The "first experiment with derivative financial instruments":
Theory of Games and Economic Misbehavior, by George Dyson, Edge: ...There are numerous precedents for [the derivatives now haunting us].
As early as the twelfth century it was realized that money ... can be made to exist in more than one place at a single time. An early embodiment of this principle, preceding the Bank of England by more than five hundred years, were Exchequer tallies — notched wooden sticks issued as receipts for money deposited with the Exchequer for the use of the king. "As a financial instrument and evidence it was at once adaptable, light in weight and small in size, easy to understand and practically incapable of fraud," wrote Hilary Jenkinson in 1911. ...
A precise description was given by Alfred Smee... "The tally-sticks were made of hazel, willow, or alder wood, differing in length according to the sum required to be expressed upon them. They were roughly squared, and one end was pointed; and on two sides of that extremity, the proper notches, showing the sum for which the tally was a receipt, were cut across the wood." 11
On the other two sides of the tally were written, in ink and in duplicate, the name of the party paying the money, the account for which it was paid, and the date of payment. The tally was then split in two, with each half retaining the notched information as well as one copy of the inscription. "One piece was then given to the party who had paid the money, for which it was a sufficient discharge," Smee continues, "and the other was preserved in the Exchequer. Rude and simple as was this very ancient method of keeping accounts, it appears to have been completely effectual in preventing both fraud and forgery for a space of seven hundred years. No two sticks could be found so exactly similar ... when split in the coarse manner of cutting tallies; and certainly no alteration of the ... notches and inscription could remain undiscovered when the two parts were again brought together. ..." 12
Exchequer tallies were ordered replaced in 1782 by an "indented cheque receipt," but the Act of Parliament (23 Geo. 3, c. 82) thereby abolishing "several useless, expensive and unnecessary offices" was to take effect only on the death of the incumbent who, being "vigorous," continued to cut tallies until 1826. "After the further statute of 4 and 5 William IV the destruction of the official collection of old tallies was ordered," noted Hilary Jenkinson. "The imprudent zeal with which this order was carried out caused the fire which destroyed the Houses of Parliament in 1834." 13
The notches were of various sizes and shapes corresponding to the tallied amount: a 1.5-inch notch for £1000, a 1-inch notch for £100, a half-inch notch for £20, with smaller notches indicating pounds, shillings, and pence, down to a halfpenny, indicated by a pierced dot. The code was similar to bar-coding... And the self-authentication achieved by distributing the information across two halves of a unique piece of wood is analogous to the way large numbers, split into two prime factors, are used to authenticate digital financial instruments today. Money was being duplicated: the King gathered real gold and silver into the treasury through the Exchequer, yet the tally given in return allowed the holder to enter into trade, manufacturing, or other ventures, producing real wealth with nothing more than a wooden stick.
Until the Restoration tallies did not bear interest, but in 1660, on the accession of Charles II, interest-bearing tallies were introduced. They were accompanied by written orders of loan which, being made assignable by endorsement, became the first negotiable interest-bearing securities in the English-speaking world. Under pressure of spiraling government expenditures the order of loan was soon joined by an instrument called an order of the Exchequer, drawn not against actual holdings but against future revenue and sold at a discount to the private goldsmith bankers whose hard currency was needed to prop things up. In January 1672, unable to meet its obligations, Charles II declared a stop on the Exchequer. At the expense of the private bankers, this first experiment with derivative financial instruments came to an end. ...
Posted by Mark Thoma on Wednesday, July 29, 2009 at 12:51 AM in Economics, Financial System |
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