system, they played along with the sticks-for-gold investment strategy.

Over time, the market got wise to the game. Buyers started attaching larger and larger discounts to the King’s debt to offset the perceived risk in loaning money to the King. The discounts prompted the King to issue even more tallies, promising out more future tax revenues just to meet his short-term spending desires. But remember only the discount was changing here. So the mountain of taxes to be redeemed in order to pay off his debts grew in comparison, soon overwhelming the King’s income.

By the time the whole Ponzi scheme came to an end, the King’s sticks were trading at a 10% discount (to put that into perspective, short-term T-Bills are currently trading with discounts of one-tenth of one percent or less). The payments on his newer issues trading at that discount soon outmatched all the Kingdom’s tax revenues, effectively bankrupting his Exchequer and threatening to put the monarchy in the poorhouse.

So with the stroke of a pen, the King simply declared those debts illegal and ceased payment.

With that single stroke he stole most of England’s gold — having already spent it — and forced the young economy to fall flat on its face. The King’s various creditors ended up on “the short end of the stick” and all credit in the country evaporated very nearly overnight.

Pretty scary, huh? I’m glad such a thing could never happen today.

14 thoughts on “the short end of the stick

  1. Ms. Walden,

    A thoughtful piece. A few quick comments:

    1. A discount represents a market price below the face value of an instrument e.g., if a bond has a face value of $1,000, it is trading at a value less than $1,000. A premium is a situation where the market price is higher than the face value.

    2. A yield is the interest rate. Treasury yields had fallen to historic lows late last year. Currently, the 3-month T-bill has a yield of around 0.3%.

    3. A yield is not the same thing as a discount.

    Anyway, nice piece.

  2. Oh, Don. No complexity, please! But since you brought it up I’ll add a further clarification.

    Treasury bonds carry a coupon interest rate which is calculated on the face value of the security, say 6% on a $1000 bond, and is paid every six months, until the bond matures in 20 or 30 years. If that coupon interest rate is higher than an investor could get for a similar security, say a corporate bond, the bond may trade at a premium or discount, meaning an investor would buy the bond for more or less than a $1000. At the end of the term, the holder would be paid $1000. The premium or discount plus the coupon interest received determine the “yield” which is, as Don explained, the effective or actual interest rate.

    Treasuries — the way the government borrows money — come in four varieties: 1. Treasury bills which mature in under a year and carry no coupon interest rate, meaning the entire yield is determine by the discount, 2. Treasury notes which mature in two to ten years, 3. Treasury bonds which mature in 20 to 30 years, and 4. Treasury Inflation-Protected securites. There are also a number of non-marketable securities that are bought and sold directly through the Treasury, such as U.S. savings bonds.

    There are factors other than yields that affect the price of Treasury securites, e.g. risk. In times of market volatility Treasury securities are seen as a “safe bet” as compared to corporate stocks and bonds. When I was an auditor for KPMG we didn’t worry about the valuation or collectibility of government debt instruments held by the corporations we were auditing. We simply put a note in our workpapers that these securities were BACKED BY THE FULL FAITH AND CREDIT OF THE US TREASURY and trusted that our government would never do what King Charles II did.

  3. Nice additional comments, Marie.

    Overall, I like the piece Ms. Walden wrote. I didn’t mean to nitpick.

    And, speaking of other factors that could become more prominent as the U.S. seeks to raise unprecedented funds, a former advisor of China’s central bank advised that the U.S. provide currency risk-related guarantees. In other words, the advisor wants China to seek assurances that the U.S. won’t take steps that lead to the dollar’s decline relative to the yuan. That’s the opposite of Secretary Geithner’s stream of thought that implied a U.S. desire for a stronger yuan and it is not surprising considering the 43% decline in China’s overall exports in the 12-months ended in January 2009.

  4. Exactly, Marie.

    I always assumed that NMT is a room, even if its dimensions are virtual. Descartes once observed, “An optimist may see a light where there is none…” Perhaps we see a room where there is none?

  5. Where does one buy hazelwood wholesale? Can we automate carving tools? Would eBay allow the sale of such items? How about networks like Avon or Mary Kay? Would sandalwood or scented woods be acceptable? Does these woods float? Do they clear custom X-Rays? So many questions and so little time!?!

  6. Well I assume this thread has gone stale but, while reading Browns “Web of Debt” and trying to understand the ununderstandable I was struck by Marie’s take on tally sticks vs Browns. It was clearly the abuse by the king and not the medium. Brown’s point is that the tally stick was a much more honest currency in that it was meant to actually represent a substance or act of real value. So Marie’s article is probably an accurate snapshot but left me uninformed with respect to the fundamental nature of money.

  7. One further observation, on bonds, interest and yields.

    Several Wall Street banking interests with ties to the Hoover Regime took full advantage of, and probaby caused, a devaluation in War Bonds from the Spanish War and Great War (they hadn’t gotten a running start on the 2nd World War so there wasn’t a “first”)
    The Banks offered a payout of 70 percent of face value of the bonds, which should have been face value plus 15% by that time. The deflated valuation was “toilet paper” and the bonds couldn’t yet be cashed anyway..

    Many people, including and especially the Doughboys who had been paid half their salary in Bonds, fearing the inevitable loss of every penny such as had already happened to the German Mark, held their collective nose and took the stinking deal. The banks then negotiated with the Treasury to sell back the bonds at face value plus 10%, supposedly a gain for the treasury. Win for the bank, win for the Treasury, huge freakin’ loss for a cash-strapped American public.

    King Charles on steroids.

    A comparison to what’s happening now? The bonds floated by Reagan, Bush, Clinton and Bush Jr to finance their military spending “without raising taxes” the 10% per annum interest rate now making the “War on Terror” bonds twice their face value, the $5 trillion estimated as the base cost of the war is actually 10 Terabucks just from the interest, the Vets are being screwed, American civilians are being turned out of their jobs, and their homes, “squatters” being violently evicted…

    Just like the start of the Great Depression, just like the Bonus Army, American soldiers firing on American (veterans0 soldiers, in a movement that shadowed Occupy 8 decades before Occupy began, the suddenly migrant American farm workers who had been farm owners having their “squatter” settlements brutally attacked, repeatedly…

    And the banks buying credit debt, bundling it and selling it the same way they did Mortgages 6, 5, and 4 years ago. With the bailout money they got when they crashed the economy 5 years ago using the same techniques they used more than 8 decades ago.

  8. There’s the notion that the banksters deliberately crashed savings and loans because they were far more grass-roots than banks.
    It would have made consolidation harder.

    Neil and Jeb Bush both went into S&Ls and got slapped on the wrist for Conflict of Interests There sure was a lot of wrist-slapping going on with their clown clan.

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