How A Criminal Invented Modern Money, Central Banking and Inflation

He was a broken and desperate man, at the end. Johan Palmstruch, a Latvian-born, Dutch raised Swedish banker defended himself against persecution. A nation wanted to know where its money had gone and the best answer Johan could muster was to describe the chaos of the final days of the world’s first Central Bank. The days when depositors and government lined up outside the bank’s doors scolding, threatening and swearing and himself in fear for his life or a limb. The investigation into Johan Palmstruch discovered thousands of daler (currency) missing in its vault and thus a huge cost to the Swedish Crown. Palmstruch was ordered to pay and when he failed he was executed, this was 1668 after all and not 2020.

It all started in Seventeenth-Century Sweden, then one of the world’s superpowers stretching present-day Germany, Poland, and Russia. With its agriculture unproductive, it relied on fishing and copper mining. But for a country to truly thrive, there must be a medium of exchange, something more flexible than barter. 

In 1534, Sweden printed its first daler. The similarity in pronunciation with present-day US dollar is no coincidence. It was made of copper metal. The Swedes were having a hard time distributing the daler, they needed an institution to store, lend, and distribute. They named this idea bank, a corruption of the Italian word banco, however, they did not know how to actualize this and lost 3 decades in this dilemma. This was until the arrival of a little known stranger.

Swedish Daler Photo
The old Swedish Daler was made of copper and was quite heavy and inconvenient.

Hans Witecker was born in 1611 in Riga, Latvia. He was the son of a successful Dutch Merchant. As a young man, he worked in the financial system of Amsterdam. At 28, he was jailed for not paying debts. Once released, he made his way to Stockholm to re-invent himself even taking up the name Johan Palmstruch.

A smooth talker with charm and charisma, he quickly endeared himself with the wealthy and powerful. So much that the King entrusted the middle-aged foreigner with Swedens Banking System. In 1656, by  Royal Decree, King Karl chartered Stockholm Banco to be run by Palmstruch. Palmstruch quickly covered his political bases giving half of the shares to the King and apportioning several nobles vast shares.

Palmstruch was a master of financial innovation, he knew the disadvantages of copper as official currency. Copper weighed so heavy and was so unstable. War in Germany or England could reduce the value of the currency leading to economic collapse. The first invention of Palmstruch was to store giant plates in Stockholm Bancos Vault while offering paper notes as a receipt. 

This move was hailed by the King and a large inflow of deposits into the bank and after three years it was worth present-day $76 million. He soon started to lend money in return for collateral the nobles, in particular, taking out big loans. The system worked well and commerce flourished for a while until the King died and was replaced by a council who decided to devalue the dealer.

As a result, people stormed the Bank to withdraw their money. He tried to call in on loans but it failed. Loans to the nobles were almost non-performing ab initio, their power could waive a debt at their convenience. As a result, Palmstruch failed to pay the people who lined up at his bank and even his home regardless of whether it was working hours or not.

The sheer distress of the moment forced Palmstruch into an innovation that changed finance forever. He had seen that he could not have enough money to pay his depositors but he could always print receipts. He told people that the receipts could be used to trade. These receipt notes weren’t tied to a specific deposit but could be traded freely from person to person. The government went along with the plan agreeing that banknotes could be used to pay tax bills. Modern money, not backed by precious metal, but the credibility of a bank and its leader, Palmstruch had arrived.

First bank notes financial history economic Misfit
A sample of the notes made by Palmstruch’s Stockholm Banco. This was a genius idea that would influence money for many centuries.

In the 1660s, paper money went so wildly popular that Palmstruch could not print fast enough. Before long, the bank was down to 4,000 copper dealers, and a depositor wanted 10,000. Rumors started to spread that the bank was paying depositors slowly and irregularly sometimes closing its doors. With the bank behaving like there was something to hide, confidence flew out the window, and in no time the value of the money followed. Money that had been too readily available was now tough to get, and the first-ever recession followed.

By 1667, the Swedish Government had taken over Stockholm Banco and Palmstruch had lost his privilege of running a bank. Sweden thereafter came up with the Swedish Riksbank as a replacement controlled by the government, which remains the central bank of Sweden to this day.

Swedish Riksbank Economic Misfit
Present Day Swedish Riksbank

In other words, in a few years, Sweden had experienced both the best and the worst of central banking. But Johan Palmstruch and everyone in Stockholm Banco had done something more. They had begun the modern era of global finance, and all that is great and awful that would emerge from it.

For centuries, across Europe and the Islamic world, mankind had sought ways to turn mundane materials into far more precious gold and silver. it turns out;  humanity didn’t need magic to create gold from thin air. As Palmstruch had proved, all it took to create gold was some paper, a printing press, and a central bank, imbued with power from the state.

 

Source: Neil Irwin, The Alchemists, Inside the Secret World of Central Bankers.

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