“YOU AIN’T GOT ANY REAL money, ’av yer guv?” asked my taxi driver last week as I offered him a Clydesdale Bank tenner, proudly decorated with a lithograph of one Mary Slessor, not a household name this side of the Wall. I had just flown in from Edinburgh, where even the Alliance & Leicester cash machines dish out Monopoly money, so the answer was no. Grudgingly, he trousered Ms Slessor, grumbling that he would never find anyone else mug enough to take it. Wait for a Scottish accent, I helpfully suggested, or maybe an Australian, as Clydesdale belongs to the National Australia Bank Group.

Scottish banknotes are among the more exotic flora of the monetary landscape in England. (Not the most exotic — try passing a Manx fiver in your local Slug and Lettuce.) But a new survey of money and credit through history reminds us that there have been thousands of ways of storing value, many of which have proved illusory, and have cost dear those who believed in them. It also demonstrates that modern finance is not so modern as we think: most of the complex instruments that make the City and Wall Street rich today have their roots long in the past.

The most basic test of a financial instrument — confidence in it as a promise to pay — will be met by a Clydesdale tenner. But there are three other principles on which our financial system is based. The first is what theorists call intertemporal value transfer — what you and I call loans — that allow the long and the short to transact with each other. The second we might call contingent claims, in which one side of the contract pays the other depending on the outcome of some event. These include straightforward gambles, futures and options, but also insurance policies, whether life or general.

The third key principle is negotiability, in other words the ability to buy and sell financial contracts after they have been agreed. If I lend you money for five years, but then find I need it back earlier, I can sell the promise to someone else, perhaps at a discount, in return for cash today. Your obligations are thereby transferred, usually without your permission.

These three fundamental principles underlie most of what goes on in financial markets today. The language may sound different, but the underlying economics are the same. The principles seem simple, but they all depend heavily on respect for property rights, and on trust. In many societies these essential underpinnings have been lacking. Where that is so, the financial system remains underdeveloped, with damaging consequences for economic growth and prosperity.

The Chinese play a crucial role in the story. The earliest financial contracts for which we have reliable records date from the Zhou period, beginning around 1000BC. (It is a nice irony that now China has once again assumed a crucial role in global finance, three millennia later, the central bank governor is a Zhou.) The Chinese invented paper money and, even more importantly, what we now term fiat money — notes that have value because the Government says so, rather than because they are backed with explicit quantities of precious metal. Yet, after 400 years of use, the Chinese abandoned paper money in the 15th century, with immensely damaging consequences for their development.

In the early modern period the West took up the cause of financial innovation, most notably the Dutch, whose claim to have invented the joint stock company is the strongest. The Dutch East India Company was the first major limited liability venture. The British followed close behind, and from 1694 the Bank of England played a crucial role in overseeing the London market. Playing host to an increasingly flourishing capital market proved to be a decisive advantage for the Government, not least in allowing it to finance successful wars.

One key characteristic of financial innovation is mobility. There are few durable patents in financial markets. So the tables were quickly turned on the British Empire when the American colonies, with French assistance, resorted to imaginative debt issues to finance their War of Independence. The rebels sold a remarkable range of instruments in an effort to appeal to risk-seeking investors. Some were linked to the price of tobacco, others were essentially lottery tickets, still others were “tontines”, a kind of life insurance where the last survivor scoops the pool. At difficult moments, when the redcoats were on top, American debt traded as low as five cents in the dollar. Later, the new government redeemed it at par, creating confidence in one of the two underpinnings of the US capital market today: the Treasury Bill.

The other, of course, is the New York Stock Exchange, built on the back of the Buttonwood Agreement, a deal struck between the market brokers in 1792 to fix commissions and implement a closed shop. An anti-competitive arrangement of that kind would now be outlawed almost everywhere, outside Cuba and North Korea, but it served the US well for 150 years.

The Origins of Value, written by a star-studded cast of economic historians, rightly emphasises the elements of continuity in financial markets. But we are left with an uncomfortable question. Have financial markets now become detached from the real economy that they are supposed to serve? Can we make sense of the massive escalation in the scale of financial transactions? In the US and the UK, financial assets now total more than 400 per cent of GDP. Across the world they are growing about twice as rapidly as the economy as a whole.

Are we heading for another crash, like the South Sea Bubble, John Law’s Mississippi scheme or Leopold’s Congo adventure, fascinatingly described here, with pretty pictures of defunct bonds decorated with non-existent cities and railway engines? In one sense, we must hope not, but in another we should expect disappointment, and even welcome it. Markets are prone to irrational exuberance, to coin a phrase, and have always been so. They allow optimists to pursue their dreams with funds provided by their more cautious counterparts. Without such a mechanism, we depend on the chance coincidence of enterprise and wealth, and our growth potential is thereby much reduced.

In another context, Gordon Brown often likes to say that the Government has done away with “boom and bust”. In financial markets, he is unlikely to have succeeded, and in the long run we would suffer if he did.

THE ORIGINS OF VALUE
Edited by William N. Goetzman and K. Geert Rouwenhorst
OUP, £30; 404pp
£27 (free p&p) 0870 1608080
www.timesonline.co.uk/booksfirst

Explore Books

• Book Extracts

• Book Reviews

• Books Group

• Audio Books

Times Recommends

• The 100 Best Books of the Decade
• The Times picks the 50 best paperbacks of 2009
• The conversation: James Ellroy